Note to Advisers and Clients: Put Your Investment Plan in Writing

Pop quiz for financial advisers: do you help your clients write an Investment Policy Statement (IPS)?

And, for investors: do you insist on drawing up an IPS with input from your adviser?

If not, why not?

Whether you are a financial adviser or an individual investor, an IPS is the cornerstone of any investment process.

I was reminded of this while flipping through a press copy of Charlotte B. Beyer’s forthcoming book, Wealth Management Unwrapped. As Beyer points out, when it comes to working with an adviser, “Everything begins with an Investment Policy Statement.”

The IPS has been around in the institutional investment world for quite some time. Foundations and endowments routinely use them to guide investment decisions. As Morningstar put it, an IPS “forces you to put your investment strategy in writing and commit to a disciplined investment plan. It’s both a blueprint and a report card.”

But it’s not just a document for institutional investors. Increasingly, individual investors and financial advisers are using them, too.

What Is an IPS?

Paul Sullivan, who writes the Wealth Matters column for the New York Times, says that an IPS “is to a financial plan what a Range Rover is to a minivan. Both will carry your children safely, but only the Range Rover will power up a gravelly mountain. Of course, most people who own a Range Rover are traveling the same, well-paved suburban streets as the minivan driver, making all that engineering a bit of overkill. To some, the same argument can be made for an IPS. It’s just too much. But the people I spoke with who had one talked about a difference in their investment performance and their state of mind.”

The key here is “state of mind.” When markets are rallying, few investors need to refer to their IPS to keep them on track. But when markets are crashing, as they did in 2008, panic and fear quickly override investment decisions made when calmer minds prevailed.

When asked, “What’s the most important lesson for investors from the 2008 market meltdown?” Manisha Thakor, CFA, founder and CEO of MoneyZen Wealth Management, had a great answer:

“For over a decade I had the honor of working for one of our nation’s great long-term investors, Fayez Sarofim,” she wrote in a Wall Street Journal online forum. “One of the many lessons he taught me is, ‘Nervous energy is a great destroyer of wealth.’ I can’t think of a better take-away for investors from the 2008 market meltdown. In retrospect it is clear that investors who had a written investment policy statement (‘IPS’) fared much better (yes, IPS’ are not just for institutions — I establish one for each of my individual clients).”

The upshot? Put it in writing.

What Should Be in an IPS?

Sullivan explains that “in its structure, an IPS is fairly simple. Investors sit down with their advisers and assess their return objectives and comfort with risk. Then the adviser designs the portfolio with that in mind. Where an IPS goes further than a financial plan is that it sets a target allocation for each type of security — say, stocks — and adds an upper and a lower range for the percentage of the portfolio that can be in that security.”

In her book, Beyer, a Wall Street veteran who founded the Institute for Private Investors (IPI), says that, at a minimum, an IPS should include:

• The purpose of your money: what is this portfolio supposed to provide for?
• The target return and target level of risk along with the measure of risk, time period, and benchmarks that will be used.
• The allocation that will get you where you wish to go, both in terms of return and risk.
• When you will rebalance or reset the allocation.
• Permissible investments and investments that are not allowed, e.g. no options.

It’s important, she notes, to be concrete in your expectations. Here are some things Beyer says you should consider:

• Decide which reports are most valuable to you and your style of learning.
• Do you want to be called weekly? Monthly? Never?
• When do you wish to meet face-to-face? Quarterly? Is Skype preferred?
• Do you prefer a one-page executive summary backed up by an appendix?
• Do you wish to receive paper or online reports?
• Determine what benchmarks you will use and over what time periods for the entire portfolio — and each fund manager.
• Decide on metrics for individual managers or funds, such as style drift or style in favor/out of favor.
• Set up a way to monitor risk using user-friendly charts.

Remember: “Nervous energy is a great destroyer of wealth.” And: An IPS is only as useful as the information it contains. If you want to establish a measure of discipline and structure around your investment strategy, it’s important to spell it all out in the document.

If you’d like to learn more about crafting an IPS with the help of your financial adviser, see Elements of an Investment Policy Statement for Individual Investors, a free resource from CFA Institute.

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Please note that the content of this site should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute.

Photo credit: ©iStockphoto.com/jamesbin