Investment Policy Statements: What It Is and How To Write One

When you engage with a financial advisor, you are beginning the journey toward financial independence. Your advisor can provide effective investment counsel to help you prioritize a variety of financial matters and concerns, along with addressing the bottom line of your investments performance. For this purpose, a financial advisor prepares an investment strategy aligned with your overall financial plan, short-term and long-term objectives, risk appetite, and investment preferences. However, it can be difficult for the professional to accommodate all these factors in an investment strategy unless you document it and specify all parameters in detail.

One smart way to help guide your financial advisor is by creating an investment policy statement (IPS). The IPS functions as a strategic guide to the planning and implementation of an investment program. If crafted and implemented properly, the IPS can help you and your financial advisor appropriately plan your asset allocation, monitor the results, govern the investment portfolio, manage investment risks, and ultimately achieve the set targets for growth. The IPS can also be used to establish accountability of the financial advisor. Most importantly, an IPS serves as a guiding document for a financial advisor directing the professional on the objective course of action to be followed in the case of market disruption, especially when your emotions and instincts might lead you toward less prudent actions. An IPS is a customized document uniquely tailored as per your preferences, goals, attitude, and financial situation. It explicitly lists down factors that are highly relevant to your investment concerns. When you are writing an investment policy statement, you should ensure that the document is comprehensive, enabling your financial advisor to thoroughly understand your objectives, restrictions, tolerances, and preferences.

Here is everything you need to know about an IPS and how to write one:

What is an Investment Policy Statemnt?

As per the investment policy statement definition, an IPS is a document between you and your financial advisor that outlines the general investment rules for your advisor. The IPS contains your investment goals and objectives and lays down the strategies that the financial advisor should employ to meet these objectives. The individual investment policy statement also includes details about your asset allocation, risk tolerance, and liquidity requirements. Overall, the IPS acts as a roadmap for your financial advisor, offering precise guidance for the investments they make on your behalf.

A well-written IPS enables you and your advisor to stay focused on the short-term and long-term objectives.

Why do you need to create an Investment Policy Statement?

There are several benefits of creating an investment policy statement. Comprehensive investment plans can deliver better performance. Investment decisions based on emotions and instinct often cause a disaster for your investment portfolio. So, the goal of an IPS is to provide a clear road map for you and your financial advisor, guiding you through regular investment decisions as you move forward in your professional association. An individual investment policy statement is a comprehensive guide to your financial future. It helps you and your advisor stay committed to your long-term investment strategy. Without the presence of an IPS, your investment decisions could be focused only on the short-term or chase near-term performance. This approach might generate some short-term success, but ignoring long-term goals can prove to be detrimental to your financial security in the long term.

An IPS functions hand-in-hand with your long-term financial goals. By writing an investment policy statement, you are helping ensure that you and your financial advisor remain focused on achieving the right goals.

What does an individual Investment Policy Statement contain?

As mentioned, an IPS is a customized document created as per your unique investment directives. However, generally, the IPS contains two distinct sections:

• Financial goals and related investment strategy
• Assistance needed for the financial advisor

When you set to define your goals and investment strategy, you should ideally give an all-encompassing view to the financial advisor by listing down these factors:

• Investment objective: The purpose for investing should be mentioned. Whether it is for growing wealth, creating a retirement nest egg, establishing a secondary source of income, minimizing tax, buying a home, sponsoring your child’s education, or any other reason, the IPS should have it all.


• Time horizon: Another key determinant that impacts your investment is your investment period. This means how sooner or later you want to achieve the goals mentioned in the IPS. The investment horizon significantly influences the choice of assets and also impacts the returns of your portfolio. For instance, if you want to buy a home in the next two years, your investment portfolio should comprise more market-linked investment options. Inversely, if you want to buy a home, but not for another ten years, and have a low-risk appetite, investing in debt-based assets might be a preferential choice.


• Risk tolerance: The most critical component of your IPS is your risk appetite. Your risk tolerance typically governs the choice and allocation of assets. For instance, if you are a high-risk investor, you would want your financial advisor to allocate a higher percentage of your assets in equity. Whereas, if you are a risk-averse investor, you would prefer your advisor to take the safe route and allocate your assets in secure options, such as bonds, mutual funds, real estate, etc. You can also define the specific percentage of your asset allocation across bonds, stocks, real estate, mutual funds, cash holdings, etc.


• Investment preferences: Your investment preferences impact the selection and management of your portfolio securities. As an investor, if you prefer a more actively managed portfolio, the financial advisor will make investment decisions accordingly. In a passively managed portfolio, the fund only follows a specific market index. If you have preferences like investing in environment-friendly companies, social impact investing, or some specific sub-asset classes, etc., you can lay down the directives in your IPS. It is good to mention preferences for particular investments, like small-cap or mid-cap equities, precious metals, REITs (real estate investment trusts), target-date funds, etc.

Apart from these factors, other sections or topics you might want to include in the IPS are emergency fund strategy, drawdown strategy, and other considerations.

In the second part of the IPS, you mention the role you expect your financial advisor to play in helping you achieve the above-listed goals. For this purpose, you should be careful to include the following parameters in your IPS:

• Role of the financial advisor: This will include everything you expect your financial advisor to do for your investment goals. Right from understanding your financial goals, investment preferences to selecting the right securities and monitoring the portfolio, your IPS will list the duties and responsibilities of your financial advisor. You can also specify how often and through which medium you expect to receive updates on your investment performance. The IPS can state if you require your financial advisor to suggest recommendations to alter your investment strategies in situations of market disruption or when you fail to achieve your financial objectives.


