Article by Marcel LeBlanc for the Times & Transcript published November 30, 2019.

You’re sitting there 
with an advisor trying to figure out how you would feel if your hypothetical investment account dropped by 20%. Who remembers the challenge of trying to understand risk tolerance questions when filling out investment applications? 

LBI Facebook Link PostProperly communicating investment risk is a struggle most investors and investment professionals have in common. The problem is that, even if you get through all 
the questions, investor profile and risk tolerance questionnaires often fall short of clearly articulating an investor’s true ability or willingness to take on investment risk. While most Canadian retail investors may have never heard of an Investment Policy Statement (IPS), it’s a tool widely adopted by most sophisticated and institutional investors in order to clearly articulate how an investor’s portfolio should be invested.  

Think of an IPS document as a detailed plan for your investments. Instead of simply setting a maximum amount of volatility or risk in a given portfolio, an IPS will collect and describe pertinent information about the investor. That could include their goals, what the money will be used for, when it’s likely to be needed and what other assets are available to cover emergencies. It can also include notes such as investor preferences, what sectors should be avoided and what kind of emotional and cognitive biases the investor might be prone to. Once all pertinent investor information is collected, a competent portfolio manager or investment advisor can set guidelines or policies which will determine how the portfolio will be constructed and managed.  

Because risk is an important consideration for investors, a well thought out IPS will focus on two ways of looking at investment risk: the ability to take risk in a portfolio and the willingness to take risk in a portfolio. The risk an investor is able to take brings their financial position into consideration. This is where investors need to consider when and how they plan to use their investments and what are the risks of that timeline being broken. The risk an investor is willing to take is the risk that they are comfortable taking on an ongoing basis in order to try and achieve higher returns. It’s the way most investors see investment risk measured by the potential decline that their investments could generate in a given time period. 

The reason the IPS exercise is so important is that it dives much deeper into the investor’s true risk profile and expectations. Once the information is collected, the portfolio manager or advisor can interpret the information, make recommendations and confirm everything with the client before putting it into the IPS document 

An IPS can also serve as a great reference guide to keep investors on track for long-term success. As an investor’s circumstances change, an IPS can always be revisited and changed if needed.      

Investing without an IPS can work if the goal is simply to avoid taking on too much risk in a given account or portfolio. But if the goal is to properly plan how an investment portfolio will be managed, a properly designed IPS is certainly a great tool to work with.