Stay on the Same Page as Your Advisor

An investment policy statement is a good tool for ensuring the investor-advisor relationship is fully understood by both parties, writes Rob Carrick, report and columnist for The Globe and Mail.

A nervous client called financial planner Rona Birenbaum recently to ask about fleeing the stock market.

She talked him down by reminding him that his portfolio was designed to withstand volatile times like these. And then, to document this, she e-mailed him a copy of his investment policy statement, or IPS.

An IPS puts a client’s needs and objectives in writing, Birenbaum said. "It says this is how much downside I can take as an investor, this is a reasonable return expectation, this is my asset mix."

Investors, ask your advisor for an IPS if you don’t already have one. Advisors, consider the IPS as a way of demonstrating your understanding of clients’ needs.

"I think they’re fundamentally important," said Kathleen Clough, associate portfolio manager at PWL Capital in Toronto. "From my perspective, it basically says to the client, ’Here’s how we’re going to manage your money.’"

There’s no standard format for an IPS, but they typically cover such factors as:

• Risk tolerance: Where you say how much of a stock market decline you can live with.
• Rate of return goals: The annual average return required to fulfill the financial plan your advisor should have produced for you.
• Mix of assets: The blend of stocks, bonds and cash that you will follow in all types of market conditions.
• Time horizon: When you expect to move from accumulating money to living off it.

Birenbaum’s client was prompted to think about selling after hearing from another advisor who was prospecting for new customers.

This advisor had sent out an e-mail explaining a strategy of lightening up on exposure to the stock market in anticipation of more declines ahead. This is what unnerved the client to the point where he wanted to sell his stock exposure.

The response from Birenbaum was to refer back to the client’s IPS, which outlined an investing approach that was designed specifically for stock-market gyrations such as we’ve seen lately.

It called for the client, who was relatively new to her firm, to use dollar-cost averaging to move gradually into the stock markets. In fact, the client was only about 45% exposed to stocks at the time the market fell, and had a substantial amount of cash still to be invested in stocks.

NEXT: Why It’s So Important Now

Stephen Horan, an expert on standards of practice for advisors, said an IPS can be particularly useful during volatile periods for financial markets. "It becomes a reference for responding to investor angst," he said. " It provides a very steady hand on the rudder."

Horan works out of the Charlottesville, Va. office of the CFA Institute, a global organization for people who have earned the elite Chartered Financial Analyst designation. CFA standards call for advisors to produce an investment policy statement as part of the process of getting to know a new client.

Clients should expect to be interviewed thoroughly as part of the process in which an advisor prepares an IPS, Horan said. The advisor will ideally pose a series of questions to the client rather than relying on a fill-in-the-blank template.

"Filling out a perfunctory risk-tolerance questionnaire is not an investment policy statement," he said.

Ms. Birenbaum said she and her clients have a thorough discussion about the IPS before it’s completed, to make sure that risk tolerance and expected rate of return line up properly.

For example, a client might say she can accept losses of no more than 10% over one year, but she wants an annual average return of 8%. In this case, either the client would have to accept more risk, or she has to lower her return expectations.

Once completed, the IPS is signed by the advisor and client, who receives a copy.

High-net-worth investors are probably already familiar with investment policy statements. The use of these documents by the broader advisory community is growing, but they’re far from standard.

Today’s stock-market volatility may change that. In the past, advisors were encouraged to use the IPS as a marketing edge that indicated a high level of service to clients.

"Now, people are talking about an IPS in terms of, ’This is really going to help you and your clients make better decisions during times of market upheaval,’" Birenbaum said. "I think it has a lot to do with the fact that we’ve had back-to-back bouts of volatility since 2008."

Why isn’t the IPS used universally? "It’s more work, and it’s not mandated," she said.

If you’re interviewing potential advisors, an obvious question to add to your list is, do you provide investment policy statements for your clients? A positive answer is an indication you’re dealing with an advisor who acts professionally.

Clients who don’t have an IPS should just request it from their advisor. "Asking for one is not at all pretentious or confrontational," the CFA Institute’s Horan said.

Bear in mind that the economic realities of the advisory business may be a factor here. If your account is on the small side—say, less than $25,000 to $50,000—your advisor may not feel he or she is being paid enough to warrant the time required to produce an IPS. It costs nothing to ask, though.