[Editor’s Note: This is a republis
hed post from Physician on FIRE, a member of The White Coat Investor Network. The original post ran here, but if you missed it the first time, it’s new to you! This one is all about a document near and dear to my heart- the IPS. Enjoy!]
I enjoy internet forums. I’ve been a lurker (non-participating reader) of several forums for quite awhile. Since launching the Physician on FIRE, I’ve become a more active participant.
I learn a lot when a question is raised and then answered by dozens of interested people with different backgrounds and perspectives. Crowdsourcing for a solution to any dilemma can be a great way to help you make a decision or simply become more educated on a topic of interest.
A question that comes up often on the forums I frequent looks something like this:
“Which is better, a Small Cap Index Fund or Small Cap Value Fund?”
“I’m starting a Roth IRA. Should I use a Target Date Fund, a Total Stock Market Fund, or a 3-Fund Portfolio?”
“My 401(k) has expensive investment choices. Which of the following lousy funds should I have in my 401(k)?”
“I received a bonus / windfall of $10,000 / $100,000 / $1,000,000, How should I invest it?”
The answer to these 4 questions and hundreds of other similar questions that are posted on the internet everyday is the same exact answer:
“You Need an Investor Policy Statement.”
To answer any of these investment questions in isolation is problematic. The specific answer to the question proposed depends on a wide variety of factors that are rarely disclosed. I’d like to help, but I cannot responsibly tell you which fund(s) I think you should hold in a particular account without knowing what holdings you’ve got elsewhere, what your desired risk tolerance and asset allocation might be, your time horizon, or your goals. If you don’t know these things yourself, we need to establish them first. This is where the Investor Policy Statement (IPS) comes into play.
What is an IPS?
An IPS is a list of your investing goals and strategies, incorporating your risk tolerance, desired asset allocation, and specific plans to achieve them.
Where can you get an IPS?
Here’s mine. If you want it, you can have it, although you will certainly need to change it to adapt it your own situation. A much better solution would be to create your own from scratch based on your life circumstances, goals, and risk tolerance.
The Physician On FIRE Investor Policy Statement
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.
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%.
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
Other Considerations:
- Maximize tax deductions via 401(k), 457(b), HSA, donor advised fund. Front load 457(b).
- Annual backdoor Roth contributions of $5500 each (spouse and I) in January
- Tax loss harvest when possible, which will require some attention to balances.
- Fund boys’ 529 accounts (each February & August).
- Invest in taxable account monthly.
- forego monthly investment to taxable account to cover large expenses(vehicles, home improvement).
Pre-retirement Considerations:
- Research health insurance options.
- Consider part time work as an option to transition to retirement.
- Consider what’s best for the boys / family.
Drawdown Plan:
- Set up 457(B) to pay $1000 to $2000/month.
- Receive dividends and capital gains as cash transfers to bank account.
- When cash is needed, sell taxable assets and minimize / optimize capital gains.
- Attempt to remain in 15% tax bracket to avoid taxes on capital gains (unless tax laws change).
- Convert 401(k) / IRA to Roth as income / tax bracket allows.
- Donate appreciated securities to Donor Advised Fund when needed to maintain low tax bracket.
- 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.
- Pay for boys’ college with $2000 to $4000 cash (to obtain tax credits), then tap 529’s.
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%.
Why do I say you need an IPS?
That’s a fair question, and I’ll admit that need is a rather forceful word, but there are many benefits to creating an IPS. You can get by without one, but you really ought to have one. Here are five reasons why:
# 1 Asset Allocation
It defines your desired asset allocation. This is the keystone to a solid IPS, and if you don’t want to bother with creating an IPS document, you should at least start with a sensible asset allocation.
# 2 Goals
It will force you to define your goals, and make a realistic plan to help you achieve them. In my experience, it’s way tougher to get somewhere if you don’t know where you’re going or what mode of transportation you’ll be using.
# 3 Behavior
An IPS will make you less likely to jump from one investment to another. Investing with emotion and acting on recent performance data causes many a casual investor to chase returns, buy high, and sell low
. These activities will decrease long-term returns and make reaching your goals more difficult and less likely to happen. Sticking with your IPS and updating it infrequently will help you “stay the course” and avoid costly mistakes.
# 4 Working With Your Advisor
If you work with a financial advisor, creating an IPS together will ensure that your advisor understands your goals, and that he or she is helping you invest your money in a way that is consistent with your stated goals.
# 5 Education
While drafting an IPS, you can expect to learn more about investing, about yourself, and about how your goals can best be achieved, particularly if you are not initially well-versed in personal finance when you begin.
How do I get started?
