Make An Investor Policy Statement
With the stock market dipping down last week then rebounding shortly after, it shows us how volatile stocks can be. And it’s easy to become emotional when following the ups and downs of market volatility.
We all know that it’s important to not be distracted by the noise, stay the course, and stick with your investment plan. But what if you don’t really know what your plan is? The solution to that is, you formulate a plan. This is done by making an investor policy statement.
Is an Investor Policy Statement Necessary?
To be honest, I never thought I needed one. The path to wealth and financial wellbeing seems so simple.
Earn money from your job. Potentially earn even more money through various side hustles. Keep lifestyle expenses relatively low. Save as much money as you can while maintaining a good quality of life. Max out all available tax advantaged retirement accounts. Then invest the rest of your saved money in passive index funds that have ridiculously low management fees.
And to keep track of everything, just use Personal Capital to aggregate all your investments, evaluate your asset allocation and see if it is on the efficient frontier.
Easy peasy.
At least that’s what I thought…
Life was a bit simpler ten years ago. I was somewhat of an oblivious frugal resident who happened to stumble on this fortuitous path despite knowing very little about investing.
But now I’m married, have a baby, make more money, have a sizable mortgage, and I am bit more financially literate. Life and investing isn’t quite as simple as it used to be.
My wife and I often talk about buying nothing and saving a lot of money. But it’s time to clarify our financial goals and implement an investment strategy to create a sustainable future. This is the primary reason why we decided to make an investor policy statement.
So what exactly is an investor policy statement anyway?
Investor Policy Statement
An investor policy statement is essentially a mission statement that clearly defines your investment goals and financial values. It provides a roadmap for achieving these goals in a way that aligns with your principles.
In addition to specifying concrete financial goals, an investor policy statement may also delineate your personal philosophy on saving, spending, and investing. It also outlines your desired asset allocation along with specific strategies on how to invest and rebalance your portfolio.
Writing out an investor policy statement makes it more compelling to follow a thoughtful and disciplined investment plan no matter what happens with the stock market. A well formulated investor policy statement helps to remove emotion out of all investment decision making. It can help prevent bad decisions such as panic selling when stocks are low and panic buying stocks at all time highs due to fear of missing out (FOMO).
Additionally, an investor policy statement can serve as a guideline for heirs to follow in the unfortunate event that you pass away or are unable to make financial decisions.
So what does my investor policy statement look like?
My Investor Policy Statement
Overall Goals
- Achieve financial freedom before I am 45 years old (I’m 35 right now, so this will be in 2028). Financial freedom can best be described as having enough wealth to cover expenses indefinitely.
- Assuming our annual expenses are about $100,000. This would mean that our investment net worth should be 25 to 33 times annual expenses according to the 3-4% safe withdrawal rate rule of thumb. Therefore, the specific goal is to attain 2.5 to 3.3 million in invested assets by 2028.
- Alternatively, we can potentially reach financial freedom if our passive income streams (e.g. dividends, income from rental properties, side business, etc.) exceed annual expenses.
- Have enough money to care for elderly relatives in the future.
- Create a strong financial foundation for our children so that they never worry about having enough money. Eventually provide a meaningful inheritance for our children.
Short Term / Medium Term Objectives
- Pay off home mortgage in less than ten years. To achieve this, we will pay an extra $4,000 toward the principal every month.
- Anticipate public service loan forgiveness (PSLF) in about six years. While my medical student loans are completely paid off, my wife still has about $200,000 in law school loans. So far, she has made four years worth of income based repayments that qualify for PSLF. The specific plan of action is to minimize her adjusted gross income by maxing out tax-sheltered accounts, be diligent in re-certifying her employment status at least annually, and regularly check FedLoan Servicing to ensure that every qualified payment is credited.
- Maintain a sizable taxable account that will serve as insurance in the unlikely event that PSLF is repealed. To that end, we will continue investing about $4,000 a month in Wealthfront and Vanguard taxable accounts.
Saving
- Save at least 50-60% of our after-tax income in tax-advantaged vehicles and taxable accounts
- Max out all tax-advantaged vehicles every year: My 401k ($18,500) + My Keogh ($36,500) + My Backdoor Roth IRA ($5,500) + Wife’s 401k ($18,500) + Wife’s governmental 457 ($18,500) + Wife’s Backdoor Roth IRA ($5,500) = total of $103,000 (based on 2018 limits)
- Invest at least $100,000 every year in our taxable brokerage accounts. Split between Wealthfront and Vanguard.
