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- March 10, 2016
I recently shared my IPS with you when I told you rather brashly that You Need an Investor Policy Statement(and later shared a Revised IPS). In that original article, I laid out some of the rationale as to why I think it’s a good idea to create one and to have one. I even gave you mine, but I didn’t explain how or why I came up with the information within.
I’d like to do that today, section by section. Fasten your safety harness and keep your hands inside the vehicle at all times. Personal finance doesn’t get much more exciting than this!
Objective
- Retire early, no later than age 54 / empty nest, most likely earlier.
- Acquire a large cushion, with > 40x annual expenses and > 50% available before 59.5.
I’ve made it clear that I intend to Retire Early. Those words appear in big font at the top of every page on the site. If you’ve read some other posts, you might have noticed that I usually talk about retiring in my 40’s, but here I state no later than 54.
If you transpose those numbers, you’ll get an age that I’m more likely to retire (45), but the IPS is drawing a hard line at the maximum age that it might make any sense for me to still be working. I should be 54 when my younger of 2 boys graduates from high school, and at that point my wife and I will be free to travel and no longer tied to the school schedule.
I threw the “empty nest” rider in there in case we follow through with our frequent threat to send the boys to boarding school kindergarten. That’s usually good for a laugh at the dinner table.
I’ve set a soft goal of wanting 50x annual expenses before I retire, which would give me an ultra-safe withdrawal rate of 2% to kick off my early retirement. I should be able to get there in the next 5 years or so with even modest positive returns. But this says 40x. Why? This is the minimum I would accept without fear of regretting I walked away too soon. If my portfolio delivers negative returns over the next 5 years, 40x could still be within reach.
The final condition, having the majority of the money easily available, has already been met, and that ratio of available money will continue to increase as my taxable account gets the bulk of my investments going forward.
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Philosophy
- Invest in a diverse portfolio of Vanguard Index Funds, keeping expenses low.
- Accept market returns, rebalancing with monthly investments.
- Risk tolerance quite high. Anticipate withdrawal rate < 3%.
Vanguard has excellent, very-low cost funds that satisfy my needs. The company is owned by the investors. You can’t walk into your local Vanguard office, but helpful people are a phone call away.
I’m not going to try to beat the market. I don’t have the time, and if I did, I’m quite confident in my ability to fail, as most others do. Simple investing is evidence-based investing.
I’m not afraid to watch my net worth expand and contract with the greater market. I believe that the long-term trajectory of a diversified portfolio will point upwards.
Asset Allocation
- 60% US Stocks, 20% International, 10% REIT, 10% Bond / Cash.
- U.S. stocks: Lean toward small and mid-cap value to maximize potential long-term return.
- International stocks: 50% Developed, 50% Emerging Markets
I have detailed the reasons for my asset allocation in the PoF Portfolio. It’s not terribly complicated or sophisticated, but it works for me.
Other Considerations
- Maximize tax deductions via 401(k), 457(b), HSA, donor advised fund. Front load 457(b).
As an aspiring early retiree, I can pretty much guarantee that I will be in a lower tax bracket in retirement. Tax deferred / traditional retirement savings accounts are a no-brainer. A Roth 401(k) would be a poor choice.
I plan to superfund the DAF in my final years before retirement. I contribute the maximum to my 457(b) in the first few paychecks to get a year’s worth of returns on the full $18,000.
I would do the same with the 401(k), but that goofs up the match, a fact I learned the hard way. It happened to work out in my favor since I received the match in a true-up early 2016 when the markets were lower than they were throughout the year last year, when I thought I would be receiving the match. Better lucky than good!
- Annual backdoor Roth contributions of $5500 each (spouse and I) in January.
I will take advantage as long as the door stays open. This money would go to taxable otherwise. In the Roth, the dividends and gains are not taxed. I’ve made a step-by-step guide on how to do this with Vanguard.
- Tax loss harvest when possible, which will require some attention to balances.
“Set it and forget it” is not the best advice. You don’t need to check your portfolio daily, but you need to pay attention. I will be able to deduct $3000 from my income for many years due to tax loss harvesting.
- Fund boys’ 529 accounts (each February & August).
I receive a larger paycheck a couple times a year. The extra cashflow funds the boys’ education. 529 accounts work like Roth accounts when used for education-related expenses, with tax-free growth and withdrawals.
- Invest in taxable account monthly.
The amount varies monthly. I try to keep 1 to 2 months’ expenses in ready cash (checking / savings). The rest is invested in the taxable account. I believe in dollar cost averaging.
