What is the step-by-step process for creating an Investment Policy Statement for a private client?

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AcadiFi · Accepted Answer

The Investment Policy Statement (IPS) is the foundational document for managing private wealth. It serves as a contract between the advisor and client and guides all subsequent investment decisions. Here is the systematic process: ```mermaid graph TD A[Step 1: Client Discovery
Interview, questionnaire,
financial documents] --> B[Step 2: Determine Objectives] B --> B1[Return Objective
Required vs desired return] B --> B2[Risk Objective
Ability + willingness to take risk] B1 --> C[Step 3: Identify Constraints] B2 --> C C --> C1[Time Horizon] C --> C2[Liquidity Needs] C --> C3[Tax Considerations] C --> C4[Legal/Regulatory] C --> C5[Unique Circumstances] C1 --> D[Step 4: Determine
Strategic Asset Allocation] C2 --> D C3 --> D C4 --> D C5 --> D D --> E[Step 5: Draft IPS Document] E --> F[Step 6: Client Review
and Approval] F --> G[Step 7: Implementation] G --> H[Step 8: Monitor and
Review Annually] H -->|Life events, market changes| A style A fill:#c9a84c,color:#000 style D fill:#1e3a5f,color:#fff style H fill:#2d6a4f,color:#fff ``` **Worked Example — IPS for Margaret Chen, Age 58:** **Background:** Margaret recently sold her software company for $12M (after tax: $9.6M). She has a $400K pension starting at 65, owns a home worth $1.8M (mortgage-free), and wants to retire immediately. Annual living expenses are $280K. She is divorced with two adult children. **Return Objective:** - Annual spending need: $280,000 - Investable assets: $9,600,000 - Required return = $280,000 / $9,600,000 = **2.92% real** (plus inflation) - If inflation is 2.5%, nominal required return = approximately **5.5%** - This is a modest requirement — she does not need to take excessive risk **Risk Objective:** - **Ability to take risk:** Above average. Large portfolio relative to spending needs, no debt, pension provides additional income at 65. - **Willingness to take risk:** Below average. Margaret describes herself as conservative and lost sleep during 2022 market volatility. - **Overall:** Below average. *Willingness governs when ability and willingness conflict downward.* Educate the client about the mismatch, but respect the lower willingness. **Constraints:** | Constraint | Detail | |---|---| | Time horizon | Two-stage: 7 years pre-pension (58-65), then 25+ years with pension supplement | | Liquidity | $280K annual spending + $200K gift to each child next year ($400K one-time) | | Tax | Capital gains on business sale already paid. Focus on tax-efficient withdrawal strategy | | Legal | None specific — no trust structures currently | | Unique | Wants to fund a $1M charitable foundation within 5 years; prefers ESG-aligned investments | **Strategic Asset Allocation (given constraints):** Given below-average risk tolerance and modest return needs: - 35% Global equities (diversified, tilt toward dividend/quality) - 40% Investment-grade fixed income - 10% Real assets (REITs, inflation protection) - 10% Alternatives (low-volatility hedge fund) - 5% Cash (liquidity buffer for year 1 gifts + spending) **Critical Exam Points:** 1. **Ability vs. Willingness:** When they conflict, the lower one usually governs — but you should recommend client education. This is a classic constructed-response question. 2. **Two-stage time horizon:** Before pension starts, the entire spending burden falls on the portfolio. After 65, the pension covers part of spending, allowing more aggressive allocation. 3. **Unique circumstances matter:** ESG constraints limit the investable universe. Charitable goals affect cash flow planning. 4. **The IPS is a living document:** It must be reviewed when life events occur (health change, inheritance, marriage) or at least annually. Practice IPS construction with our CFA Level III Private Wealth question bank.

What is the step-by-step process for creating an Investment Policy Statement for a private client?

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