- With the above savings rate, we effectively live on less than half of our after-tax income.
Spending
- Anticipate about $100,000 in annual expenses. A majority of this is our mortgage PITI costs since California is a high cost of living area.
- Be cautious of excessive lifestyle inflation. Remain frugal.
- Buy nothing that does not bring happiness, fulfillment, or sustained value. It’s okay to spend on life-enriching experiences (like travel) over material things. Be an essential minimalist.
- Be mindful of every purchase by following the guidelines of conscious consumerism.
- Spend on good quality, healthy food. Understand that restaurants are primarily for convenience, entertainment, and social events; they are not a reliable source of health-promoting food. A majority of meals should be whole food plant based meals cooked at home. Eating this way is inexpensive and healthy.
- Use credit cards responsibly. Always pay credit card bills in full and on time. It’s acceptable to have a lot of credit cards for the purpose of making money and/or travel hacking. Just be mindful of the various rules of opening up credit cards.
- Track expenses monthly for the purpose of being mindful of our money. There should not be a need for strict budgets.
Emergency Fund
- Keep three to six months of living expenses in cash. Some of this cash is held in a checking account for ongoing expenses. Most the money is held in a high yield Discover money market savings account with a current APY of 1.9%.
- At least three months of living expenses is saved in cash as an emergency fund.
- The rest of the money is reserved for paying estimated quarterly income taxes.
Investment Philosophy
- Buy and hold strategy with passively managed index funds as primary investments.
- Maintain a diverse portfolio of uncorrelated assets.
- Risk tolerance is high because my wife and I are young, our investment horizon is long, and we both have reliable income from stable jobs. Our risk tolerance will decrease over time as we become more conservative with the goal of preserving capital.
- Keep expense ratios low. Favor passively managed funds. However, actively managed funds are acceptable if expenses are relatively low (<0.5%).
- Okay to hold individual stocks, but no more than 5% of total portfolio.
- Consider real estate investing (direct ownership, syndication, crowdfunding, etc.) if a valuable opportunity arises.
- Never invest in an asset class that I don’t understand. This is why I never invested in cryptocurrency.
- Minimize tax liability on investment returns as much as possible.
- Never try to time to market. Don’t panic sell during market corrections. Stay the course and stick to the plan.
- Tax loss harvest whenever possible
Asset Allocation
This is subject to change and fine-tuning, but it currently looks like this:
- 50% US Stocks
- ~20% Large Cap
- ~15% Mid Cap
- ~15% Small Cap
- 25% International Stocks
- ~15% Developed markets
- ~10% Emerging markets
- 15% Bonds
- ~14% US Bonds
- ~1% International Bonds
- 5% Other
- ~3% REITs
- ~1% metals
- ~1% natural resources
- 5% Cash
- ~4% high yield money market savings account
- ~1% checking account
Investment Accounts
- Vanguard taxable account: primarily consists of large cap funds consisting of VLCAX, and VFIAX.
- Automatic re-investment of dividends is turned off to avoid wash sales. Transfer dividends to checking account.
- Perform tax loss harvesting (TLH) using VLCAX and VFIAX as partners. VTSAX is not used for TLH purposes. This is because Wealthfront performs automatic tax loss harvesting using VTI (an ETF that is substantially identical to VTSAX because it tracks the same index).
- Wealthfront taxable account with aggressive asset allocation algorithm (9/10 risk score): 35% US stocks, 25% foreign stocks, 19% emerging markets, 10% dividend stocks, 6% municipal bonds, 5% natural resources.
- Pro: automatic balancing, tax loss harvesting, and direct indexing
- Con: 0.25% assets under management fee on top of expense ratio of low cost ETF/funds
- Wife’s Roth IRA: primarily consists of mid cap index funds.
- My Roth IRA: consists of both small and mid cap index funds.
- Wife’s 401k and 457: primarily consists of target date retirement funds.
- My Keogh and 401k: primarily consists of small cap index funds and VPMAX.
