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Sample Investment Policy Statement
INVESTMENT POLICY STATEMENT
Prepared for
John and Susan Smith
By
Winn Booth, C.P.A./P.F.S.
PKS Investment Advisors LLC
January 2004
INVESTMENT POLICY DISCUSSION
WHAT IS AN INVESTMENT POLICY?
An investment policy outlines and prescribes a prudent and acceptable individualized investment philosophy and sets out the investment management procedures and long-term goals for the investor.
THE NEED FOR A WRITTEN POLICY
A written investment policy allows you to clearly establish your investment time horizon and goals, your tolerance for risk (as measured by returns in bear markets and historic volatility) and the prudence and diversification standards that you want the investment process to maintain. A written investment policy also helps identify your need to take risk in light of such factors as your financial objectives and income stability.
Articulating a long-term investment policy explicitly, and in writing, offers significant assistance to both our clients and their investment advisors in protecting the portfolio from ad hoc revisions of a well-reasoned policy based on important personal considerations. Studies have shown that investors all too often act on emotional responses, generally to their detriment. A written policy helps assure rational analysis is the primary basis for important investment decisions.
INTRODUCTION
The purpose of this Investment Policy Statement (IPS) is to establish a clear understanding between John and Susan Smith ("Investor") and PKS Investment Advisors LLC ("Advisor") as to the investment objectives and policies applicable to the Investor's investment portfolio. This IPS will:
- Establish reasonable expectations, objectives and guidelines for the investment of the Portfolio's assets.
- Set forth an investment structure detailing permitted asset classes and the desired allocation among asset classes.
- Encourage effective communication between the Advisor and the Investor.
- Create the framework for a well-diversified asset mix that can be expected to generate acceptable long-term returns commensurate with the level of risk suitable to the Investor.
- Serve as a reference over time to provide long-term discipline for an established investment plan.
- Describe constraints that the Investor chooses to place on the investment strategy.
This IPS is not a contract but will provide the framework within which the Advisor will exercise discretion on the Investor's behalf. This IPS is intended to be a summary of an investment philosophy that provides guidance for the Investor and the Advisor.
INVESTMENT OBJECTIVES
The Investor's objective for the investment assets of the accounts, set forth in Exhibit A, is growth and income, accompanied by a moderate level of risk. The Investor has no expected immediate need of the assets in this account, except as noted below, and is willing to accept short-term volatility in order to achieve higher expected rates of return over the long run. The Investor's performance objective is to equal or exceed the performance of the S&P 500 Index, the EAFE (International) Index, and the Lehman Intermediate Bond Index allocated in a ratio of approximately 60%/40% (stocks and bonds) including an international equity allocation of 20%. However, no guarantees can be given about future performance and nothing contained in this IPS shall be construed as offering such a guarantee.
LIQUIDITY AND INCOME NEEDS
The Investor has determined that sufficient disposable income and liquidity is available from other sources so that the Investor does not need to maintain cash balances among these assets, except for investment reasons, including payment of investment management fees or as dictated below. The Investor's income need from the investment portfolio is $40,000 per year subject to an annual cost of living/inflation adjustment if necessary. Income will be distributed quarterly and is to be achieved on a total return basis (i.e., interest, dividends and capital appreciation). The size of the required annual distribution relative to the size of the account may necessitate a withdrawal of principal (assets as they were valued on 12/31 of the prior year) depending on capital market performance.
Diminution of portfolio value due to prolonged periods of poor market performance may require an alteration of investment policy.
TIME HORIZON
For the purpose of planning, the investor's time horizon for these investments is to be 20 years. Investor does anticipate withdrawing a portion of the portfolio prior to that time. Such anticipated needs are noted above. Capital values do fluctuate and the Investor recognizes that the possibility of capital loss does exist. Historical asset class return data suggests the shorter the holding period the greater the risk of the Investor's objective not being achieved.
RISK TOLERANCE
The Investor recognizes that seeking increased returns generally involves accepting greater volatility and risk. In determining the Investor's own risk tolerance, the Investor acknowledges that since January 1, 1973 a portfolio with the approximate asset allocation being implemented under this IPS experienced the following (results do not include investment advisory fees or transaction costs which will reduce the return numbers):
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Risk Tolerance
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| Worst single calendar year decline in value | Worst 24 month total return | Worst 3-year total return | % of calendar quearters with negative returns |
# of occurences of 2 consecutive negative quarters | # of occurences of 3 consecutive negative quarters |
| -10.4% | -18.5% | 3.2% | 25% | 5 | 1 |
The Investor understands that risk is inherent in investing in marketable securities and results could be better or worse than indicated above in the future. The Investor is prepared to tolerate negative performance in order to meet the Investor's longer-term objectives as a result of expected long-term returns.
The statement of the Investor's risk tolerance is an indication that the investor is unlikely to abandon the investment strategy set forth in this IPS if negative performance is no worse than indicated. The Investor understands that maintaining a consistent strategy during good and bad markets is an important factor in achieving longer-term objectives.
The Portfolio will be managed in a manner that seeks to minimize principal fluctuations within realistic market expectations consistent with the stated objectives and the chosen asset allocation over the established horizon. Financial research has demonstrated that risk is best minimized by holding assets over time and through diversification across low correlating assets, including international investments. Investor recognizes that inherent in this strategy is the likelihood that portfolio performance will differ over various time periods from any particular asset class or popular index (e.g., S&P 500, Wilshire 5000, etc.). The Investor accepts the likelihood of such tracking error as an acceptable condition of this strategy. The Investor recognizes, however, that performance results cannot be guaranteed and historical performance is not indicative of future performance.
