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Why an Investment Policy Statement is Essential

4 Steps Advisors Should Take To Strengthen Compliance

Warren Buffett has been accused of “investing like a girl,” a charge to which he has proudly professed his guilt. The world’s most successful investor is patient and exercises self-control, muted confidence, and discipline because he strictly adheres to his investment policy statement. This enables him to remain cool and calm while the market panics. And, the fact that he never deviates from his strategy is the primary reason why he avoids typical and costly investor mistakes. Many investors would benefit from having an investment policy statement (IPS), to serve as an investing guidepost for them as well as their financial advisor.

Yet, according to a survey of advisors from Russell Investments, more than 60% of advisors do not bother to create an IPS for their clients. It’s not surprising then that 60% reported being hounded by their clients to take actions that strayed from the investment strategy they agreed upon. Considering that most advisors find themselves having to confront clients who want to break from their strategy at the first sign of trouble, it’s puzzling that they don’t make an IPS the cornerstone of their advisory relationship.

Breaking Down the Investment Policy Statement

The purpose of an IPS is to document an investment strategy to use as a guide for consistent and informed decision-making. It serves as a roadmap for achieving an investor’s investment objectives. But, more importantly, it can also keep investors from making costly mistakes in reaction to short-term events, reminding them to stay focused on their long-term objectives.

In addition to specifying goals, priorities, risk tolerance, and investment preferences, a well-conceived IPS contains guidelines for asset allocation targets, including the target allocation for main asset classes (i.e. stocks and bonds) and for sub-asset classes (i.e. global stocks by region). It should also include minimum and maximum deviations that trigger portfolio rebalancing when exceeded.

An IPS also establishes monitoring and control procedures to be followed by advisors and clients, including frequency and benchmark tracking. More importantly, it includes the possible reasons for adjusting or altering the IPS based on the client’s changing circumstances as well as changing market and macroeconomic conditions. It also includes the reasons not to change the IPS (i.e. short-term market fluctuations). Finally, the IPS establishes a systematic review process that enables advisors and their clients to stay focused on the long-term objectives, even as the market gyrates wildly in the short term.

Advisors Have Much to Gain with an IPS

Considering the time and effort required to develop a sound investment strategy for clients, it only makes sense to commit it to writing and gain the commitment of clients to a true partnership.

Not to mention the wasted time and effort involved in confronting clients who fret at every turn in the market. Whenever clients want to call an audible on their strategy based on a market event or something they heard in the media, advisors can use the IPS to reinforce the virtues of patience and discipline.

As new rules and regulations continue to muddy the fiduciary waters, making it more difficult for advisors to distinguish themselves as true fiduciaries, an IPS can provide that distinction. Adherence to a fiduciary standard is grounded in the process and an IPS is clear evidence that a “best interest” decision-making process is in place and is consistently followed.

Considering the increasing scrutiny by regulators through the lens of a “best interest” standard, advisors risk more by avoiding an IPS than by taking the extra measure to formalize a client’s investment strategy and make it the core of the client-advisor relationship.

Akhil Lodha Author
Co-founder & CEO StratiFi Technologies

Building the industry standard for understanding portfolio risk through cutting- edge technology at Stratifi.

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