A Detailed Dissection of My Investor Policy Statement

One doctor's IPS is detailed line by line. The thought process and individualization are described.

I recently shared my Investor Policy Statement (IPS) with you when I told you rather brashly that You Need an Investor Policy Statement. In that 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!

You're in for quite a ride!

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. If you’ve read some other articles, you might have noticed that I usually talk about retiring in my 40s, 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 two 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 five 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 five 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.

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.

• US 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 $5,500 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.

• 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 $3,000 from my income for many years due to tax loss harvesting.

• Fund boys’ 529 accounts (each February and 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 one to two 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

• Research health insurance options.

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 five years or so. I’ll investigate my options as the date draws near. If I were to retire right 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 one or two years full time compared to working part time for two to four 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.

• 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).

Hang in there! We're almost done.

Drawdown Plan

• Set up 457(B) to pay $1,000 to $2,000/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 income must remain in 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 social security until age 70. There’s plenty of time for that to change, however.

• Pay for boys’ college with $2,000 to $4,000 cash (to obtain tax credits), then tap 529’s.

I don’t mind allowing the US government to pay for the first $2,000 (and 25% of the next $2,000) 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’t need 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.

That's it. An IPS doesn't need to be this lengthy or complicated, but I recommend creating a simple document, a roadmap to guide you on the path towards a successful retirement.