- Forego monthly taxable deposits to cover large expenses (vehicles, home improvement).
I’m debt-free and I’m not about to give that up to buy a car, quartz countertops or cork flooring.
Pre-Retirement Considerations:
The cost of healthcare is a huge question mark and continues to be a hot political issue. This is one area of personal finance that might be the most likely to change over the next 5 years or so. I’ll investigate my options as the date draws near. If I were to retireright now
, I would be looking at the ACA exchanges.
- Consider part time work as an option to transition to retirement.
Part-time work may or may not be an option for me. If it is, I’ll consider it. I can’t decide if I’d rather press on for 1 or 2 years full time compared to working part time for 2 to 4 when I get close to my goals. That’s a tough call. If the option’s not on the table, my mind will be made up. [Update: I chose part-time work]
- Consider what’s best for the boys / family.
This statement is intentionally vague. Obviously, I wouldn’t put a premature end to my career without lengthy discussions with my wife and family. I want to have a vision of how our lives will be different after I retire. I want to make sure the 529 funds are adequately funded (they will be).
Drawdown Plan
- Set up 457(B) to pay $1000 to $2000/ month.
When retired, I don’t want too much taxable income coming in if I can help it. I’d like to have room for Roth conversions while staying in the 15% income tax bracket. The account should last at least 15 years with poor returns and perhaps a lifetime at withdrawal rate in this range.
- Receive dividends and capital gains as cash transfers to bank account.
- When cash is needed, sell taxable assets and minimize / optimize capital gains.
The bulk of our spending money will come from our taxable account in early retirement.
- Attempt to remain in 15% tax bracket to avoid taxes on capital gains (unless tax laws change).
It’s possible to avoid all federal income taxes in early retirement, but taxable incomemust remainin the 15% bracket with taxable income less than $74,900 (in 2015).
- Convert 401(k) / IRA to Roth as income / tax bracket allows.
The goal here is to make Roth conversions to fill up the lowest tax bracket, reducing Required Mandatory Distributions (RMDs) that are mandated at age 70 and beyond.
- Donate appreciated securities to Donor Advised Fund when needed to maintain low tax bracket.
This only makes financial sense if I am itemizing deductions. Donating prior to retirement will be much more beneficial from a tax perspective.
- At 59.5, evaluate 401(k) / IRA and estimate RMD’s, which kick in age 70.5.
- Anticipate delaying Social Security to get the maximum benefit, assuming good health.
I expect the rules to change between now and then. Based on current law and our current health, I would be delaying taking SS until age 70. There’s plenty of time for that to change, however.
- Pay for boys’ college with $2000 to $4000 cash (to obtain tax credits), then tap 529’s.
I don’t mind allowing the U.S. government to pay for the first $2000 (and 25% of the next $2000) that we put towards our boys’ tuition. Thank you, American Opportunity Tax Credit!
Retirement Asset Allocation:
- 10 years of expenses in bonds (in 457(B) and 401(K)).
- Remainder in Equities, maintaining 3:1 US / International Ratio.
- Consider decreasing REIT holdings to 5%
I believe I got this idea from the Bogleheads forum. The point is to have enough money in fixed income / bonds to survive a prolonged drop and subsequent recovery in the equity portion of your portfolio.
I came up with 10x because that would give me a typical retirement 60 /40 stock / bond ratio in the 25x that is considered a pre-requisite to being financially independent. All monies exceeding the 25x can be invested more aggressively since my risk tolerance with the overage is extremely high. I very likely won’tneed it, but I’d love to see it grow.
Decreasing REIT exposure to 5% would give me 5% to do something different with. I could keep it in real estate with a crowdfunding opportunity, or try some peer-to-peer lending for higher returns with associated risk.
I didn’t speak much to the Donor Advised Fund here, although I’ve stated on this site and on other forums that I’d like to build it up to 10% of my own nest egg. I’ve pledged to give a large part of my profits generated by this site to the charitable fund, and I anticipate making large donations from my own income in the final years before my early retirement to make that happen.
The IPS is a dynamic document, and it should be reviewed and revised occasionally. Since I’ve made a commitment to build up that DAF to 10% of my own nest egg, I will make that revision when I revisit it next.
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[Post-publication update: As I said, the IPS is a dynamic document, and I have made some changes, as highlighted in Revisiting and Revising the Investor Policy Statement. Follow the link to see what changes were made and why.]
What are your thoughts? What would you do differently? I’m always open to suggestions.