- VPMAX is an actively managed Vanguard PRIMECAP fund. I hold this fund because it has a relatively low expense of 0.32% and the fund managers have a good track record for outperforming the S&P 500 index. I fully understand the notion that past performance dues not guarantee future results. However, I think that the potential benefit of greater long-term returns outweighs the cost of a higher expense ratio. We shall see.
- 403b from former employer: mostly consists of international stocks and US bonds.
- Robinhood account: primarily consists of a few individual stocks that I buy, sell, and trade for free.
- My top three holdings are Apple, Facebook, and Tesla.
- This is a very small portion of my investment portfolio.
Rebalancing
- Rebalance portfolio with monthly new investments. Try not to buy and sell funds unless the purpose is to tax loss harvest.
- Acceptable to buy /sell to rebalance within a tax-advantaged account to avoid a taxable event
Other Considerations
- Set up 529 account for children
- Maintain appropriate insurance (home, auto, disability, health, life)
- Term life insurance will end in about ten years. Plan is to not renew term life insurance assuming I reach financial freedom by that time.
- Create estate plan and living trust
- Set up Donor Advised Fund to donate appreciated securities for charitable giving
Summary
My wife and I frequently discuss our financial goals and investment strategies. Nevertheless, we recently decided to put it all in writing by creating an investor policy statement.
Our investor policy statement will help us stay the course through market volatility and when the next correction or recession happens. I don’t know when it will occur. But it will happen some day. Whenever that is, we will be ready.
Investor policy statements are personal. Yours may not look like ours at all.
Everybody has their own unique goals, values, principles, and philosophy which will be reflected in their own personal investor policy statement.
Do you have an investor policy statement? I would like to read about your goals and strategies!
Fascinating to see all your goals laid out, they do say you’re more likely to reach goals that are written down. Thanks for sharing! We will have to ponder this.
Thanks, BE!
Yes, we finally put everything in writing 🙂
Thanks for the candid look behind the curtain, DMF. Out of curiosity, have your thought about saving in an HSA using a high deductible health plan? Not good if you plan on more kids soon, but once you’ve got your lucky number of children, assuming no chronic health issues, it’s a great addition to your already solid foundation.
Also wondering, what is your slice and dice allocation based on? One particular lazy portfolio our a hybrid of several?
Fondly,
CD
Thanks for chiming in, CD! Our health insurance plan is completely covered by my medical group and an HSA is not an option available to me. However, an HSA is available to my wife. In retrospect, we could have opened an HSA account for her and used it pay for things like prenatal vitamins and possibly a breast pump for milk. That would have further reduced her AGI even more! When she goes back to work, we are going to open one for her. Thanks for the reminder 🙂
As for asset allocation, it is loosely based off of Personal Capital’s recommended asset allocation based on my investment risk profile. This recommendation lies on the effect frontier. Everything is pretty much spot on, except for I hold more bonds and less alternatives compared to their recommendation. I accept a slightly lower return for a lower risk.
The only reason why I have a Wealthfront in addition to a Vanguard taxable account is because I started both of them as a newbie investor. I wanted to see how a roboadvisor invests my money while learning more about DIY investing at the same time. Back when I first started, I felt like there was so much to read and learn! Now that I know a little bit more and I have regularly invest in each account, I have a sizable amount of money in both. I don’t plan to sell and transfer into one account for the sole purpose of consolidation. I would probably be hit with a considerable tax bill if I did this.
Therefore, I plan to continue investing with both. One or both of the accounts serve as PSLF repeal insurance. I let Wealthfront do its thing with automatic tax loss harvesting and direct indexing.
Meanwhile, I use my Vanguard taxable account to add new investments to rebalance my overall portfolio (following Personal Capital’s recommended asset allocation). Also, I try to manually tax loss harvest from my Vanguard taxable account when I can. And like I mentioned in the article, I try to make sure to avoid wash sales by holding different funds in each account. I preferentially hold large cap growth and value stock funds in this account because of the better tax efficiency plus lower volatility and turnover of large cap funds.
