You wouldn’t prepare to build a new home or renovate your existing one without first thinking through your vision, drawing up architectural plans, selecting the right contractors and tradespeople, and planning ahead for possible budget overruns and surprises. Yet many people approach their long-term investments without any plan at all. An investment policy statement (IPS) is a written document that you and your advisor create to keep you and your investments on track. The IPS brings clarity, vision, and discipline to the investment process. Think of it as a personal investment road map for long-term investment success.

Advisory Firm’s Investment Philosophy Pledge

If you’re building or managing investment wealth over the long term, you need to adopt a comprehensive investment philosophy that will guide you along the way. The IPS integrates your personal objectives and financial situation with your investment strategies and your investment philosophy. An IPS should spell out that philosophy and help you and your advisory firm put it into practice with the ongoing management of your investments. This also serves as a pledge by the advisory firm that determines how your portfolio will be managed. The following is an example of how an investment philosophy may be spelled out in your IPS using the principles of The Empowered Investor. The pledge below is from our firm’s IPS.

1. Consistent process for managing investments. « We have an investment process which includes the following components: a thorough know-your-client process, an investment policy process, standardized and consistent portfolio practices, fairness of client allocation policies, regular rebalancing, regular current-vs.-target portfolio reviews, full investment transparency, and professional investment reporting. »

2. Diversified global approach to investing. « We take a global approach within the equity component of each client portfolio to enhance diversification and provide participation in equity appreciation opportunities worldwide. Portfolios will typically include: Canadian, U.S., International, and Emerging Markets equity exposure (unless otherwise stated in your investment policy statement). »

3. The inclusion of value and small cap companies. « We will include exposure to broad equity market, value companies and small cap companies in each major geographic equity component in your portfolio: Canadian, U.S., and International and Emerging Markets. We include value and small cap exposure as a way to increase the expected long-term returns of your portfolio. Long-term periods and patience are required to fully capture the value and small cap premiums. » 

4. Using asset class investments. « We will execute your portfolio strategy using asset class investment vehicles. By using passively managed asset class exposure we are able to provide our clients with full and consistent long-term exposure to broad equity market, value companies, and small cap companies. As an independent firm we are able to use the best investments possible to execute these strategies. We do not build portfolios through individual stock selection or through the selection of active money managers. »

5. Rebalancing your portfolio. « We will rebalance your portfolio on a regular basis to ensure that it is in line with your long-term IPS “target” allocation. Our primary method of rebalancing is through cash flow management (deposits and withdrawals). When investing your deposits, we will buy asset classes that are underweighted relative to your long-term IPS targets. When raising cash to fund your withdrawals, we will sell asset classes that are over- weighted relative to your long-term IPS targets. On occasion we might rebalance portfolios due to significant market readjustments. This rebalancing process helps us buy “low” and sell “high” for your investment accounts on a consistent basis over the life of your portfolio. »

6. No market timing. « We will not engage in any form of market timing. We will not attempt to make any significant shift in weightings from stocks to bonds or vice versa based on economic forecasts or any “gut feeling.” We will not attempt to shift assets based on forecasts of business cycles (expansions or contractions) as they are too unpredictable. Not only would it detract from your investment returns, it would also add unnecessary risk and stress to your investment experience. Regular rebalancing will occur within Investment Policy Guidelines. »

7. No speculation » description= »We will not speculate with any portion of your investments. » 

An IPS Provides Discipline and Structure

An IPS provides you and your advisor with the discipline needed to overcome common behavioural pitfalls. In a 2011 paper, Andrew Ang and Knut Kjaer pointed out that long-term investors have several advantages over those with shorter horizons. These include being able to take advantage of rebalancing opportunities: in other words, buying assets when they have temporarily declined in price. However, this is emotionally difficult because periods of market turmoil tempt investors to abandon the rules. “The paradox is that it is precisely during such challenging times that you most need the rules,” write Ang and Kjaer.