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19 thoughts on “A Detailed Dissection of my Investor Policy Statement.”
I’m re-reading this for the 3rd time. I am debating continuing my 457 with a new employer. It seems that 457 Money is the first to be withdrawn. Why do you keep it in bonds? So it’s stable and allows the other plans to grow until you drawdown all the 457?
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Mine’s currently in stocks, but at retirement, I’ll be sure to have the bond portion of my portfolio split in either the 401(k) (where it is now), the 457(b) or both.
If you have good investment choices and are in a high marginal tax bracket, it’s probably a good idea to continue investing in the 457(b) with tax-deferred dollars. You can access it as soon as you retire — no waiting until 59.5.
As my balance has grown (will likely be over $200,000 when I retire), I will probably set a higher monthly draw than initially planned here. I’d like to get it all out while we have these low tax rates (i.e. before 2025). So maybe in the $3,000 to $4,000 range.
Best,
-PoFReply
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I never understand why doctors want to be in a lower tax bracket in retirement? I do not know of any successful people who work to be in a lower tax bracket. Perfect planning means is replacing your pre-retirement income in retirement that is inflation protected so that you do not take a pay cut. Retirement distribution rates should be between 7-13% and not less than the 3% that is recommended in traditional planning. The only way to do this is to have strategies in place that will not only give you more income, but more enjoyment in retirement and also with less risk. Unfortunately, since there is no magic financial product, it is a matter of looking at the big picture to accomplish this. I was happy my advisor taught me this long ago.
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I’m in the 35% tax bracket. When I no longer have earned income, my taxes will be on dividends and capital gains from a taxable brokerage account, withdrawals from a 457(b) until it’s depleted, and eventually possibly RMD’s if I haven’t done Roth coversions on that money along the way. In order to get back into the 35% income tax bracket, I would have to spending needs north of a half-million dollars. As it stands, I could easily spend $100,000 to $150,000 a year without paying federal income tax.
I hope you have read numerous sources and not simply relied on the word of one advisor, because he or she is selling a dream that sounds like it could turn into a nightmare. You might expect 7% to 13% returns most years based on historical averages, but there will be down years, which is why you can’t expect to withdraw that much annually. ERN has done an exhaustive analysis of withdrawal rates, and you’re dreaming if you expect to safely withdraw that much, unless you’re still earning income to cover the majority of your expenses. Real estate income can fit the bill, for example. I think we’re all looking at the big picture, which is why we talk about safe withdrawal rates.
Best,
-PoFReply
fantastic plan! I was reading more about you on this blog. It’s incredible how you just started the blog in 2016. It’s an amazingly informative and fun blog to follow. thank you. you are definitely a thorough planner, not just in personal finance, also evidence in your blogging endeavor. There’s so much I could learn from you!
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Thank you very much for the high praise. I’m not sure it’s deserved; all of it is a work in progress, but I’m glad you are learning and enjoying the site.
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Thanks,
Just by disclaimer I have no vested interest in talking about commercial real estate. But, I am happy to chat with you or anyone that is interested in more info.
REIT’s as we all know are stocks- that means they behave like stocks and are subject to systematic or broad market risk. I am referring to PERE – Private Equity Real Estate. Typically these are funds, not individual buildings, that purchase multiple assets for a set number of years. They can carry some high entry numbers , but with some looking around many will take less than $100K. These are managed by professionals and many companies have extensive track records. At present I am in 3 companies, and am earning between 7 and 8% cash on cash now, with reversion ( closure of the fund) IRR’s projected between 12- 14%. They do exist .
Just food for thought.
Reply
That’s some tasty food for thought. I like those returns, thank you for sharing your experience.
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I’d like some info about PERE.
ThanksReply
Firstly, let me say , nice site and I appreciate the hard work bringing important financial info to the Docs of the world.
I love the IPS and I plan on creating a formal one this weekend. Last year, I did a very brief outline and I find it helpful.Questions:
1) I get the large bond exposure to help even out systematic market risk, but assuming someone was retiring today wouldn’t it be a concern in the face of potentially rising interest rates?2) It seems to me that income is key in retirement – thus why not move a decent chunk to commercial real estate? Well run commercial real estate funds can typically produce 7-8% cash on cash returns, with 5-7 yr project IRR’s of 12-14% or higher. The cash flow is largely tax sheltered during the early years, and at the end of the cycle, you will face capital gains tax and depreciation recapture taxation, but still net a tidy return.
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Thank you for the kind words, NJDoc!
