By Christopher T. Lawson
In a recent AARP commissioned study by the American Council of Life Insurers, retirees aged 60 to 75 were surveyed to ascertain what factors they felt had the greatest potential to derail their plans for comfortable retirement. The single most concerning factor was inflation, followed by a decline in the stock market. Coming in third was the threat of having to pay for health care and prescriptions drugs. The fourth greatest concerning factor was a fear of depleting their investment and savings accounts. Rounding out the responses was the fear that they would be unable to work for pay, if necessary. Ironically enough, most of these concerns can be addressed by a simple document. Even though they may have done careful retirement planning, far too many baby boomers are still lacking an Investment Policy Statement (IPS).
In today's volatile market, an IPS can help our clients achieve the peace of mind of knowing that they are doing everything they can to preserve investment assets and protect their standard of living. So why hasn't the word gotten out yet? Why do Harvard and Yale know the value of using an IPS for their endowments, yet our clients have never heard of them? With this simple document, our preceding generations now have access to a powerful tool for managing and growing their investment portfolios, but we need to get the word out to them quickly and in terms that are easy to understand.
The Argument For An IPS
When you recommend an IPS to someone who has never heard of it, you'll likely be met with trepidation. In fact, you're liable to be asked, "Why haven't I ever heard of this?"
When dealing with clients who are unfamiliar with an IPS, remember that their unfamiliarity may cause them to doubt the veracity of such a statement. Start by letting them know that, until recently, only very wealthy individuals, qualified retirement plans like 401(k)s and certain types of trusts, endowments and foundations had an IPS. Be sure to mention that in the case of qualified retirement plans, trust assets, endowments and foundations, a written IPS is a requirement by law.
Furthermore, by explaining to clients that these documents have been in place for decades to guide key decision-makers with fiduciary responsibility, the apprehension they may feel towards formulating their own IPS should start to subside. However, to further the cause of setting up an IPS to protect your boomer clients' portfolios, explain that the IPS will aid in protecting them from these common destroyers of wealth.
Seven Destroyers of Boomer Wealth
1. Emotional Investment Style. Unscheduled portfolio investments or withdrawals during volatile market conditions have proven to destroy wealth for many investors. By setting up an IPS, clients will not make decisions that are emotionally driven. This can also protect them from fraud or scams.
2. Ravages of Inflation. An IPS will ensure that your client has addressed the decreasing portfolio purchasing power brought on by inflation.
3. Arbitrary Market Benchmarks. The IPS will allow your clients to focus on absolute portfolio returns and how they measure up to their overall objectives, rather than focusing on an arbitrary benchmark.
4. Over Diversification. When you help your client set up a pragmatic Investment Policy Statement, you also help them prevent over-diversifying their assets, thereby mitigating the risk of portfolio underperformance.
5. Under Diversification. Just as over-diversifying can lead to portfolio underperformance, so too can under-diversification. The IPS will detail how the client should diversify in order to balance risk versus reward.
6. Hasty Decisions. Our clients need to know that sometimes the best course of action is to do nothing, even in downward economic markets. The IPS will help clients make successful decisions, even if they seem initially uncomfortable.
7. Chasing Hot Investments. All too often, clients are eager to invest in what they have heard are hot investments. Unfortunately most money flows into high performing investments after the performance has occurred. Again, by implementing their own IPS, clients are directed to focus on how the new investment fits into the portfolio and into their overall objectives. This process leads to better long-term decisions.
After explaining to clients that an IPS will help them avoid these common destroyers of wealth, they will now need to know how the IPS accomplishes this goal. Again, keep the explanations accurate, but to minimize the risk of overwhelming clients with jargon use this seven-step guide to explain the process of setting up an IPS.
1. Let your clients know that the first step to drafting their IPS will involve an assessment of their financial situation through the identification of their individual goals and needs.
2. Ask your clients frankly about their risk tolerance. Are they aggressive in their investment strategy? Are they conservative? Furthermore, what is their time frame for portfolio withdrawals? If your clients are unsure of how comfortable they are with risk, provide them with a risk tolerance questionnaire to help them determine their own comfort level. While we can certainly make suggestions, our clients need to feel that they are in control of this decision. As financial planners, it is our obligation to provide objective information and allow clients to determine where they feel most comfortable.
3. Once risk tolerance has been determined, work together with your boomer clients to set long-term investment objectives. Ask them what they want their portfolios to do for them. What do they see as a realistic range of returns for their proposed asset allocation? Again, to ease any fears or apprehension, make sure your clients know that they are the ultimate decision makers.
4. We'll now have to ask our clients if they would like to place any restrictions on the portfolio and its assets. This is the step where you'll need to ask if there are any investments that your clients are averse to. Any investments that clients absolutely want to steer clear of should be acknowledged and accepted.
5. Run an Efficient Frontier Analysis on any proposed portfolio. This will allow your clients to see if they are being adequately compensated for the risk they will be taking on their portfolio. Revisions in the appropriate investment asset classes and mix will help minimize any unfamiliar or high-risk investments that may intimidate clients.
6. Explain the investment methodology that will be used with regards to the investment manager selection, rebalancing, buy/sell disciplines, portfolio reviews and reporting.
7. Let them know that you are now ready to implement the decisions they've made.
The process of making your clients feel at ease with their newly drafted and implemented IPS requires just a few more assurances. Essentially, they need to know exactly what to do with it.
Begin by letting your clients know that the Investment Policy Statement has now put their investment strategy in writing, thereby committing it to a disciplined investment plan. Clients may choose to think of their new IPS as a blueprint and regular report card for their entire investment portfolio.
As a blueprint, the IPS has successfully assured that clients will remain on track to meet their overall financial goals. As a report card, the IPS will outline the frequency with which clients will meet with advisors to review the status.
During each meeting, clients will review their Consolidated Investment Statement so that they get the big picture of the status of their portfolio. Clients should also receive a copy of the IPS during each meeting so that they can confirm that their decisions have been implemented per their wishes at the time of creating the IPS.
With these two documents, clients have a complete picture of how their portfolio is performing in conjunction with their goals and return parameters. If there is any discrepancy between what they had expected from their portfolio and what they have achieved, the IPS outlines what should be done.
Knowing that regular meetings will be scheduled to review portfolio performance should further eliminate any fears the client may still have over drafting their first IPS.
By simplifying the explanation and process of drafting an IPS for boomer clients, financial advisors are in an excellent position to secure future financial success for some of our greatest generation. Moreover, once clients begin to realize the protection and security that will be realized by drafting this crucial statement, they are likely to recommend that their friends and families seek out their own IPS. After all, who wouldn't like to know that their investment strategy is as structured and sound as the investment strategies of some of the biggest investors in the nation?
Christopher T. Lawson, CRPC, is a registered representative of Lincoln Financial Advisors Corp., a broker/dealer. Chris's investment advisory services are offered through Sagemark Consulting, a division of Lincoln Financial Advisors Corp. CA insurance license #OD25153. Chris welcomes questions via e-mail at Christopher.Lawson@lfg.com .