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What is an Investment Policy Statement?

June 01, 2023

An Investment Policy Statement (IPS) is used to define and inform a formal Investing Process.  It is the operations order, guidelines, rules and expectations used to technically and tactically implement an investment strategy.  

It is essential that a clear understanding exists between the Investor and the Advisor regarding investment objectives and the policies that make up an Investor’s portfolio.  At Sterling Edge Financial, the Investment Policy Statement guides an investment strategy to serve a specific purpose outlined in your Financial Plan. What can you expect?  

• Establishes reasonable expectations, objectives and guidelines within the investment of the portfolio’s assets.
• Sets forth an investment structure detailing permitted asset classes, normal allocations and permissible ranges of exposure for the portfolio.
• Maintains ongoing communications and communications expectations.
• Creates the framework for a well-diversified asset mix that can be expected to generate acceptable long-term returns at a level of risk suitable to you.

An IPS is typically broken down into 7-8 areas of work (see below).  The Investment Policy Statement (IPS) is the result of an intensive evaluation of the many factors and assumptions applicable to your unique situation and your personal investment objectives and financial planning needs.  An IPS is not a contract, but is intended purely to be a summary of the investment philosophy that has guided you and your Advisor in developing your portfolio.  The document is based on the information and assumptions you have discussed with your Advisor. The document assumes that you have made complete and accurate disclosures of all relevant information to your Advisor.

Here are the key components typically included in an IPS:

  1. Objectives and goals: The IPS defines the investor's financial objectives, such as capital preservation, income generation, long-term growth, or a combination of these goals. It also outlines the time horizon for achieving these objectives.

  2. Risk tolerance: The IPS specifies the investor's risk tolerance, which refers to their willingness and ability to accept investment risks. It takes into account factors such as the investor's financial situation, investment knowledge, investment time horizon, and personal preferences.

  3. Asset allocation: The IPS establishes the target asset allocation, which determines the percentage of the portfolio allocated to different asset classes, such as stocks, bonds, cash, and alternative investments. The asset allocation should align with the investor's objectives and risk tolerance.

  4. Investment guidelines: The IPS provides guidelines for selecting and managing investments. It may specify acceptable types of securities, sectors, geographic regions, or specific investment vehicles. It may also define any restrictions or limitations, such as avoiding certain industries or adhering to ethical or socially responsible investing principles.

  5. Performance benchmarks: The IPS sets performance benchmarks against which the portfolio's performance will be evaluated. These benchmarks can be market indices or customized benchmarks that reflect the investor's objectives and asset allocation.

  6. Investment management: The IPS describes the responsibilities and duties of the investment manager or advisor. It may include details about the investment manager's authority, monitoring and reporting requirements, and any specific investment strategies or techniques to be employed.

  7. Review and evaluation: The IPS outlines the frequency and process for reviewing and evaluating the portfolio's performance. It may specify the reporting requirements, including the frequency and content of performance reports, and the frequency of portfolio rebalancing.

  8. Legal and regulatory considerations: The IPS may include legal and regulatory disclosures, ensuring compliance with applicable laws, regulations, and industry standards.

By documenting the investor's objectives, risk tolerance, and investment guidelines, an IPS provides a roadmap for investment decision-making. It helps maintain consistency in managing the portfolio and provides a benchmark for evaluating the portfolio's performance over time. Regularly reviewing and updating the IPS ensures that the investment strategy remains aligned with the investor's goals and evolving circumstances.

Additional risks and considerations.

Failure to coordinate all of your investments together increases your investment risk.  Working with multiple investment advisors, custodians and firms who are not working together or able to observe each others investment positions they do not directly manage on your behalf tends to result in higher investment fees, tax inefficiencies, inconsistent risk management and competing or overlapping processes that could increase the time required to manage your investments.

Research and historical data shows the average investor without an IPS or formal rules based investment strategy tend to underperform their own investments and the overall benchmark by 1.5% - 3.5% per year or more. (See Dalbar, Russell, S&P and Vanguard research for more information)