When visiting a new destination, it helps to map out the directions. Once you arrive, it's a good time to make an activity plan. If you’re going to a state park for a hike, you'll want to determine how to get there and which trail to follow at the park.

Similar to an expedition, an Investment Policy Statement (IPS) is a guide to your financial future.

What Is an Investment Policy Statement (IPS)?

An IPS is the map, activity schedule and outcome document between a financial advisor and client. The first section of the statement includes the client’s broad investing goals and objectives. The next component discusses the path that the advisor, in collaboration with the client, follows to reach a set of goals.

The details include topics such as asset allocation, risk tolerance, and financial goals.

An Example of an IPS

Take a look at the following fictitious example of an Investment Policy Statement.

Investor First Advisory, LLC Investment Policy Statement for Juan Martinez

Executive Summary:

Juan Martinez, Individual Investor, age 55

Portfolio: Individual, Taxable

State: California

Tax ID: xxx-xx-xxxx

Current Assets: $500,000

Return Goal: 6%

One year loss limit (worst case scenario): 15-18%

Objectives:

  • Long-term growth and capital preservation
  • Risk profile: Conservative
  • Time horizon: Greater than 5 years
  • Short-term liquidity needs: None
  • Long-term rate of return expectation: 6% (based upon historical rates of return)

Financial Advisor Duties and Responsibilities:

  • Fiduciary, non-biased third-party charged with helping clients meet long-term financial goals.
  • Confer with client to create asset allocation.
  • Select assets in accordance with asset allocation providing sufficient diversification of risk and returns.
  • Control and report all investment costs.
  • Monitor all investment options and portfolio custodian. (Custodian is responsible for safekeeping of client’s assets)
  • Value all portfolio holdings on a regular basis.
  • Provide monthly reports that include securities, cash flow, income, and the monthly change in value.

Portfolio Selection Guidelines:

In general, long term investment performance is determined by asset performance. Historically, stock assets offer higher rates of return along with greater volatility. Fixed assets generally yield lower rates of return, lower correlation with equities and less risk. Diversification across asset geography and size is recommended.

Based on the client’s conservative risk profile, the portfolio asset allocation will be 60% stock assets and 40% fixed.

The individual composition of holdings will be selected from index funds and exchange-traded funds from the following asset classes:

Equity

  • U.S.
  • High-Dividend
  • Value
  • Small Cap
  • International, including developed and developing markets

Fixed

Rebalancing of Asset Allocation:

According to data from Vanguard, there is no universally agreed upon asset allocation. Neither is there data to recommend rebalancing more frequently than annually. Thus, the portfolio will be rebalanced annually, while attempting to minimize the tax consequences of asset sales.

Performance Monitoring:

Each index mutual fund or exchange-traded funds’ returns will be compared with their related benchmark. Any deviation from that benchmark will be evaluated and discussed annually. The holdings will also be compared with peer group funds. 

The parameters for selling a fund due to poor performance include one year of greater than 1% deviation from the benchmark and/or falling in the bottom half of the cohort fund group.

Costs will be monitored annually to ensure that total costs do not surpass 1% of all investable assets.

Annually, at a minimum, the overall portfolio will be monitored to consider whether initial goals are in place or have changed. Performance and fees will also be included in this conference. Together, Mr. Martinez and the advisor will determine the future portfolio direction.

The Bottom Line

An investment policy statement is personal and individualized for the circumstances of the advisor’s client. The previous example is one type of IPS. Each financial advisory firm will have a version of their own statement.

Finally, large investment brokerage companies also have investment policy statements for their individual mutual funds and/or client groups. The investment policy statement keeps both the client and advisor on the same investing page and holds the advisor accountable to a certain standard.