Why Every Financial Advisor Needs an Investment Policy Statement (IPS)

An Investment Policy Statement (IPS) is a critical tool for financial advisors. It serves as a guiding document that aligns the advisor and client’s expectations, laying out the client’s financial goals, investment strategies, and risk tolerance. Despite its importance, many advisors underutilize the IPS and neglect regular updates as client circumstances change.

This post explores the key components of an IPS, the risks of not maintaining it, and best practices for keeping it relevant over time. Advisors who prioritize an updated IPS not only protect their clients’ portfolios but also strengthen trust and compliance in their practice.

What is an Investment Policy Statement (IPS)?

An IPS is more than a document; it’s a roadmap that provides direction and consistency in investment strategy. By defining objectives, risk tolerance, and asset allocation, the IPS establishes a clear understanding between advisor and client, guiding decisions through various market conditions. The IPS formalizes the investment approach in a way that is transparent and tailored to the client’s long-term goals.

The Core Purpose of an IPS

At its core, the IPS ensures that both the advisor and client are on the same page. It allows advisors to document the client’s objectives and creates a structured approach to managing the portfolio. In essence, the IPS is the backbone of a well-coordinated financial advisory relationship.

How an IPS Helps Advisors and Clients Align on Goals

With clear documentation of investment goals, the IPS reduces ambiguity and sets clear guidelines on risk tolerance and investment preferences. This alignment is crucial for managing expectations, especially during times of market volatility.

Key Components of an Effective IPS

An IPS outlines essential components that create a comprehensive strategy, ensuring consistency and structure across the investment process.

• ‍Investment Objectives and Asset Allocation‍
  • The IPS should define the client’s primary goals, whether it’s growth, income generation, or capital preservation. Asset allocation strategies are mapped out based on the client’s risk tolerance, determining how the portfolio will be diversified to reach their objectives.‍
• Benchmarking and Performance Metrics‍
  • Benchmarking provides a framework for assessing portfolio performance. The IPS should specify benchmarks, like comparing the client’s portfolio to market indices or other relevant indicators. This helps advisors track whether the investment strategy is performing as intended.‍
• Risk Management Guidelines‍
  • An effective IPS includes detailed risk management guidelines. These guidelines set limits on certain asset classes, define diversification standards, and establish thresholds for acceptable volatility. This structure helps prevent the portfolio from taking on unnecessary risks that could jeopardize the client’s goals.

The Benefits of Using an IPS

An IPS offers several advantages for both advisors and clients. It keeps investment strategies consistent, builds trust through transparency, and provides a steady approach to portfolio management.

1. ‍Providing a Long-Term Roadmap for Investment‍
   • The IPS helps advisors maintain a disciplined strategy even during turbulent market periods. With a clear plan in place, advisors can make informed decisions based on the client’s long-term goals rather than short-term market movements.‍
2. Reducing Impulsive Reactions to Market Volatility‍
   • By committing to a long-term strategy, the IPS reduces the urge to make reactive decisions when markets fluctuate. Instead, it provides a pre-set framework, enabling advisors to navigate market ups and downs with a steady approach.‍
3. Building Trust Through Transparency‍
   • An IPS builds trust by showing the client that their financial goals are being addressed methodically. By clearly documenting each aspect of the investment strategy, the IPS helps clients feel informed and confident about their portfolio.

Risks of Not Having or Updating an IPS

While some may view the IPS as just another formality, neglecting it creates considerable risks that can impact both the advisor and client.

• ‍Misaligned Investment Strategies‍
  • Without an IPS, advisors risk making decisions that don’t align with the client’s objectives or risk tolerance. This can lead to inconsistent or impulsive actions, which may harm portfolio performance or create unwanted exposure to risk.‍
• Regulatory and Compliance Risks‍
  • Regulatory requirements, like Regulation Best Interest (Reg BI), obligate advisors to act in their client’s best interest. An IPS provides documented evidence that the client’s goals and risk profile were considered in decision-making. Without this, advisors risk compliance issues, potential fines, and legal liabilities.‍
• Increased Client Dissatisfaction‍
  • A poorly maintained or outdated IPS can lead to investment decisions that no longer reflect the client’s current financial situation or goals. This can create dissatisfaction, as clients may feel their advisor isn’t responsive to their needs, potentially leading them to seek a new advisor.

Best Practices for Keeping an IPS Up-to-Date

Creating an IPS is only the beginning; keeping it updated is essential to its effectiveness. Here are some best practices for maintaining an accurate and relevant IPS.

Scheduling Regular Reviews

Advisors should schedule annual reviews or update the IPS whenever significant changes occur in the client’s financial picture, such as retirement, marriage, or the sale of a major asset. These reviews help keep the IPS aligned with evolving goals and market conditions.

Using AI Tools for Automation and Real-Time Updates

Maintaining IPS documents manually for each client can be time-consuming. AI-powered tools like Investipal’s IPS tool make this process easier by using AI to automatically generate IPS documents in real-time. Automation helps advisors ensure that each IPS remains accurate and compliant, allowing them to focus more on strategy and client relationships.

Keeping Your Clients’ IPS Relevant

An IPS is far more than a simple document; it’s a cornerstone of effective portfolio management that protects both advisor and client by aligning strategies with long-term goals, ensuring compliance, and managing risk. Advisors who don’t implement or update IPS documents run the risk of misaligned strategies, regulatory challenges, and client dissatisfaction.

Regularly reviewing and updating the IPS not only mitigates these risks but also strengthens client trust. By using tools like Investipal’s AI-driven IPS management platform, advisors can simplify the update process and keep IPS documents relevant in real-time. Schedule a demo today.