A surgeon earning $900,000 adds a $1.5 million vacation home to her retirement plan. Monte Carlo success probability drops from 89% to 61%. The Investment Policy Statement (IPS) is the contract that codifies a client's objectives and constraints so portfolio decisions cannot drift from them. The IPS framework, central to the CFA® Program private wealth curriculum, exists to force that conversation before portfolio construction begins.
Where wealth comes from shapes how it should be managed. Four common origins matter for the IPS:
- Inherited wealth. Transferred across generations. The time horizon is often multi-generational, basis may have been stepped up at the prior owner's death, and the client's emotional posture is frequently one...
- Entrepreneurial wealth. Created by founding, operating, or exiting a private business. Pre-exit, the wealth is concentrated, illiquid, and economically correlated with one industry.
- Executive compensation. Generated through salary, bonuses, restricted stock units, options, and deferred comp. Wealth concentrates in employer stock through vesting cycles.
- Professional and labor income. Built by physicians, attorneys, engineers, and other high-earning employees through saving from current income.
Common mistakes
- Forgetting to gross up for taxes when computing required return. A 6% after-tax need at a 30% tax rate requires 8.57% pre-tax, not 6%. This error understates the required return and leads to an insufficiently aggressive allocation.
- Using total spending instead of net-of-other-income spending. If Social Security or a pension covers $50,000 of a $200,000 spending need, only $150,000 must come from the portfolio. Candidates who use the full $200,000 overstate the required return.
- Defaulting to the higher risk tolerance when ability and willingness conflict. The conservative default applies. High ability + low willingness = use low willingness. Low ability + high willingness = use low ability. Never average the two.
Bottom line
- Wealth source (labor, business ownership, executive comp, inheritance) shapes risk capacity, concentration risk, and stewardship posture; inherited wealth often shows ability above willingness.
- The IPS translates a client's situation into return objectives, risk tolerance, and five constraints: time horizon, liquidity, legal/regulatory, unique circumstances, taxes.
- Required return is real and after-tax: start from the after-tax spending need, then gross up for inflation, taxes, and fees.
- Risk tolerance = ability + willingness; when they conflict, use the lower one (never average or default high).
Exam shortcut
When the vignette gives client age, spending, portfolio value, and tax rate, compute required return first, it anchors everything. The formula: (Spending - Other income) / Portfolio + Inflation, then divide by (1 - Tax rate), then add fees. When you see a concentrated stock position, immediately think: what percentage of total wealth, what is the cost basis, and what are the tax consequences of selling.
The full lesson (about 4,325 words, 29 min read) adds 2 worked examples, all 10 common mistakes, a self-check, free in the app.
Learning objectives
- private wealth overview
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