What are the main components of an investment policy statement (IPS)?

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AcadiFi · Accepted Answer

An investment policy statement is the foundational document that governs how a portfolio is managed. It has two broad sections: objectives (return and risk) and constraints (liquidity, time horizon, taxes, legal/regulatory, unique circumstances — remembered as LLTUT or the Tim Loves Cake mnemonic reshuffled).

Objectives:
1. Return objective — quantified required or desired return, after fees, inflation, and taxes where relevant.
2. Risk objective — measured by standard deviation, max drawdown tolerance, or downside risk metrics. Distinguishes ability to take risk from willingness.

Constraints:
1. Liquidity — near-term cash needs (distributions, planned expenses).
2. Time horizon — single-stage or multi-stage (e.g. pre-retirement and post-retirement).
3. Tax — relevant tax status, jurisdiction, account types (taxable vs retirement).
4. Legal and regulatory — ERISA, prudent investor rule, UPMIFA for endowments, concentration rules for insiders.
5. Unique circumstances — ESG preferences, holdings restrictions, family considerations.

Example: wealth manager Philomena Oduya-Arrington at Silverbrook Advisors drafts an IPS for client Rohan Katsuragi. Return: 5.5 percent nominal to fund retirement at age 65. Risk: 12 percent annual volatility max, no peak-to-trough loss greater than 18 percent. Constraints: 2 years of expenses in liquid assets, 22-year horizon, 35 percent marginal tax bracket, ERISA-compliant 401(k) portion, prefers no tobacco holdings.

```mermaid
flowchart TD
    IPS[IPS] --> O[Objectives]
    IPS --> C[Constraints]
    O --> R[Return]
    O --> K[Risk]
    C --> L[Liquidity]
    C --> T[Time horizon]
    C --> TX[Tax]
    C --> LR[Legal]
    C --> U[Unique]
```

The IPS is reviewed at least annually and after major life events.

What are the main components of an investment policy statement (IPS)?

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