• Monitor the investments: The IPS will assign the responsibility for monitoring and reporting. It will also mention who is responsible for determining investment policy, executing the transactions, monitoring the results of the decisions, and more. You could also describe the complete process of reviewing, monitoring, and reporting.

You can start simple and eventually update your IPS along with your financial advisor to make it a fully comprehensive document for your investment goals. At a minimum, you should review your IPS every year and see if you need to make any alterations. You should change your IPS when:

• There have been meaningful changes in your investment goals and life stage since the last IPS update.
• You plan to make alterations to your asset allocation or investment preferences in the next 12 months.
• Your current investment portfolio does not match the asset allocation as documented in your IPS.

That said, it is not wise to make changes to an individual investment policy statement concerning the state of the economy or the market volatility. The IPS should ideally only be reconsidered if there has been a change in the financial needs/goals, investment preferences, risk tolerance, or time horizon.

What is the process of writing an Investment Policy Statement?

Creating an investment policy statement is not a difficult task, provided you have a clear understanding of your financial situation and goals, risk preferences, time horizon, and investment preferences. You can follow these steps to write your individual investment policy statement:

1. Talk to your financial advisor: Before you begin writing an investment policy statement, sit down and talk to your financial advisor to check if there are any internal guidelines or a particular format to follow when creating an investment policy statement. You can ask your advisor to walk you through the process. Be open and ask questions about financial terms, concepts, investing strategies, etc., that you do not understand. Assess if their IPS process and format of writing an investment policy statement align with your goals. If yes, you can use their IPS format and make alterations accordingly. If their IPS format does not match your needs, feel free to create your individual investment policy statement.


2. Define your financial goals: The first thing you should mention in your IPS are your financial goals. Your purpose for investing should be defined. Mention your goals along with a timeline for achieving them. Your goal could be to create a retirement corpus, grow your wealth, sponsor the higher education of your child, buy a home, buy real estate, etc. Each goal that you list should have a timeline. Your goals can be short-term or long-term. For instance, buying a house can be your short-term goal, whereas creating a retirement fund can be your long-term objective. Once you know your goals and their timelines, you must list them in the order of their priorities. Consider this investment policy statement example – the IPS specifies that you want to create a portfolio that generates dividends, interest, and rental income of $10,000 per month before tax until you turn 65. Post the age of 65, you plan to retire and use the corpus created along with Social Security benefits as your income during retirement.


3. Specify your risk tolerance: When creating an investment policy statement be clear about your risk tolerance. Risk appetite is unique for every investor and also changes over time. In the IPS, be sure to mention your general investment philosophy and the level of risk exposure your investment portfolio should have. Depending on your risk tolerance, your returns can be positive or negative over time. Typically, define the investment risk in terms of liquidity, legal, political, longevity, mortality, and business risk. To make the IPS holistic, you can include thresholds that define absolute loss. You can additionally list strategies to minimize the risk of further loss to avoid complete loss of investment. Consider this investment policy statement example - you do not want to achieve high returns in a short period. You prefer the security of principal and moderate returns that give you the peace of mind that your money is safe. This philosophy tells your advisor that you have a low-risk tolerance.


4. Set asset allocation limits: Your individual investment policy statement should also define the allocation limit for different assets in your investment portfolio. You can specify the specific percentage for each asset class, such as equity, debt, and balanced funds in your portfolio. For instance, if you prefer to invest heavily in equity, you can allocate 80% of your assets in equity and 20% in bonds or other securities. You can also define if the asset allocation percentage should change specific to some conditions. Do mention if you prefer investing in real estate or REITs. As an average investor, you should keep 30-50% of your holdings in high-quality, blue-chip stocks that pay high dividends, along with 10% in cash and cash holdings and some percentage in real estate assets or other securities.


5. Explain your investing preferences and strategy: After defining each of the above parameters, specify any investing preferences. For instance, if you want to invest in environment-friendly companies or opt for large-cap shares, etc. Define your investment strategy and your portfolio management - active or passive. Moreover, mention how aggressive or passive your investment strategy should be and any requirements for liquidity, emergency corpus, and related issues like a drawdown strategy. It is also good to disclose all your existing investments, such as your retirement accounts, cash reserves, real estate, etc. This will help the advisor know your future investment needs, investment preferences, current net worth, etc.


6. Establish the rules of portfolio management: In this step, set the metrics that will help them monitor your investment portfolio in terms of risk and rewards. Define the assessment process to make meaningful comparisons over time and if there are any performance benchmarks or metrics/frameworks to be considered. Some deviations that can help you analyze performance and risk include standard deviation, Sharpe ratio, R squared, beta, etc. Write about how diversified your portfolio should be and the timeline for asset rebalancing. Be sure to mention the timing along with fixing an acceptable range for asset deviation. In some of the cases, you can also highlight the maximum level of cost for your portfolio.


7. Define the role and responsibilities of the advisor: The last section of your IPS is where you clearly describe what you want your financial advisor to do for your portfolio. You can ask your advisor to identify securities, conduct risk assessment, execute the transaction, monitor the assets, balance the portfolio, manage the investment basket, etc. You can also mention the degree of control and flexibility the advisor has over the investment decisions. Be open about any dos and don’ts when managing your portfolio. Also, state if you need annual, monthly, or quarterly reports, as well as your preferred mode and frequency of communication.

After creating an investment policy statement, sign and date the document to make yourself and your advisor accountable. Revisit the IPS periodically to check if you are still on track.

To summarize

The IPS is like a business plan for your portfolio. This critical document helps you ensure that you stay on track with your financial plan and achieve your goals. You can create your IPS yourself or consult a professional financial advisor and design a comprehensive IPS together.