IPS: Investment Policy Statement

IPS: Investment Policy Statement

IPS: Investment Policy Statement

This was a fairly new term for me until it actually popped up as a part of my study curriculum. Actually most of us in India (this is my belief) haven’t actually started framing an IPS for our self at all. We are driven by thoughts like:

  • Do we need to do this?
  • Can’t we directly jump into trading without all this?
  • This only for sophisticated investors and not for us

But after understanding and gaining some insights into it I feel we all should devote some of our investing time in framing the individual IPS (or get someone do it for us). In this blog, we will go through the different ingredients of what goes into making a good IPS and how is it useful to all of us.

To state it in one line, IPS is a document which identifies one’s Investment Objectives and Constraints. Why are you investing? What are your goals? How much risk can you bear?

Once you understand the purpose, IPS will sound more Relevant and Interesting to you. It’s more Process Oriented, Less Mathematical and No Formula or Technicalities. Basically it summarizes the relevant fact and concludes the Investment strategy of one self.

Main Ingredients of IPS

  1. Objectives  (Risk and Return)
  2. Constraints (Time, Liquidity, Tax, Legal and Unique)

IPS Objectives (Risk and Return)

As a Return Objective you should list down your required (more priority goals) and desired objectives. Goals like having a retirement, child’s education, child’s marriage etc. has to be noted down. Also, the Risk Tolerance has to be noted down, Risk in terms of both Ability and Willingness.

To understand risk you have to do “situational profiling” of yourself and it’s done by understanding your biases, preferences and perceptions.

  • Active Wealth creator has higher willingness towards risk.
  • If perceived self wealth is more, one will take more risk.
  • Stage of Life also matters.

Risk and return goes hand in hand. If you can’t take more risk, you can’t get more returns. This does not mean you have to take lot of risk. The only point is your Return objective has to match your willingness and ability to take risk.

Objectives should also be consistent with Capital Market expectation and one’s constraints.

IPS Constraints (Time, Liquidity, Tax, Legal and Unique)

You should list down different constraints under which the investments have to be made, as they are more likely to limit your risk taking abilities and in turn hamper the return objectives.  Different individuals face different types of Constraints and they have been grouped into different categories like, Time constraint, Liquidity constraint, Tax constraint, legal constraint and unique constraints.

  1. Time Constraint

    (How much is timeframe of the investment):  This is critical because if we have a longer time frame, we do not have to worry about the short term market fluctuations and can concentrate on more long term investments. The age of the individual is one of the factors which determine his time constraint.

  2. Liquidity Constraint

    It determines how much dependent; the individual is on the Investment. Does he have sufficient emergency reserve or other sources of income to meet the sudden fund requirements?

  3. Tax, Legal and Unique Constraints

    Similarly Client should be aware of the before and after tax returns from the investment, the Legal constraint under which he can make investment and any specific Unique Constraint he may be subject to.

It’s better to approach IPS in a reverse order, meaning first analyze your constraints, then the risk tolerance and then the return objective. Because Constraint affects your risk tolerance and which affects the Return objective. I suggest after reading this article you sit down with a pen and paper, make a list of all your constraints and Risk tolerance and then jot down the Return objective and then analyze your portfolio and check if it meets your requirement. Happy Reading!!!

Amit Lalan

Amit Lalan

Amit holds a Finance MBA degree and has cleared all 3 levels of CFA exam. He loves to read books and listen to music.

  • vivek

    It’s better to approach IPS in a reverse order, meaning first analyze your constraints, then the risk tolerance and then the return objective. Because Constraint affects your risk tolerance and which affects the Return objective. I suggest after reading this article you sit down with a pen and paper, make a list of all your constraints and Risk tolerance and then jot down the Return objective and then analyze your portfolio and check if it meets your requirement. Happy Reading!!!