What Is an Investment Policy Statement (IPS)?

An investment policy statement (IPS) is a document drafted between a portfolio manager and a client that outlines general rules for the manager. This statement provides the general investment goals and objectives of a client and describes the strategies that the manager should employ to meet these objectives. Specific information on matters such as asset allocation, risk tolerance, and liquidity requirements are included in an investment policy statement.

It's standard practice for portfolio managers to have an IPS in place for their institutional clients such as retirement plan sponsors and mutual funds. Many financial advisors will also draft one for their individual clients as well.

  • An investment policy statement (IPS) is a formal document drafted between a portfolio manager or financial advisor and a client that outlines general rules for the manager.
  • This statement provides the general investment goals and objectives of a client and describes the strategies that the manager should employ to meet these objectives.
  • Specific information on matters such as asset allocation, risk tolerance, and liquidity requirements are included in an investment policy statement.
  • A well-conceived IPS enables both the manager and the investor to stay focused on the long-term objectives,


Understanding the Investment Policy Statement (IPS)

Investment policy statements are frequently, though not always, used by investment advisors and financial advisors to document an investment plan with a client. It provides guidance for informed decision-making and serves as both a roadmap to successful investing and a bulwark against potential mistakes or misdeeds.

An IPS lists the investor’s investment objectives, along with his time horizon. For example, an individual may have an IPS stating that by the time they are 60 years old, they want to have the option to retire, and their portfolio will annually return $65,000 in today's dollars given a certain rate of inflation.

A well-conceived IPS also delineates asset allocation targets as well. For instance, it specifies the target allocation between stocks and bonds, further breaking down the target allocation into sub-asset classes, such as global securities by region. The targets should then have a minimum and maximum deviation that, when exceeded, will trigger portfolio rebalancing.

An IPS should give special attention to describing the investor's risk/return profile. That includes naming asset classes that should be avoided—as well as those that are preferred.  

Special Considerations

In addition to specifying the investor's goals, priorities, and investment preferences, a well-conceived IPS establishes a systematic review process that enables the investor to stay focused on the long-term objectives, even if the market gyrates wildly in the short term. It should contain all current account information, current allocation, how much has been accumulated, and how much is currently being invested in various accounts.

The IPS should include monitoring and control procedures to be followed by everyone involved in the investment process. This includes establishing the frequency of monitoring, specifying benchmarks for comparison of portfolio returns, and concrete procedures for making any future changes to the IPS. Serious investors think through the possible reasons for changing their IPS, such as financial or lifestyle changes. More important, they specify the reasons not to change their IPS (i.e., short-term market performance).

Finally, a comprehensive IPS contains actionable provisions that are intended to be followed can help advisors "talk down" clients who want to drastically (and potentially harmfully) change direction with their portfolio when markets start to falter. 

Example of an Investment Policy Statement

Napa Valley Wealth Management, an investment advisory firm located in Walnut Creek and Saint Helena, Calif., prepares investment policy statements for individual clients that might run about a dozen pages. "Your IPS helps ensure we’re both on the same page, and it serves as a roadmap for ongoing investment decisions about your portfolio," the document's introduction reads.

A Napa Valley IPS then summarizes the client's investment policy in a table:

STATEMENT OF YOUR FINANCIAL OBJECTIVES
     SEE PAGE
PORTFOLIO DESCRIPTION Together, we selected Sample Portfolio B/Balanced Income as the most appropriate investment portfolio for you now. 6
PORTFOLIO RATE OF RETURN This portfolio recommendation is designed to generate an average, expected rate of return of 2.5-3.5% above inflation, net of fees and costs. Based on current projections, this equates to a current nominal return of 5.5-6.5%.
YOUR CASH REQUIREMENTS Currently you are not taking a monthly distribution.
INVESTMENT PERIOD Your investment period is over 10+ years 2
YOUR RISK TOLERANCE Your risk tolerance is a maximum, aggregate loss of 5% over a one-year time frame. 3
PORTFOLIO TAX STRATEGIES Your portfolio is to be managed as a taxable & tax deferred account, and your combined federal and state tax bracket is to be the marginal tax bracket of 32%.  3
     
Source: Napa Valley Wealth Management

The Bottom Line

An investment policy statement essentially acts as a business plan for your portfolio. Developing a solid IPS is not a typical exercise for most investors. It requires a lot of thought. It also requires an understanding of how the market works as well as familiarity with investment principles and practices.