The Importance Of The Investment Policy Statement

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Scarecrow overboard

Every good advisor has at least an informal method of getting to know their clients. The best advisors formalize the process.

In 2005 I completed the Accredited Investment Fiduciary (AIF) designation through the Center For Fiduciary Studies. Part of this training included the importance of formalizing what is often an informal process of getting to know a client well enough to manage their finances. By 2007 we had developed the core attributes of a good Investment Policy Statement, telling a client’s story, objectives, strategy and implementation plan.

An Investment Policy Statement (IPS) is a blueprint for the development of your financial dream home. Like a blueprint, an IPS not only provides a map of the project ahead, but it also provides a tool by which you can measure your success – or the success of your investment advisor. As your investment advisor implements your investment policy, you can determine if the construction accurately matches the blueprint.

Fiduciary advisors should take the time to develop an IPS. Commission based agents and brokers will often feign interest all the while knowing that the way to meet your goals will be one of three different products they sell. The best advisors formalize the process of developing an IPS in writing, and are always looking for ways to improve getting to know their clients better.

The aim of a fiduciary advisor is to do whatever the client would do if they had the advisor’s time and expertise.

In order to even approach accomplishing that task, an advisor has to get to know his or her clients.

It was with interest, therefore that I read Blaine F. Aikin’s article “The importance of the investment policy statement” in InvestmentNews which read in part:

Knowing that most advisers regularly confront clients who want to change course at the first sign of turbulence, it’s confounding that so many avoid implementing an IPS.

Clients probably don’t realize how frequently 20-20 hindsight makes it appear as though they were sure whatever happened was going to happen and hides the fact that we are wired to chase returns and therefore earn less than either a buy-and-hold strategy or and even better buy-and-rebalance strategy. An IPS helps advisors point back to the plan and suggest we stick to the plan. Akin continues:

As an adviser, you spend lots of your time, particularly with a new client, carefully gathering information about that client, developing risk and return parameters for the client’s time horizon, building an asset allocation, presenting your plan to the client for approval, conducting due diligence, selecting service providers, etc., all so that you can achieve a level of confidence that the client’s investment goals are attainable.

And then, you allow that confidence to be eroded when the client decides to call an audible and make new decisions, often based on something he saw on television, or heard from a friend or family member, or just has a hunch about. Considering the time and effort it takes to formulate a sound investment strategy with and for your client, it is simply negligent to fail to commit that plan to writing.

So one of the benefits of having an IPS is to keep client and advisor from letting one year’s (or sometimes even one quarter’s) returns ruin an otherwise brilliant investment strategy. Akin finishes his argument with:

And that’s where we hit on the defining reason why the investment policy statement is so important: because adherence to the fiduciary standard is all about process. If questions ever arise as to whether or not you did your job as a fiduciary, the answers won’t come from the investment results themselves, but what decisions you made and how you made them. You will be asked to demonstrate that there was a decision-making process in place and that it was consistently followed. Demonstrating this without a documented plan is difficult, actually maintaining any kind of consistent process without an IPS is nearly impossible.

Your clients are human, so they will continue to exhibit the human traits of being reactionary and wanting to take action when things don’t go their way. And while there is nothing wrong with revisiting your plan periodically to ensure that it still holds up as being the best plan, you do want to ensure that the act of making changes to the plan is itself the result of a careful decision-making process.

An IPS provides one of the most important benefits of being with a professional advisor, the discipline to stay the course with an investment strategy and give the strategy the longer terms sometimes necessary to see results.

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President, CFP®, AIF®, AAMS®

David John Marotta is the Founder and President of Marotta Wealth Management. He played for the State Department chess team at age 11, graduated from Stanford, taught Computer and Information Science, and still loves math and strategy games. In addition to his financial writing, David is a co-author of The Haunting of Bob Cratchit.