The difference between an Investment Policy Statement and a Know - Your - Client Form

All this jabbering about the importance of having an Investment Policy Statement, and I forgot to mention an important dynamic already in place in the industry. An IPS is not to be confused with a Know Your Client form, which are designed to protect and limit liability of the brokerages. While the IPS is an extensive document outlining the vital dynamics of the client-broker relationship, the know-your-client form represents the industry's minimum standard of what is expected for an advisor to know about their client. For example, the Mutual Fund Dealers Association requires the following:

- Investment Knowledge: extensive, moderate, none
- Risk tolerance: low, medium, high
- Time Horizon: 1 to 3, 4 to 5, 6 to 9, 10 plus
- Investment Objective: income, growth (short/long term), balanced
- Individual income
- Household net worth

Note how general a profile this is. If you are ever a victim of advisor malfeasance, it is the first thing that is looked at by the Branch Manager or perhaps the Compliance Department. Furthermore, John Lawrence Reynolds wrote in his book, The Naked Investor, that financial advisors will have their clients sign the bottom and fill the rest in later. Be wary of this because, if there is problem, it will be the place you'll have to turn to in order to make your case.

The Importance of having an Investment Policy Statement

If there's one thing that we hammer home with our clients, it's the necessity of an Investment Policy Statement prior to beginning your relationship with your financial advisor. If you don't have one, have your advisor set one up for you. If you do have one, verify that it's complete. In his book The Professional Financial Advisor, John DeGoey put forth the statistic that 15% of retail investors with financial advisors have investment policy statements. Although it has been six years since the book came out and, surely, the percentage has increased significantly since then, it is quite an issue.

An Investment Policy Statement (IPS) is a document that details the dynamics of a client's relationship with their financial advisor, such as the most vital elements of a portfolio's elements and design. It is the ultimate guide to transparency between an advisor and the client. Having an Investment Policy Statement, quite frankly, makes the client's expectations clear, and the advisor will understand fully the standard he or she is being held to. The more a client knows entering a relationship with a financial advisor, the healthier that relationship will be.

The best breakdown that could be found of what should be in the Investment Policy Statement (this includes the industry textbooks) was in Warren Mackenzie's The Unbiased Investor. Great book pick it up, if you have a chance!

An IPS should have:
i) the target average rate of return for this investment portfolio over different time periods.
ii) The expected range of returns for the portfolio as a whole over different time periods.
iii) The percentage of each asset class in the recommended portfolio and the permissible ranges for each asset class.
iv) The benchmark that will be used to evaluate actual performance (see next page).
v) Possible investment constraints
vi) Rebalancing strategy
vii) All fees that will be charged
viii) Frequency of contact
ix) Topics to be covered in the quarterly review meetings.
x) Assumptions being made