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Investment policy statements can serve as a guide for you and your advisor.

Entrepreneurs don’t start a business without a plan and contractors don’t start a house without blueprints. Given the important role your wealth plays in your life, as an investor, you require your own strategy or blueprints to guide your way forward. An investment policy statement may fit the bill.

Typically a tool used by institutions managing significant assets, an investment policy statement (IPS) defines and documents your investment goals and tolerance for risk. It can help guide your relationship with your financial advisor, acting as a foundation and benchmark as you work together to pursue your financial objectives.

Finding clarity

We often think of our financial goals as relatively straightforward. But in reality, once we consider market turbulence or our environment of increasingly complex investments, it’s rarely a simple matter.

Completing a risk assessment when crafting your IPS will help clarify both your comfort with risk and your portfolio’s ability to weather that risk. For example, a 10% drop in the market may sound manageable, but if that means your $250,000 portfolio drops by $25,000, will you still be comfortable? Would you be tempted to make impulse decisions, or would you trust in the long-term plan you’d previously laid out? These are the moments in which an up-to-date IPS can serve as a valuable guidepost.

The discussions you’ll have when developing your IPS can also help clarify the personal motivations behind your financial goals, including the aspirations you have for your family, career or enduring legacy. Defining those, in turn, will help your financial advisor ensure your portfolio continues to support your long-term vision for the future.

Your financial touchstone

When markets fall, seeing the immediate decline in your assets will be more distressing than discussing such an event hypothetically. But this is when an IPS can serve as a grounding tool – which is exactly how they’re used by institutions tasked with the management of significant assets. An IPS helps to keep them from straying from their mandate while pursuing their objectives.

Going through the measured and thoughtful practice of creating an IPS can help you stay confident and focused on your long-term goals, even during times of market uncertainty. And that’s exactly what a thoughtful plan and trusted financial advisor are for – in fact, a recent Dalbar study found that about nine out of 10 investors reported increased confidence and trust in their advisor as a result of the volatility-laden pandemic.

Common ground for you and your advisor

As your life evolves, an IPS will serve as a benchmark for both you and your advisor, ensuring neither of you loses sight of the future you’ve long been working for. An IPS will also give you an opportunity to define the roles and responsibilities you and your financial advisor each hold, as well as the roles of other professionals such as accountants and portfolio managers. If you and your financial advisor do part ways, say after a move or retirement, having a document with your goals and expectations already laid out can help smooth the transition.  

A living document

Your IPS should evolve as your life does and will likely need adjustment as your family expands, business grows or you make significant purchases. You’ll want to review the document regularly with your advisor to ensure it continues to reflect your goals.

The architecture of an IPS

Make sure to cover these key elements when drafting your IPS.

Investment objectives and constraints

What do you hope to accomplish by investing? What’s your risk tolerance? This section also will detail your time horizon, contribution and withdrawal needs, tax considerations and target return goals.

You’ll also share your personal motivations behind your financial objectives. Do you have strong preferences for sustainable companies or companies whose values mirror your own?

Outline what you want your wealth to do – fund an active retirement; help you pursue a philanthropic legacy; or further education for your loved ones – and who you want to benefit as your money grows. Be sure to update this section as your goals change or evolve.

Portfolio allocation

Based on your risk tolerance, return objectives and any other constraints, your advisor will help determine the appropriate mix of assets that aligns with your overall investment philosophy. Here, you’ll lay out your portfolio preferences including how you’d like your assets allocated among various investments with different risk/reward profiles. These details should change as your tolerance for risk does, particularly when nearing or entering retirement.

Roles and responsibilities

How hands-on would you like to be? Clarify what you are responsible for and what your financial advisor is responsible for. Having this in writing can help manage expectations moving forward.

Rules for rebalancing

Together with your advisor, determine how often you’d like to review your portfolio and rebalance it to stay close to your ideal asset allocation model. This will include whether you’d like your dividends reinvested or disbursed to you as cash.

What not to do

We’ve covered the do’s. When it comes to your IPS, make sure you don’t:

• Underestimate time horizons. For investments, these can extend much longer than most might think, even past your retirement or passing.
• Generalize your goals. Get specific. Are you hoping to buy a cabin in Colorado with room for grandkids, or spend a certain amount each year on travel?
• Use jargon or vague language. Avoid wording that is either too restrictive, too broad or could be misinterpreted later.
• Abandon an IPS that needs fixing. Instead of scrapping it all together, work with your advisor to determine where adjustments make sense.
• Set it and forget it. Your IPS should be a flexible, living document. When your life changes significantly, talk to your advisor to see if updates to your IPS are needed, too.

Given its role in your life, your wealth is far too important to gloss over. Going through the practice of creating and updating an IPS will ensure you’ve considered each element of your investment strategy – all while helping your financial advisor to maintain a thorough understanding of your priorities and goals.

Investing involves risk, and you may incur a profit or loss regardless of strategy selected. Past performance may not be indicative of future results. The performance noted does not include fees or charges, which would reduce an investor’s returns. Diversification and asset allocation do not ensure a profit or protect against a loss. The process of rebalancing your portfolio may result in tax consequences.

Sources: The Globe and Mail; Investopedia; USA Today; Wilshire Advisor Solutions; Dalbar