Elements of a Clear IPS:
1. Purpose
and Background:
Explains the purpose of the Portfolio (e.g., long-term growth for retirement; or
balanced growth, or fixed income, etc.).
The IPS also notates:
a. The size of the
Portfolio (including planned additions and withdrawals).
b. The tax status of
the Portfolio (whether the investment funds are taxable, tax-deferred, or
tax-exempt).
c. The amount of time the
Portfolio can be committed to the investment policy (i.e. when do you plan to
withdraw the money for purposes of short-term income needs or a cash infusion?)
2. Investment
Objectives: A
typical objective for an investment plan is to maximize returns while assuming a
reasonable level of risk, and to minimize costs and income taxes. The IPS
addresses investment objectives, and sets a target annual return, before and
after inflation. Risk tolerance is stated in terms of acceptable volatility
(the range of returns above and below the target return that you would be
willing to live with).
Additional IPS Objectives
Include:
a. Specific income needs.
b. Liquidity requirements.
c. Any lump-sum cash
distributions.
3. Asset
Allocation Strategy:
A specific balance between stocks, bonds and cash will be predetermined
according to your long and short-term goals. Establishing a sound asset
allocation strategy requires you to provide guidelines regarding your tolerance
for risk, asset class preferences, investment time horizon, and desired rate of
return that is specific to you, since there is no “universally correct" asset
allocation.
“Asset Classes” can be
identified by asset [e.g. equity (stocks) versus fixed income
(bonds, CD’s etc.)], size (large capitalized companies versus mid
and small cap), style (growth or value), or by market
(U.S. versus international).
Before setting the asset
allocation strategy, it is important that you understand the principles of risk
and return, and the potential impact of the asset allocation strategy on your
financial situation. Informed studies have shown that over 90% of the
variability of Portfolio returns can be explained by asset allocation strategy.
Only a small amount of a Portfolio's variability is due to security selection,
market timing, and/or random luck
(Gary P. Brinson, Brian D. Singer, and Gilbert L. Beebower,
“Determinants of Portfolio Performance II: An Update”, Financial Analysts
Journal, May/June 1991).
Additionally, one achieves
highest value and lowest cost based on proper “asset mix” (stocks &
bonds), than over all other management styles that instead concentrate on such
factors as “equity mix” (large or small stocks, U.S. or international, growth or
value), “methods of implementation” (passive versus active or active
disciplined), “advisor/manager due diligence”, or “portfolio manipulation”
(timing or strategy changes
- Charles D. Ellis,
“Levels of The Game”, Journal of Portfolio Management, Winter 2000).
A preferred way of
identifying “asset allocation” involves looking to the “efficient frontier”,
which is a representation of the theoretical Portfolios that provide the maximum
return for each level of risk (the risk return equation). An investor with a
known risk tolerance can achieve the maximum expected return for that known
level of risk, and an investor with a known target rate of return
can obtain the lowest risk Portfolio that corresponds with that rate of return.
The IPS helps in identifying your “efficient frontier” for your specific,
customized, Portfolio.
The IPS will also indicate
how often you prefer to rebalance the proportion of stocks, bonds and cash in
order to match your original target asset allocation (due to natural variations
in the growth or movement of each segment of the allocation, a Portfolio's asset
allocation often strays from its’ original targeted settings, such that adding
“auto-rebalancing” helps to keep closer to the originally desired allocation).
4. Values-based
Investing Limitations:
You are advised to consider what areas of business you feel uncomfortable owning
and seek to avoid investments in companies that fail any screening tests you may
want to employ.
5. Portfolio
Management Guidelines:
The IPS includes parameters for LeagueFinancial.com to follow. Portfolio
management guidelines should not be so restrictive that we cannot do our job,
rather, guidelines could:
a. Limit the amount that may
be allocated to any one security or industry (to ensure proper diversification),
or
b. Indicate securities or
practices that are not acceptable (e.g., minimum quality bonds, values-based
investing).
6. Money
Manager or Investment Selection:
The IPS also establishes the mass/criteria for selecting money managers and/or
investments. The guidelines set specific qualitative and quantitative
requirements -- for example, conformity to a specific asset class and style, a
minimum tenure of the current manager, historical performance standard relative
to a representative index/peer group, and/or fund expense standards relative to
a peer group.
7. Control
and Review Procedures:
The IPS includes a process for ensuring adherence to the investment policy, and
monitoring the effectiveness of the IPS. The duties of all investment
decision-makers should be delineated, including a requirement for periodic
Portfolio & performance reports. Sometimes, an IPS may also establish specific
criteria against which each money manager will be evaluated.
So that we can best assist
in developing a proper and thorough IPS for you, please contact us for more
information today at:
Paul M. League*, QFP, CFP®
[California
Insurance License #0610019]
League Financial & Insurance Services
P.O. Box 11800
Palm Desert, CA 92255-1800
Paul@LeagueFinancial.com · www.LeagueFinancial.com
T: 1.800.482.5347 · F: 1.310.861.8466
*A Registered Representative Offering Securities and Advisory
Services Through Royal Alliance Associates, Inc.,
A Registered Broker-Dealer and Registered Investment Adviser, Member FINRA, SIPC
