Following the lead of relevant trust law, some trust documents prohibited the investment in equities far into the 20^th century. Indeed, some trust documents today still place an undo emphasis on income, much to the financial ruin of the beneficiaries. 

With the advent of Graham-Dodd's Security Analysis in the middle of the 20^th century came a meaningful way to measure the relative merits of individual securities and, eventually, the value of portfolio management itself. (Yes, I know this wouldn't have been possible without the Prudent Man Ruling in the 19^th century, but just because the door was opened doesn't mean the consensus walked through it.)

It then became incumbent for portfolio managers to match the quantifiable attributes of potential investments with some sort of quantifiable description of the beneficiary or, as they were becoming more often, the client.

This ultimate led to a list of seven traits identified and promoted by the CFA Institute (nee AIMR) as part of the training and testing associated with their CFA certification program. By the 1990's, these seven traits found themselves being named the critical components of a traditional Investment Policy Statement (IPS).

By the end of the 20^th century, the IPS had supplanted the trust document as the governing document of choice when it came to investments. Even in actual trust accounts, it's not uncommon to see a separate IPS created for that specific trust portfolio.

But there are three problems with the traditional IPS for the 401(k) plan sponsor.

First, the original seven traits were devised in the pre-401(k) era, when a single portfolio was often used to address the retirement needs of an entire universe of employees. Under a 404(c) safe harbor, a 401(k) plan will need a minimum of three portfolios specifically designed to be inconsistent with each other. The traditional IPS cannot brook this inconsistency. We get around this problem mostly by ignoring it.

Second, the original seven traits do not account for education, a critical component for any 401(k) and something that must be incorporated into its IPS. In fact, this is how we get around the aforementioned inconsistency.

A 401(k) plan that offers a series of distinct and exclusive investment options does so under a defined due diligence system for defined reasons. Employee (and trustee) education must speak in terms compatible with this system and these reasons.

Third, the original seven traits initially appeared during the era of Modern Portfolio Theory (MPT). Worse, they were interpreted in terms of MPT. With recent research in behavioral finance, specific to 401(k) plans, calling significant aspects of MPT into question, does it make sense to continue to use this archaic language in IPS developed for a 401(k) plan?

Perhaps it's time to review that IPS you've faithfully filed in the "Legal" folder for your 401(k) plan. You might just find a few things missing.

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