Answers:
1) With 10% bonds / cash, at age 40 and within 10 years of an early retirement, I think I’m more likely to be accused of being underweight as opposed to overweight in my bond allocation. Some would argue for 0, others > 30%. I do what works for me, which is 8 to 10 percent. As interest rates rise, the price of bond funds could very well fall, but I figure the expectations are already built into the price.
2) I’ve got 10% in Vanguard’s REIT fund, which gives me good exposure to commercial real estate. The fund gives me lower risk with less upside. I am tempted to do some individual deals via RealtyShares. I’ve been approved and get the e-mailed opportunities. If I pull the trigger, I’ll let you and other readers know. Going in on an isolated venture can certainly be more rewarding, but carries more risk. I wish I could get 7% to 8% guaranteed, but that’s not happening these days.
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Nice post, I love the idea of the IPS. Two questions: First, when front-loading your annual 407(b) contribution of $18k in the first few paychecks, have you found that the returns stack up favorably against dollar cost averaging the same amount over the entire year? And second, are you calculating net worth as investable assets or are you including non-liquid assets such as real estate, home(s), etc. in the aggregate? Thanks.
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Great questions. Frontloading works out better roughly 2/3rds of the time. In down years, you are better off dollar cost averaging. Since we don’t know which years will be down years in advance, choosing not to frontload when you can afford it could be considered market timing, which is generally regarded as ill-advised. See this page on dollar cost averaging from the Bogleheads wiki; the frontload is equivalent to investing a lump sum or windfall.
For the purposes of retirement planning, I only look at invested assets, the taxable account, Roth accounts, HSA, 401(k) and 457(b). When calculating net worth, I include property and 529 accounts, but I don’t intend to use either of those to fund our retirement. The Donor Advised Fund is not included in either calculation, as the money is only available to be given away.
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I am a fan of the vanguard index funds as well. My current approach is to keep it simple and be aggressive with pre-tax allocation to index funds that are fairly aggressive as I still have some time ahead on the horizon. I also figure now is the time to get the habit as we intend to start our family in the next 2 to 3 years and have to adjust the budget.
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Sounds like a good plan. It’s never to early to start!
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We have six children and 3 are out of the house, but we still pay for some of their expenses to aid the one who is in college and the one who is a missionary. Our income/expenses did not allow us to set aside funds for college, but we had family that helped. As kids leave and expenses decrease we may be able to set aside funds to help with college. But our own retirement account is still quite small. We have taken some big trips over the years and I will never regret the memories that were built. Of course having six kids makes everything more expensive to begin with. I also can’t imagine not having any one of our kids, although raising a large family in this day and age is not for the faint of heart. As I don’t have my own plan, I can’t really critique yours, but thank you for the motivation to work on one. :O)
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Hats off to you, Chris! My 2 boys are more than enough to handle most days.
I won’t fault you for taking big trips and getting the most of your time with your family. You will never be able to relive those years. We are in the midst of a memory-making family vacation ourselves. Just catching up on the blog after the kids have gone to bed.
I encourage you to start with a simple plan. You don’t need to have all the details worked out from day 1.
Last, I don’t know how familiar you are with The Millionaire Next Door and the concept of “economic outpatient care”. If you are, excellent. If not, you may want to read that chapter. The message is that financially supporting adult children can be to their detriment (and yours). College tuition is exempt, of course.
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Another great post. The problem is tax laws change. I see your goal is to stay in the 15% bracket but as your wealth expands you might have too much money coming in via dividends to stay there. I am considering roth conversions when I completely retire. I think you have identified two things that worry me. RMDs being applied to Roth accounts and health care premiums. I am 58 and have significant muni bond holdings but still generate lots of money in my taxable accounts. I will probably be fine living off dividends and interest until the government forces me to take RMDs.
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Thanks, Hatton1. You are absolutely correct that the laws will change. The rules in the 4th quarter may barely resemble what we knew before kickoff. The best we can do is to have a tentative strategy based on what we know now, and revise the IPS annually or as the need arises due to rule changes.
I’d like to stay in the 15% bracket as long as possible, assuming LTCG remain untaxed in that earned income range. I’d like to be able to do Roth conversions, but the higher the dividends from the taxable account, the less I’ll be able to do. If I’m able to build readership and better monetize this site, it could become an obstacle to my plan as well. I’d welcome the “problem” and wouldn’t let the tax tail wag the dog, but I recognize the possibility. Donating half the proceeds will reduce the tax implications if this site were to someday generate substantial revenue.
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