Investment advisors make sales calls every day, pushing investments that often aren’t in their clients’ best interest.
Sometimes they don’t even bother to make a call. They just load up accounts with investments and beg for forgiveness later, if and when things go wrong.
How can you prevent this from happening to you? Three words: Investment policy statement. You can think of an investment policy statement (IPS) as a contract between you and your investment advisor.
By filling it out and signing it, you and your investment advisor agree what will be in your investment portfolio, and what will not be in there.
Most importantly, your IPS establishes how much risk you are willing to take in your portfolio by setting down your target asset allocation.
Setting a target asset allocation
What’s a target asset allocation? Well, you might agree with your advisor, for example, that your portfolio will hold 5% in cash, 40% in bonds and other fixed-income securities, and 55% in stocks, also known as equities.
These basic asset classes would then be broken down further. For example, you could designate 20% of the equity portion be in Canadian stocks, 50% in U.S. stocks and 30% in international stocks.
You could take it another step by saying, for example, you don’t want any new stock issues in your portfolio. Or, you could say you only want ethical or green investments and define what you mean by that.
The important thing is that it’s written down.
How much is your advisor earning?
It’s also crucial for your IPS to clearly state how your investment advisor will be compensated and by how much. It should list all commissions, fees and charges you will be paying to have your investments managed.
Why is an IPS so important?
First and foremost, it keeps you on track in terms of controlling how much risk you are taking in your investment portfolio.
Think about the strong returns we’ve seen in the stock market. As your stocks appreciate, they represent a greater percentage of your portfolio and more risk.
Your investment advisor would see that and rebalance your portfolio in line with your IPS. He or she would increase the percentage of fixed income to re-establish your target asset allocation and agreed risk profile.
Helps you not to panic
On the other hand, say the market is falling sharply and you start to panic. You want to sell stocks. Your investment advisor can use your IPS to persuade you to ride out the storm and even buy stocks to rebalance on the other side.
Finally, an IPS can help protect you from bad or risky investments. Too often in Canada, advisors have conflicts of interest and clients are sold investments that are not in their best interest.
I’m proud to say that at PWL Capital, we sign an IPS with all our clients. We have done so since we started the firm 20 years ago. We think it’s an essential tool when you venture into the investment world.