Start with the basics. Determine your risk tolerance, and come up with a reasonable, preferably simple, asset allocation. Take some time to consider your goals. Talk with your significant other if you’ve got one. When you’ve got some goals figured out, write them down. Take time to understand the investment options available via the workplace and externally, and how to best utilize them to reach your goals. Your IPS can be much simpler than mine and could fit on an index card. The specifics can wait. You can make it as detailed as you like, of course, and I’ve seen some much longer than mine, too.
Where can I find additional resources?
The Bogleheads Wiki has examples and links to threads with many more examples.
The White Coat Investor has written a How To Guide on writing an IPS.
Google is a great starting point for the answer to just about anything, ever. This link is set up to search Google for you, so you don’t have to.
In this post, I discuss the individual sections of The PoF IPS and the reasoning behind my choices. Since publishing this post, I have revisited and revised my IPS in a one-year update.
What do you think? Do you have an IPS? Do you revisit or revise it? How often? Do you think a written down IPS is overkill? Comment below!
Great stuff. Everyone needs to consider (if not actually write-out) an IPS. Otherwise you’ll get blown around by the hot topic of the day… which works against most investors.
We can’t hear this message too often. This is critically important for the DIY investor. One of the roles of a financial advisor can be to talk you off the ledge before making crazy changes based on a new idea. For those without an advisor they need to be able to refer to their IPS before making a major change.
PoF’s IPS is very sophisticated. It can be pretty simple though. Feel free to see mine for another example: http://wealthydoc.com/blog/we-all-need-a-written-investment-plan
If I may, whether one calls it goal setting or formalizes the exercise with an IPS, the exercise is incredibly powerful. But it is important to differentiate “how to” from “so that.” The former might drive an asset allocation in order to reach a wealth target. The latter might be, say, retire by54, as PoF plans to do. Some readers might procrastinate for lack of a specific end goal in the sense of “what to do with the wealth.” (Even POF would re-evaluate his early retirement to consider what would be best for the family.) To them I say, make the IPs anyway. Following the path laid out by your “how to” plan is far more likely to get you to a point that you have options for your “so that” goals than not haviing a plan.
Excellent points, Larry.
You don’t need to have a specific “why” in order to come up with a sound plan. I was a diligent saver long before I contemplated an early retirement. And once I came up with a desired allocation, my investments became much less haphazard. The IPS was built around that asset allocation later on.
It’s similar with financial independence. You don’t have to have concrete plans to make a life change when you get there, but it’s a smart goal regardless. I never thought I would work part time — I thought it would be all or nothing — but once I realized I was comfortably FI, part time sounded like a great option. The new schedule starts next week.
Cheers!
-PoF
My ‘why’- incorrect as it turns out- was that when we got married in ’91 I was certain we’d have single payer medicine by, maybe, ’97 at the latest? And that doctors were at risk of having our pay cut as low as that of high school teachers. My guiding principle was ‘if they pay us very little we might as well have planned the money to quit and become high school teachers by choice’. Still a sound consideration for younger doctors!
“Forego monthly investment to taxable account to cover large expenses(vehicles, home improvement).” Is it better to pay for larger expenses with cash or with money that has been in a taxable account for more than a year? I’ve been planning on using a taxable account but after reading this I’m wondering if there is a better way to do it.
Cash beats liquidating an investment, even at long-term capital gains rates. So if you have it, use that.
I’m going to disagree with WCI, or maybe we’re just thinking about the question differently.
Generally, it’s better to be invested than sitting on cash. So if it’s the difference between keeping cash available for a potential expense versus investing it and selling from taxable if / when necessary, I’d opt for the latter. It’s similar to the question of whether or not to keep a six-month emergency fund or not.
I can cover a $20,000 to $30,000 expense with a couple months’ worth of paychecks, since we’re debt free and our expenses are relatively low. Anything bigger than that, and I’m selling mutual funds from the taxable account. I recently did this to purchase 7 acres of waterfront property. In this article, I discuss how I selected the funds to sell. Prior tax loss harvesting allowed me to do so with zero tax consequence. https://www.physicianonfire.com/lakefront/
Best,
-PoF
Very interesting. I still have a mortgage so I’m only able to come up with about $2000 to $3000 extra per month so I’m not able to buy a car using cash that is readily available. I wonder if anyone has ever come up with a threshold, above which you use money from a taxable account based on amount of cash you can come up with in one month.
I plan and store money in CDs or other longer term but not likely to drop 10-90% in value in the short term. And, as for my daughter, you wreck the old and need a new car quicker than planned, you just lose the CD penalty on interest. Like PoF I’m leery of having a big cash amount sitting there- spouse might think he can afford a Lotus or something!- but unlike him not secure enough to park money in stock type funds with less than 5 year need for the money.
