Investment Policy Statement (IPS)

Definition

An Investment Policy Statement (IPS) is a formal, written document that sets out a client’s investment objectives, risk tolerance, and investment limitations. It serves as a guide for a financial advisor in making investment decisions for the client. The IPS is usually established at the inception of the relationship between the client and the advisor, and is periodically reviewed and updated.

Phonetic

Investment Policy Statement (IPS) in phonetics is:”In-ves-tuh-muhnt Pol-uh-see Stayt-muhnt”For IPA (International Phonetic Alphabet):/in’vest-mənt/, /ˈpɑːləsi/, /ˈsteɪtmənt/

Key Takeaways

1. Guiding Document: An Investment Policy Statement (IPS) serves as a guiding document for investors and their financial advisors. It lays out the investor’s goals, risk tolerance, time horizon and investment strategy, helping to ensure that all parties are on the same page about the approach to managing the investments.

2. Accountability: The IPS holds the financial advisor accountable as it defines the investor’s expectations and the acceptable level of risk. It’s a tool for both the investor and advisor to assess performance and make adjustments as necessary to keep the investment strategy on track.

3. Flexibility: The IPS is not a fixed or inflexible document. It should be reviewed and revised periodically, especially when there are changes in market conditions, the investor’s financial situation, or in their personal goals. This means that an IPS is a living document that mirrors the evolving circumstances of its owner.

Importance

The Investment Policy Statement (IPS) is a critical document in business and finance because it clearly delineates the strategies, goals, benchmarks, and investment plan that guides the business or individual’s investment decisions. This document encapsulates an investor’s risk tolerance level, time horizon, and financial goals, thereby guiding all future investment decisions and actions. It brings discipline and consistency to the investment process, helping to prevent impulsive or emotional decision-making during unexpected market movements. It also helps evaluate the performance of investments over a period of time. The IPS serves as a communication tool between the investor and the investment manager, providing a clear roadmap to achieving specific financial goals. This ensures everyone is working toward the same goals, minimizing the potential for misunderstanding and conflict. Therefore, the IPS is a strategic cornerstone of sound financial planning and management.

Explanation

The primary purpose of an Investment Policy Statement (IPS) is to provide a strategic long-term framework for managing investments to meet stated financial objectives. This framework forms the basis for all future investment decisions, effectively guiding the types of investments the investor chooses along with the risk tolerance and time horizon. The IPS serves as an action plan detailing an investor’s expectations, strategies, and guidelines, anchoring the investor during times of volatility in the market, preventing any reactive decision making in response to extreme market conditions. An Investment Policy Statement is used as a communication tool between the investor and their financial advisor. It clearly articulates an investor’s investment objectives, constraints, and risk tolerance, which aids in eliminating potential misunderstandings. In essence, it provides clarity on how the money should be managed to achieve the investor’s long-term financial goals. Furthermore, it puts in place mechanisms for monitoring and review of the investment strategy ensuring that it remains aligned with the changing dynamics of the market and the investor’s life circumstances.

Examples

1. Retirement Planning: A retirement planning organization may have an Investment Policy Statement addressing the specific investment strategies to be implemented on behalf of their pensioners. This could include the types of assets or funds to be invested, such as a mix of stocks, bonds, or mutual funds, and the targeted rate of return. It would also spell out the risk tolerance in terms of market volatility and the amount of potential loss that is acceptable. 2. University Endowment Fund: A university’s endowment fund might use an IPS to guide its investment process. The statement may outline the objectives, such as long-term growth and funding for scholarships, while taking into account the constraints such as liquidity needs and risk tolerance. The IPS may also define the asset allocation strategy i.e., what percentage will be invested in equities, bonds, real estate, etc., and how investments will be evaluated and monitored.3. Nonprofit Organization: A nonprofit can have an IPS to manage their reserve funds or any investment income. This document would provide a clear understanding about their investment goals, risk tolerance, and spending policy. The IPS might require conservative investments with a focus on preserving the principal while generating income to support their ongoing programs and operations. The document would also set standards for diversification to reduce risk and guidelines for reviewing investment performance.

Frequently Asked Questions(FAQ)

Related Finance Terms

• Asset Allocation
• Risk Tolerance
• Investment Objectives
• Time Horizon
• Review Procedures

Sources for More Information

• Investopedia
• CFA Institute
• Corporate Finance Institute
• The Balance