These taxable accounts (Vanguard and Wealthfront) potentially have a shorter time horizon compared to my tax advantaged accounts. This is because their primary purpose is to serve as PSLF repeal insurance. Therefore, we may actually need to tap these funds in 6-7 years. Although I think this is highly unlikely. The secondary purpose of these accounts is to potentially fund an early retirement. I don’t plan on retiring early, but for some reason if I did, I will be withdrawing money from these accounts first. This is analogous to Gasem’s lifeboat portfolio insurance strategy.
I place small and mid cap assets in our Roth IRAs because I am expecting (or hoping for) greater returns in the long term. My intent is to not touch these accounts for a very long time, if ever as they can eventually be passed down to our children tax free. Because these accounts have a longer time horizon, I accept a higher risk for the potential of greater returns.
My retirement accounts are funded with small and mid cap index funds as well as the actively managed large cap PRIMECAP mutual fund because I am hoping for greater returns over a long investment time horizon. I plan to continue working until I’m at least 55-58 years old.
We decided to fund my wife’s tax advantaged retirement accounts (her 401k and 457) with Target Date Funds for several reasons. 1) The TDF options in her plan have very expense rations (0.05%); 2) She is not as active in monitoring our investments as I am, so the set it and forget it aspect of TDF’s are appealing; 3) They have a natural glide path, becoming more conservative over time; 4) We wanted more conservative investments in her accounts simply because she does not make as much money as I do. So her appetite for risk is not as high; 5) Additionally, we also chose more conservative investments because her 457 account potentially has a shorter time horizon. If we need to access her 457 before age 59 1/2, we can do so without penalty; 6) Finally, another reason for a more conservative TDF approach is because while I am not planning to retire early, my wife may decided to leave her job some time after her loans are forgiven/paid off. While she has a great job that gives her some fulfillment, she probably wouldn’t do it if we achieved complete financial freedom and absolutely didn’t need the money.
DMF,
Well thought out plan, thanks for the in-depth explanation. Everything you lay out seems rational and entirely reasonable. The PSLF repeal insurance is a brilliant and necessary tactical move.
I similarly paired a Betterment account early on (mostly taxable) with my Vanguard DIY retirement accounts – admittedly a far simpler proposition, since our dual emergency physician household in a specialty where we are independent contractors by tradition makes keeping all accounts under one or two brokerages a much more feasible scenario.
Over time I grew more confident (or developed greater hubris, the jury is still out), and decided it made more sense to have everything under my DIY Vanguard funds, so I made an in-kind transfer of Betterment funds to Vanguard.
While the legacy funds from Betterment are all diversified, low cost ETFs, I’d just as soon make it simpler and would sell them if it weren’t for the tax hit from caital gains I’d incur. Over time the legacy funds are continuing to represent a smaller slice of my overall pie since new contributions flow to Vanguard. My solution has been to donate the most appreciated funds to our Donor Advised Fund over time.
I’ll be curious to see what path you take. Will you stay hybrid between roboadvisor + self-directed, or decide to take it over completely? Will you continue to enjoy the sexiness of a slice and dice with small cap and value tilt, or grow old and crusty like me and reduce your total number of funds to far fewer to enjoy Bogle’s vaunted “majesty of simplicity?”
Regardless, it’s highly enjoyable to watch a bright and thoughtful star like you shining on his journey. Thanks for sharing it with us.
Fondly,
CD
Thanks for the follow up, CD. For now, I’m sticking with the hybrid Wealthfront and Vanguard dual. Some time down the line, I may transfer it all to vanguard if I can do in-kind transfers without getting taxed. I do plan to keep investing in small and mid cap funds in my retirement accounts then slowly invest new funds with a greater percentage of bonds as I get older. We shall see if I enjoy the complexity over time 🙂
Nicely done on this IPS!! I wrote one a few months back but it is not as extensive as yours. I totally agree with the philosophy of having one.
Now, I need to get to elaborating on mine…
Thanks Deanna! Yeah, I didn’t realize how helpful they can be until we sat down to plan and write it out. 😀
That’s super helpful, Dr McF! Definitely going to be linking to this one in the future. I think this is a really practical example of what this should look like.
Thanks for sharing and for doing it so specifically!
TPP
Thanks, TPP! I’m glad you found it helpful. If you haven’t created one or fine tuned yours yet, you should. Especially now that you’ll be building up a sizable taxable account! A detailed IPS can be incredibly helpful to have on hand especially when setting a plan for implementing tax loss harvesting strategies to prevent wash sales.