With all this talk about cash, I actually added up what I have in cash this very minute. I think we could live off it for 3-5 years. But most of it consists of unpaid taxes on money already earned.
Those of you who can manage to keep less than $20K in cash must be a lot better at managing cash flow than I am.
Not sure if you’re a doc or not, but if so, there might be a problem here. Let me explain:
An average doc makes $225K. Let’s round it off to $20K a month. She should be saving about 20% for retirement and some smaller percentage toward other goals like college, the next car, the next vacation etc. So let’s call that $4K and $2K. Taxes are probably 25%, or about $5K a month. That leaves $9K a month in spending. So the emergency fund should be something between $27K and $54K. Let’s say $27K. Hopefully you also have some type of sinking next car fund. Let’s say there’s $10K in there.
Let’s say you discover your car will soon be dead and you want to buy a new one in 2 months. How much can you spend on a car without affecting your lifestyle or having to liquidate investments?
$27K + $10K + $6K + $6K = $49K. That’s a pretty nice brand new sedan or a decent nearly new SUV. In fact, you can get a pretty nice used sedan for just $12K. That’s a 3 year old Nissan Altima with 30K miles on it.
If a doctor can’t buy a decent used car with 2-3 months of “extra cash,” there’s likely a spending problem. And we haven’t even considered cutting lifestyle at all.
I thought we were answering this question:
If you have $20K in cash and $20K in stocks, which one should you use to buy your $20K car?
Not this question:
Should you leave cash sitting around just in case you might want to buy a car soon?
I figured we weren’t at odds in our thinking. I would answer that question the same way. Spend the cash and replace it with earnings.
It’s difficult to know the question without knowing about the presence or size of an emergency fund. I don’t normally keep much of one, but I nearly always have at least a couple months of expenses handy. Every paycheck delivers another ~1.5 months of expenses. Of course, the paychecks are about to get smaller next month!
That’s too bad, but they should rise after that and hopefully keep rising indefinitely.
Back of the envelope IPS.
Retire 60-65 depending on healthcare premiums.
Large cash cushion in place (greater than 50x spend).
All new money going into Vanguard Indexes. Still have some old higher ER funds in a taxable account that I am letting distribute and dividend their way down.
Accepting market returns but still have a high risk tolerance.
Current asset allocation 66/32.5/1 stock/bond/ short term. Stocks have drifted up. Trying to keep 60-65 stock. International 22 trying to keep >20.
Continue to fund IRA with catchup at $6500.
Tax loss harvest. Roth conversion with correction. Rebalance with dividends and capital gains if possible.
Large purchases from short term funds. (mmf, ultra short term bonds.)
Continue part time work until clarity with health insurance or personal health concerns develop.
Plan to delay SS until 70 unless health deteriorates or real concern about cuts to program materialize.
Just because you write it in shorthand on an envelope doesn’t mean it isn’t an extremely sophisticated plan. It takes a certain amount of education and experience to make a plan even that detailed.
It is just what I am doing.
Love this idea. It’s like putting your financial flag in the ground and rallying around it. Rather than just investing based on emotions. I have a kind of hazy framework of what my investing philosophy is, but I will work on this to get it in writing.
very informative thank you for posting this.
Nice post. This needs to be more prevalent on finance blogs. Removing emotion is a key to long term success.
PoF,
What bond index/fund do you invest in now? And what would be the 10 years worth of money bond allocation in retirement? Any diversification in bonds?
I’m in the Vanguard Total Bond Fund, and I keep all of the bond allocation in my tax deferred 401(k). It’s one fund, but well diversified in US bonds.
More details of my asset allocation in my latest quarterly update. https://www.physicianonfire.com/2017q2/
Another will be published in the next week or two.
Cheers!
-PoF
Curious you left out any mention of dividends in taxable account as passive income. Some ppl avoid dividends like the proverbial plague. Others flock to it like stink on a monkey. Any thoughts?
Dividends are nothing but a tax drag in my taxable account currently. In retirement, they’ll provide some “income” with less or possibly no tax drag, but I’m more of a total return investor.
I’d rather sell shares to create my own dividend.
Best,
-PoF
Thanks!
While reasonable minds will differ, the POF objective of targeting over 40X annual expenses (and over 50X by age 59.5) is incredibly conservative and very likely will result in people who follow it working far longer than they need to – and therefore having far less time to enjoy their retirement years. It’s their IPS so they can target what they want, but others should be careful to follow it without seriously questioning whether it is appropriate for them. Personally, I think anything over 33X is plenty conserative.
