The Benefits of Using an Investment Policy Statement

An investment policy statement is a written agreement between a portfolio manager and a client, outlining the client’s expectations and how the advisor intends to fulfill those expectations. It formalizes the investment goals of the client, solidifying and defining a plan before the fiduciary relationship begins. An investment policy statement is typically drafted after the portfolio manager has met with the client and established their investment objectives, liquidity requirements, and risk tolerance. It displays all of the information that the advisor has gathered about their client (time horizon, risk parameters, potential asset allocation, etc.) in writing so that an investment plan can be formally agreed upon.

Investment policy statements are essential to the success of a financial plan because they serve as a roadmap for decisions regarding the client’s portfolio. By creating an investment policy statement, both the portfolio manager and the client have agreed to a predetermined investment allocation and rebalancing schedule. This helps advisors to keep their clients focused on their long-term investment objectives and to convince them not to drastically change their portfolio in response to market changes. This is why, rather than being a potential compliance issue, an investment policy can serve as evidence that the advisor has invested the client’s assets according to an agreed upon plan.

The Anatomy of an Investment Policy Statement

  • Client’s Information
    • Investment Objectives
    • Liquidity Requirements
    • Risk Tolerance
    • Time Horizon
    • Investment Preferences
    • Account Information
  • Asset Allocation
    • Client’s Risk/Return Profile
    • Client’s Current Asset Allocation
    • Breakdown of Asset Allocation Targets
    • Breakdown of Diversity within Asset Classes
  • Mechanics and Procedures
    • Amount Accumulated
    • Amount in each Account
    • Guidelines for Investment Options
  • Rebalancing Information
    • Rebalancing Frequency
    • Rebalancing Procedure

Building a High-Quality Investment Policy Statement

In order for an investment policy statement to be useful, the client’s investment objectives and the procedures intending to achieve those objectives must be laid out in a manner that is both thorough and concise. It should include a comprehensive description of the procedures used to manage client investments, as well as a detailed overview of the rebalancing policies. The asset allocation and diversification techniques being used should also be clearly laid out within the investment policy statement so that the client is able to reference why those asset classes have been selected and how they’re being diversified. It should also include a complete description of the rights of the client and the responsibilities of the portfolio manager, including how and how often the returns of the portfolio will be communicated to the client.

A high-quality investment policy statement includes not only objective procedures, but also a brief explanation of the philosophy that’s governing the investment policy. If the portfolio advisor is implementing tenets of Modern Portfolio Theory, for example, it’s helpful to include such information in the investment policy statement so that the client can have a better understanding of why their investments are being allocated the way that they are. In this way, the investment policy statement emphasizes education and communication as well as the methodology to achieve great returns. To ensure that an investment policy statement remains relevant for the client, it is important to periodically review and update it as the client’s financial circumstances change.