It’s a good idea, and I need to get on it, honestly 🙂
This is really good. I need to make one like this. I have it in my head, but that doesn’t really work. If you don’t write it down, then it will keep changing. There are bits and pieces here and there so it’d be nice to have them all down in one document. Great idea.
Hey, Joe! Glad you found it helpful. Yeah, I thought that I’d be fine just keeping it all in my head too. But then when I started writing it out… I realized it was a lot to think about and keep organized. Also, writing it down with my wife helps her understand why we invest in certain assets and where they should go. Discussing it with her and writing it down keeps us both on the same page. 🙂
Very nice DMF. I have always touted the importance of doing an Investment Policy Statement.
It helps you stay the course during market volatility and also is a great way to share your philosophy with your heirs in case something happens to you so that they might be able to continue along the same path.
Thanks, Xrayvsn! Your post on Financial Evolution: The Investor Policy Statement helped inspire me!
Thanks. That makes me feel good that you took a really significant step on your path to financial wealth because of something I wrote.
Having goals written down I think does something for the psyche and I think makes a better chance for it to come true
Pretty cool an, it’s all about having a grander vision and direction in life. I tend to struggle with this sometimes, as I have shiny object syndrome sometimes. I cycle through goals often, constantly trying to find the ones that are most worthwhile.
Having a money vision can kind of serve as that north star, bringing things into focus, and helping you think long and hard about what you really want to focus on.
Thanks for sharing man!
Thanks, TJ. Yeah absolutely. Having a money vision and goals is important.
This is excellent, Dr. McFrugal.
In times of turbulence, as we saw last week, an IPS is especially important guiding light. Without it, rash decisions might be made. I see it all day long on social media. The market drops 5% and people are FREAKIN’OUT!!!
Refer to IPS. Stay the course.
Cheers!
-PoF
Thanks, PoF! I appreciate the compliment.
Yes, having an IPS is so important to refer to during market drops.
After reading all of your helpful posts about creating an IPS (I think you have four) and your posts covering tax loss harvesting, I am now more knowledgable about managing market downturns. Instead of freaking out like everyone else, I’ll stay the course and potentially see opportunities to tax loss harvest and buy equities on sale.
Thanks again!
Hey Dr. McF,
You are very thorough. My Investor Policy Statement is quite short in comparison.
I built myself a spreadsheet for my investments so that the spreadsheet just tells me what to buy at any given time. Very nonemtional indeed.
But it is great to have an investor policy statement of for nothing better than to observes one’s own investment evolution.
Oh wow! A spread sheet that tells you what to buy. That’s genius! And yeah, it would be interesting to see how my investor policy statement evolves as we achieve milestones and get older.
I’m very grateful for discovering Bogleheads and the IPS as a broke med student. I review it a few times a year and it’s amazing how boring and automatic it makes investing. (The way it should be)
Part of the reason I started exploring side hustles is that it seemed like a safer way to tinker with money than to screw up my IPS out of boredom.
Thanks for sharing yours with us!
Ha! That’s a great way to think of side hustles. Never thought it that way but it’s genius! 😀
You have half a plan. Excellent plan however, You have an accumulation plan. You don’t have a detailed deflation plan and the cost of that. Your plan takes you through induction, you have yet to plan for emergence. When you “max out retirement accounts” the government has a plan on how to spend your retirement money. When you put the rest in passive funds the government has a plan on how to spend those gains. Medicare has a plan for your money. Stanford has a plan for your money. California has a plan for your money. Understanding the granularity of their plans for your money is vital to your survival and it alters your accumulation plan. A simple example: Medicare presently charges $134/mo as it’s premium (not counting the supplemental) I pay about $347/mo for my $134 Medicare because I made too much money in 2015. Let that sink in. There are all kinds of little bombs and cliffs out there.
