Why Should Financial Advisors Use Investment Policy Statements?

January 2024, by Helen Yang, CFA, Wealth Management Outlook

The Investment Policy Statement is an important document that outlines the agreement between financial advisors and clients, providing clarity and transparency to protect both parties. Yet many advisors don’t use it for several reasons: advisors don’t know what should go into it; it can be a liability from a compliance perspective; and it can be time consuming.

These are all legitimate concerns. When we built an IPS generator in 2020, we collected a dozen or so samples, and the content was all over the place, from an abbreviated account statement to pages and pages of legal language, a clear indication of the confusion about the IPS.

When the content is too specific, for example, “rebalance monthly”, it is a compliance concern.

But you can easily mitigate it by saying “rebalance as needed”. In general, if we focus on the principles, high level facts and educational content, it shouldn’t be a problem for compliance.

So, what should a perfect IPS look like?

First, it needs to cover the key elements, including investment goals, time horizon, risk tolerance and asset allocation.

Second, it needs to be personalized. In addition to client specific items above, it also needs to provide space for client’s liquidity needs, constraints, and other important notes. Third, it needs to strike the right balance between having enough substance but at the same time, not saying too much, to avoid being a compliance concern. And finally, it needs to be educational and easy to read. Infuse it with behavioral finance to tell the long-term story and use plenty of visuals to convey the messages. Now we know what should go into the IPS, let’s talk about the implementation.

If you use a word or excel template, it is indeed time consuming to copy and paste client specific content to make it personalized and relevant. Because of this, some advisors do it for institutional clients but not for households. But if there is an easy way to generate it automatically, there is no reason not to use it for all clients. Is it possible to automatically generate a personalized IPS? Yes, absolutely. The author has filed a patent on an IPS generator with the U.S. Patent and Trademark Office, which has been approved. 

The modular design defines each section, paragraph, image and chart as an element, and chains them together to define an IPS template. It is also customizable. Financial advice is very much about investor behavior, and we are often our own worst enemies. All of us are subject to deeply ingrained cognitive and emotional biases, prompting us to make irrational decisions during market turmoil. As Eric Clarke, the founding CEO of Orion Advisor Solutions, said perfectly, “as an industry, we need to focus on solving the investor problem, and move beyond focusing so much on the investment problem.”

A well-conceived IPS is the perfect tool to bring awareness to our inherent limitations and get clients’ pre-commitment to stay on course. When emotions run high, you can invite clients to revisit the guidelines laid out in the IPS, take a collective deep breath, and remind them of the importance of staying focused on long-term objectives.

Original article here.