Institutional investors have been using investment policy statements for decades. Ang and Kjaer report, for example, that the Norwegian sovereign wealth fund followed a stringent set of rules for rebalancing during the financial crisis of 2008–2009, buying equities while others sold in a panic. As a result, the fund enjoyed great success during the rebound that followed.

The IPS is no longer the sole domain of large pension plans; it is a key tool for individual investors too. In many ways, private investors have more to gain from developing an IPS because individuals have a much deeper emotional attachment to their money than do pension fund managers and can therefore greatly benefit from the discipline, structure, and process set out by the plan.

An IPS is Your Living Document

An IPS and a financial plan are not the same. The focus of an IPS is on the ongoing management of your long-term portfolio. A financial plan on the other hand, is more encompassing and will look into your entire financial affairs, including important items such as retirement planning, budgeting and savings, analysis of cash flow, risk management (insurance), and wills and estate management. Figure 1 illustrates the relationship between the two.

Figure 1: Bring Your IPS to Life



There are many different components that form an IPS. Developing each of these components will require careful thought and analysis.

Your investment goals: Are you investing for capital preservation, long-term growth, or a mix of both? Are you currently adding new money to your portfolio, or are you drawing on it for income?

Your expectations: Based on your proposed asset allocation and asset classes to be used, you should learn and become aware of how they might work over long periods of time. What have good periods looked like and what have poor periods looked like? You should be made aware of the impact of inflation and taxes on long- term investments.

Your time horizon: Are you investing for a child’s education in ten years or a retirement that may last thirty years? As a general rule, the longer the time horizon, the more risk you can take in the portfolio.

Your understanding of risk: There are many types of risk for investors. IPS discussions should cover the following risks:

Volatility: The magnitude of the losses and gains that all port- folios will experience over time. (In financial terms, volatility is the standard deviation of returns.) Markets do not move in a straight line and investors must understand how much down- ward movement they can tolerate, both financially and emotionally.

Financial risk: The dollar or percentage amount of decline you can accept, given your need for capital preservation, income and your overall level of wealth.

Emotional risk: The amount of decline you can accept without being tempted to abandon your strategy. This risk will vary based on your personality and previous experience with investments.

Purchasing power risk: The risk that your investment returns will not keep pace with inflation over time. Over long-term periods, this risk is typically higher with bond and GIC investments.

Longevity risk: The risk that an investor will outlive his or her portfolio. Implementing a sustainable annual draw-down is one way to help manage this risk.

Your asset classes: Which asset types (government bonds, corporate bonds, Canadian stocks, U.S. stocks, international stocks, etc.) will be included in your portfolio and which will be avoided? You should understand the characteristics of each of these asset classes, and how they have evolved over time.

Your asset allocation strategy: What will the portfolio’s strategic asset mix be? (For example, will the portfolio set a target of 60% equities and 40% fixed income?)

Your tax situation: What tax-efficiency strategies will be used to minimize taxes in non-registered accounts?

Your investment costs: What are the costs associated (at all levels) with the investment strategies?
Monitor, evaluate, and report: How will the portfolio be rebalanced back to the target allocation? How often will you receive statements showing your holdings, account balances, and performance?

Monitor, evaluate, and report: How will the portfolio be rebalanced back to the target allocation? How often will you receive statements showing your holdings, account balances, and performance?

Embrace the IPS Process – It’s Yours!

The process of creating and maintaining an IPS will ultimately empower you and your advisory firm to set the winning conditions for a better long-term investment outcome. The ongoing IPS dialogue with a trusted advisor will provide you with a better long-term investment experience by making you more aware of how markets work, allowing you to set realistic objectives and reduce the number of future surprises. The IPS also provides you with full transparency concerning the role of the advisory firm.

Your investment strategy should strike a balance between all the components mentioned above. You may choose to work with a qualified advisor to construct a customized IPS and then have the investment strategy executed, monitored, updated, and reported back to you. Or you may choose to create and monitor an IPS on your own. However you choose to create your IPS, recognize that it represents a crucial ingredient in your investment success.