Also, don’t think have it backwards in their “philosophy” – risk tolerance quite “high” so accept a WD rate <3%. It would seem they have a risk tolerance that is quite low and not high.
I think he means by risk tolerance is continuing to keep a high stock allocation. He naturally has a low spend rate it has nothing to do with risk tolerance.
Sure it does. Running out of money early is a risk and POF doesn’t tolerate it well. That’s why he aimed for 33X+. The fact that he has 33X+ (and growing) is what GIVES him a high market risk tolerance.
“Lucky” couple with military pension. (Thanks hon for your 27 years service, and “thanks” for getting a VA disability.) We don’t quite live, retired, spending ONLY his pension and VA money. What is the best way to value that pension in this 20-33-40-50 times annual spending calculation? And how to factor in drop in the monthly amount I get should I survive him? (I will probably need a bit more from outside the pension if I’m widowed, no worries for him though- without me and SBP insurance his pension goes up!)
My present plan in my 50s is to ensure (hopefully with success prn) that I can return to work fulltime if I/we want/need more income. Will happily drop that ‘coverage’ in my 60s but is it crucial at all now?
Just subtract what it pays from your budget, then use the nest egg to cover the rest. So if you spend $10K a month and the pension and VA pays $5K a month, then you have a $5K need. That’s $60K a year. If you have $600K, that’s 10X. If you have $1.2M that’s 20X etc.
Your situation is more complicated if that pension goes away or is dramatically reduced when he dies though.
I agree, MikeG!
This was my very first IPS, and after much reading and reflection, I came to the same conclusion that you did. The IPS is a living document — it should be reviewed regularly and occasionally revised.
At the bottom of this post, there’s a link to my 1-year revision, which includes a higher SWR and lower target. https://www.physicianonfire.com/ipsrevised/
Cheers!
-PoF
POF,
I worry that you may have an aneurysm later this week when you read my guest post. You may not want to read it 😉 But this is a great post.
Thanks!
I look forward to your post! Maybe? Maybe not.
Cheers!
-PoF
Are the (non-medical) financial gurus on board with the IPS? Or do they feel the same way about them as I do about birth plans?
I suspect an IPS gets a non-fiduciary “financial advisor’s” nerves just like birth plans used to get on my nerves as an OB.
If you can write and follow an IPS, you don’t need a financial advisor. If you need an advisor, they should help you write and follow an IPS. That’s their job, so they shouldn’t have a problem with it.
And my goal is to get on the nerves of non-fiduciaries who call themselves advisors.
Any links to help me understand the principle behind:
“Pay for boys’ college with $2000 to $4000 cash (to obtain tax credits), then tap 529’s.”
I guess I’m not familiar with the tax credits you would be going for.
They’re not available to most readers of this blog who are still working.
https://www.irs.gov/newsroom/american-opportunity-tax-credit-questions-and-answers
Nice post. I like that you have a drawdown section. I don’t have one yet as I wasn’t really thinking about that when wrote it, but I see that I can be an important part and kind of the ribbon that ties it together. Now my IPS feels too open ended without a drawdown.
Writing our IPS was cathartic. It went through several iterations between my wife and likeminded friends. I think the best benefit from the IPS was that it got my wife and I on the same page and brought us together about investing. Even though I manage the finances, she has a good broad idea because of the IPS.
Also, it allows for estate planning because I plan on referring to the IPS if I die so that my wife doesn’t have to learn all about finances if she chooses not too. Plus, I like to look at it every so often as a reminder about all
the front loaded effort DIY investing takes now that we’re in maintenance mode.
Just out of curiosity with all the talk of accepting market returns how many on this forum stayed the course during the 2000 market downturn? 2008 Crash?
I stayed the course in 2008, but was an MS1 when the 2000-2002 bear started.
I was also in medical school in 2000, but had money invested in mutual funds in an IRA that I didn’t touch.
The 2008 / 2009 crash was a great time to be investing on the way down and during the recovery, which is what I did.
Best,
-PoF
This is an interesting IPS, nice work. I like the direct format. I’ve had this on my to do list for too long.
I really want to make two IPSs, but I don’t think everyone should have two.
I think everyone needs one, unless both spouses do the investing, they are generally in agreement, and they really understand and are committed to their plan. Even then it’s probably still a good idea. The non-investing spouse will need to know the philosophy that has successfully yielded a strong retirement fund. They will likely need further guidance if their partner passes first. In my case I plan to leave some general tips and guidance about selecting an advisor if she wants to do so, as well as common investing pitfalls.
I want to do a second because I want to build one bottoms up. Build in a short summary of portfolio theory and factor theory. Include a discussion of risk. Right now, I really can’t explain what I know in terms of considered theory, and I think it would be fun to do that.