ASSET ALLOCATION
Academic research suggests that the decision of how to allocate total assets among various asset classes will have far greater impact upon portfolio performance than security selection and market timing. Increased weighting to higher risk asset classes like small cap or value as compared to a total market weighting (e.g., Wilshire 5000) is expected to provide a higher expected return and more effective diversification. International asset class funds have historically also provided more effective diversification. Increasing allocation to fixed income typically decreases the volatility risk of a portfolio.
Deciding on the investor's appropriate asset allocation should be based on a review of the Investor's personal circumstances. This review may include the Investor's assets not included in accounts covered by this IPS, the Investor's income sources, and the Investor's employment or business holdings, and their sensitivity to factors which may impact individual asset classes specifically or markets generally. After reviewing both personal circumstances and the long-term performance and risk characteristics of various asset classes and balancing the risks and rewards of market behavior, the asset classes shown in the attached Exhibit B were selected to achieve the objectives of the Investor's Portfolio, as stated above, subject to any constraints listed below:
Other assets considered in determining this asset allocation:
Investment constraints and/or preferences:
INVESTMENT STRATEGY AND REVIEW
DIVERSIFICATION
Investment of the funds shall be limited, in general, to passively managed mutual funds or direct fixed income obligations in the following categories:
- Cash and cash equivalents, including money market funds and bank certificates of deposit
-
Bonds (investment grade or better corporate, U.S. government, municipal, or foreign
government)-
Stocks (U.S. and foreign-based companies)
-
Real Estate (REIT'S)
INVESTMENT MANAGEMENT
Generally, only passively managed asset class mutual funds shall be chosen. This strategy is employed to capture the return behavior of an entire asset class. This approach is based upon the major tenets of Modern Portfolio Theory which states that markets are "efficient" and that investors' returns are determined principally by asset allocation decisions, not market timing or selection of specific securities. Advisor does not rely on economic forecasts, employ strategies which shift allocations between stocks, bonds and cash or search for "undiscovered" stocks. Asset classes with historically demonstrated low correlation and different risk/return profiles are combined together in an attempt to both lower the volatility of the overall portfolio and enhance returns.
PORTFOLIO REVIEW AND REBALANCING PROCEDURES
From time to time, market conditions are likely to cause the Portfolio's investment in various asset classes to vary from the established allocation guidelines established by this IPS. Each asset class in which the Portfolio is invested shall be reviewed on a quarterly basis by Advisor and may, with the Investor's approval, be rebalanced back to the recommended weighting when appropriate. Rebalancing will be advised if either the weighting of an individual asset class varies by 25%, plus or minus, of its recommended weighting, or if the major components (domestic equity, international equity, total equity and total fixed income) vary by 5 percentage points, plus or minus, from those components' recommended weighting. When necessary and/or available, cash flows will be deployed or withdrawals will be made in a manner consistent with rebalancing the asset allocation. In the absence of cash flows, the advisor may effect transactions to rebalance the portfolio. Where a DFA Global Fund is used in a portfolio, rebalancing within the fund will be done automatically. Income tax considerations may influence the appropriateness of rebalancing activity.
ADJUSTMENT IN THE TARGET ALLOCATION
The approved asset allocation set out above indicates an initial target allocation for each asset class. From time to time, based on the Investor's changing economic or life circumstances or new academic research, it may be desirable to make changes in the target allocation. Such changes should not, however, be made due to expectations of the relative performance of individual asset classes. The Investor must approve any proposed changes in the form of a written amendment to this IPS.
INVESTMENT STRATEGY PERFORMANCE
The Investor recognizes that asset class investment performance is cyclical and, therefore, the Investor may experience periods of time in which investment objectives are not met. In addition, unless there are extenuating circumstances, patience will often prove appropriate when performance has been disappointing for a particular asset class, or the overall portfolio.
For the overall portfolio, the Investor should allow a five-year time period or longer for achieving the stated investment return objectives. Shorter time frames contradict the principles of long-term investing. Under no circumstances, however, can results be guaranteed.
DUTIES AND RESPONSIBILITIES
The Investor should always be cognizant that they have the ultimate responsibility for the investment of their own assets. The Advisor shall assist the Investor to discharge this responsibility with the care, skill, prudence and diligence under the circumstances then prevailing, that a prudent person, acting in a like capacity and familiar with such matters, would use in such conduct with like aims.
The Advisor is responsible for assisting the Investor in making an appropriate asset allocation decision based on the particular needs, objectives, and risk profile of the Investor, implementing such decisions, reporting portfolio performance to the Investor and rebalancing and tax managing the portfolio, as necessary.
The Advisor is a Registered Investment Advisor and shall act as the investment advisor to the Investor, pursuant to the Investment Advisory Agreement between the Investor and the Advisor.
The Investor should provide the Advisor with all relevant information on financial condition, net worth, and risk tolerances and shall notify the Advisor promptly of any changes to this information. Failure to disclose all such relevant information will limit the Advisor's ability to provide prudent investment advice. The Investor's duties, rights, and responsibilities are set forth in Investor's Investment Advisory Agreement with the Advisor.
ADOPTION
Adopted by the below signed Investor this 18th day of January 2005.
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