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Why the Traditional Structure of Investment Policy Statements Won’t Work for 401k Plan Sponsors

March 20
00:14 2012

To find the traditional structure of an Investment Policy Statement (IPS), we looked to the CFA Institute. The CFA Institute offers the CFA® designation to portfolio managers and securities analysts. We choose the CFA curriculum rather than the 1031054_70032980_old_wagon_stock_xchng_royalty_free_300CFP® curriculum because the CFA Institute has consistently promoted the concepts used in an IPS long before the industry consensus agreed to the term “Investment Policy Statement” (as far back as the 1980’s, the term was not universally accepted and at least some investment advisers used the alternative name “Statement of Investment Objective”).

Whatever it was called, the criteria promoted by the CFA Institute remained constant. Contrast that to the CFP® curriculum, which, being a broader field of study, promoted traditional investment goals instead of the IPS. In fact, as late as the 2001 in Personal Financial Planning Theory and Practice, Second Edition (by Michael A. Dalton and James F. Dalton and published by Dalton Publishing, LLC) – a popular text for those teaching the CFP curriculum – did not even have an entry for “Investment Policy Statement” in its index. The fact this text only refers to “investment goals” leads to another problem altogether, which is explained in the article entitled “401k Plan Sponsors: Is Your Investment Policy Statement Still Using Outdated Language?” (, March 17, 2011).

Regardless of the evolution of the term, the industry has now adopted its use as a minimum standard. The CFA Institute expects CFA candidates and designees acting as portfolio managers for individual and institutional clients to formally use such instruments. Page 61 of the CFA Program Curriculum Volume 1 – “Ethical and Professional Standards and Quantitative Methods” Level 1, published by the CFA Institute in 2010 states “When an advisory relationship exists, members and candidates must gather client information at the inception of the relationship.” Furthermore, the text stipulates “this information should be incorporated into a written investment policy statement (IPS)…”

Unfortunately, this is where things get a little difficult. In outlining the traditional structure for an IPS, the CFA Institute retains language from the era preceding the dominance of 401k plans in the institutional realm. While this structure certainly continues to work well for private individuals and single portfolio institutions like endowments, traditional defined benefit/defined contribution plans (i.e., pension and profit sharing plans) and, yes, even split-interest trusts with multiple beneficiaries, it represents an awkward construct for 401k plans.

To best understand why, let’s revisit the four general areas the CFA Institute requires (according to page 62 or the text) “in formulating an investment policy for the client, the member or candidate should take… into consideration.” The first area is “client identification,” by which the CFA Institute means the “type and nature of clients, the existence of separate beneficiaries and approximate portion of total client assets.” For a 401k plan, this basic information is good, but we do need more information on the plan demographics and other service providers. The CFA Institute does address this latter need on page 61 when it says “The IPS also should identify and describe the roles and responsibilities of the parties to the advisory relationship and investment process, as well as schedules for review and evaluation.”

The second area involves “investor objectives.” Here, the Institute breaks things down in two sections. The first deals with “return objectives” specifically citing “income,” “growth in principal” and “maintenance of purchasing power” (see our earlier reference to the article on outdated language). The second focuses on “risk tolerance,” meaning, per the Institute, “suitability” and “stability of values.” In both cases, these becomes more difficult for a 401k plan, which, under 404(c) must offer at least three distinct investment options that might be at odds with the consistency implied by the standard IPS structure. More significantly, we ran an entire series of articles about the problems of placing too much importance “risk tolerance” (see “7 Deadly Sins Every ERISA Fiduciary Must Avoid: The 2nd Deadly Sin – The Joy of ‘Risk’,”, August 16, 2011).

The CFA Institute calls the third area “investor constraints.” This contains six different categories, some of which are irrelevant and some of which are impractical to consider for 401k plans. The first category is “liquidity needs,” including “expected cash flows (patterns of additions/withdrawals)” and “investable funds (assets and liabilities or other commitments).” Clearly “expected cash flows” pertains only to retirees in the distribution phase (for which 401k plans in general might not offer the best place for retirees to place their assets). As for “investable funds,” that seems an issue more appropriate between the employee and his adviser than any part of the 401k plan’s IPS.

The second category is “time horizon.” This sounds like the stuff TDFs are made of and, as such, clearly of potential relevance to the plan’s IPS. The same can’t be said of the third category “tax considerations.” This has no place in a tax exempt plan. The fourth category “regulatory and legal circumstances.” This is relevant given the nature of 401k plans and ERISA, with or without the 404(c) Safe Harbor election. The fifth category is “investor preferences, prohibitions, circumstances and unique needs,” which appears to apply mainly to personal issues, not 401k issues. The final category is “proxy-voting responsibilities and guidance,” which falls into the domain of the underlying investment options and does not affect the plan itself.

The final area identified by the CFA Institute is “performance measurement benchmarks.” This area is too large to devote to a mere paragraph within a single article. Perhaps we’ll address this topic in a future article (or series of articles.

We must note what’s not included. At no point does the CFA Institute reference anything related to education as being part of the IPS. This education must address the needs of both the plan trustees as well as the plan participants. It’s critical any identified education program be delivered in a manner consistent with the IPS.

The CFA Institute makes no mistake as to the importance of a written IPS. On page 62, it bluntly states “to fulfill the basic provisions of Standard III (C), [Duties to Clients – Suitability] a member or candidate should put the needs and circumstances of each client and the client’s investment objective into a written investment policy statement (IPS) for each client.” This is good advice every 401k plan sponsor should take.

One last piece of advice offered by the CFA Institute (again on page 62) is this: “Annual review is reasonable unless business or other reasons, such as a major change in market conditions, dictate more frequent review.” Within the domain of the 401k plan, the IPS can probably be reviewed less frequently, as plan demographics generally take several years to change.

For those interested in reading about a modern template for a 401k plan IPS, you might read “How Should a 401k Plan Sponsor Construct an Appropriate Investment Policy Statement?” (, June 11, 2011).

Still interested in more insight? Then check out the upcoming book tentatively titled Fiduciary Solutions – The Best Opportunity for 401k Plan Sponsors to monitor plan compliance, plan investments and share the fiduciary burden with experienced professionals. To receive notification of its publication, e-mail us at and we’ll e-mail you back sometime this April when the book is published.

Finally, if you’re planning to attend the fi360 Conference in Chicago from April 24-27, Christopher Carosa will be presenting on the topic “How to Create a 21st Century Investment Policy Statement” during the 1:15-2:15pm session on Friday, April 27, 2012.

About Author

Christopher Carosa, CTFA

Christopher Carosa, CTFA


  1. Jeffrey D. Zimon, Esq
    Jeffrey D. Zimon, Esq March 20, 13:53

    Hi – great article. I speak often about how these policies are too strict, to arcane and inapplicable and pin fiduciaries – who must strictly follow the written terms of plan documents, to breach their duties.

    Perhaps more important is that if the IPS is a governing document, its drafting and creation is actually a legal document for plan purposes.

    Thus, if the creator and advisor of this legal instrument under which a plan is operated, is not a lawyer, they will take on the liability associated with lawyers, along with the potential for the unauthorized practice of law.

    Best – Jeff Zimon

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