Another example My biggest investment is in my taxable portfolio. It’s triple everything else. I did not “max out my retirement accounts”. As I was working through this I found the government had a big surprise for me, they were going to turn my tax free accounts into a taxable annuity at age 70 with an ever increasing rate of withdrawal. As the withdrawal rate goes up. taxes go up. When you die, taxes on your wife double. Wen you die her deductible is cut in half. When you die she loses your part of SS In other words it was their intention to tax the hell out of me and especially her in my geezerdom. When you die her medicare will likely go up because of RMD. Sneaky bastards. So I just loaded up the taxable and let the IRA ride. During the course of time I tax loss harvested the 6 recessions I’ve lived through in my investing career. I have enough tax loss accrued to turn my taxable account essentially into a Roth. I call it my rich man’s Roth. Last year I pulled 620K out of my taxable and paid zero tax. I’m using that to Roth convert the IRA over 4 years which will thwart ol Unc’s attempt to clean my clock and my wife’s clock when I’m 85, or dead. If you don’t plan for these eventualities when you’re 40 theirs a bear trap with your name on it. You get to spend what Unc let’s you keep.
Not to discourage your excellent post but you have to plan all the way to death, not just to retirement.
Thanks for the comment, Gasem. You’re absolutely right. I do have to think of a drawdown plan and how to optimize my tax situation beyond retirement, all the way to death. Admittedly, planning for accumulation is much easier than planning for de-accumulation and withdrawals. I haven’t put a lot of thought into it yet because it feels like such a long time from now and I’m pretty sure laws will change. However, it will definitely help to have a rudimentary plan in place that can be dynamic and adaptable to changing laws. I’ll work on it some time. Thanks for bringing up all the bombs and cliffs out there, and for your advice and encouragement!
Thank you for sharing this.
I believe every doctor/investor needs either a financial planner or an IPS. We all need someone or something to help calm our emotions in times of crisis. A detailed plan also helps quickly answer any new questions that come up.
For readers who may be intimidated by this: An IPS does not have to be this comprehensive. Mine relates to just to my investments, investing philosophy, asset allocation, passive versus active, etc.
This is definitely well done, but I would consider this more of a comprehensive financial plan.
Your plan looks very solid. Since I am a few years ahead of you in this process I will pass along a couple of observations. You may find that $100,000 is not enough annual income even with a “minimalist“ lifestyle, particularly in the high cost of living area.
The other part to clarify -and you may have already done this elsewhere- just to clarify what, when, and how you will pay for expenses for your children or aging parents. Many of us in the “sandwich generation“ middle part of life find our own expenses skyrocketing as well as future expenses of our children and our aging parents. The physician with a good income, high net worth, and solid investment strategy will be fine to cover their own expenses and some for their children or parents but likely cannot cover all expenses for three generations. It is good to have a strategy for selective help of the generation above and below us.
Hi, Wealthy Doc! Thanks for chiming in and providing some helpful advice. 🙂
I definitely agree with you that $100,000 “sounds like” a lot, but doesn’t amount to a whole lot when living in a high cost of living area. My housing expenses are already 70% of that. So to live on $100,000 would be bare minimum. And to move to a place where the cost of living is lower isn’t an attractive option because we like living in California and it is close to our families.
Paying for children and aging parents is definitely something I have to think about more. I’m still on the fence about funding a 529. A lot could change between now and 18+ years from now and the use of funds seem restrictive. Currently, I’m leaning towards not opening a 529 and just saving the money in a taxable account. I know there are a lot of opposing opinions for each argument.
Caring for aging parents is tricky too. One of these days, I’ll have to talk to them and make sure they have a good finance and healthcare plan in place.
Thanks again for the reminder 🙂
I think this is the best IPS I’ve seen! Very clear and succinct, and most importantly, manageable.
When it comes to tax loss harvesting, do you have a strategy of how often, or by how much of a drop needs to occur?
Thanks Michael! The tax loss harvesting question is a good one. I let Wealthfront automatically do the majority of it especially since I don’t have a lot of time during the work week hours to check if the market is down and if I have losses to harvest.
However, I do have some money in my Vanguard account I see a loss of ~$300 in my Vanguard 500 fund (VFIAX). If it continues to go down tomorrow, I’ll probably take that paper loss and exchange VFIAX for Vanguard Large Cap fund (VLCAX). Will go even lower, maybe. But like everybody says, you can’t time the market. So I guess to answer your question, I’ll manually take any loss of $250 or greater as them come. Then I’ll let Wealthfront automatically harvest losses in other asset classes so that I don’t have to think about it too much 🙂
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