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Our Investment Plan: What We Do, What’s Changing, How We’ve Performed

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A reader recently asked me to share my investment choices and portfolio breakdown. I’ll do this by sharing our investment policy statement (IPS). This includes our asset allocation, strategies to control investment fees and taxes, and plans for managing the portfolio.

A well written IPS ties an investment plan together, marrying investments with a system for managing them on an ongoing basis. Having a written plan helps prevent making bad decisions driven by fear or greed. It’s also helpful to have a written plan because, inevitably, we all forget things. Morningstar provides a worksheet that serves as an excellent starting point for developing an IPS.

We wrote our IPS five years ago. Writing this blog post provides me a great opportunity to review what we originally wrote, how well we’ve been following our plan, and what, if any, changes we need to make as we transition to a new stage of life.

Our Investment Policy Statement

I’ll share our investment policy statement as originally written. This will be in italic font for consistency.

I’ll then provide commentary to share key things we got right, where we’ve veered from our written plan, and how our plan has evolved. My commentary will be in normal font.

Investment Plan

This plan will be followed to build our assets to reach financial independence and provide for financial security in early retirement.

Assets Included In Allocation

Investment Accounts

Investment accounts include taxable, rollover IRA, and Roth IRA accounts. We will also include our current work retirement accounts. All of these accounts will be considered together for the purpose of planning and asset allocation.

Since we originally wrote our plan, my wife switched jobs, and I’ve terminated my employment. We rolled over my wife’s old 403(b) and my 401(k) to IRAs with Vanguard. This means that the vast majority of our funds are held with one brokerage.

Having this concentration of funds in one place is mildly troubling from a security perspective. However, we feel the simplicity of having our accounts in one place as well as the benefits that come with having a larger account balance outweigh the security risks. We currently have no plans to move any funds to another brokerage.

Cash

Part of our financial plan will include having cash to serve as an emergency/opportunity fund and to hold money we will plan to spend in the near term when in retirement. Cash held in a high-yield savings account and money market account will be included as part of our allocation.  

We will always keep at least 6 months of living expenses in cash. We will never carry more than 2 years of living expenses in cash at any time to avoid excessive drag on investment returns.

Cash held in checking accounts that will be used to deposit paychecks and cover normal spending will be omitted from the plan/allocation.

Cash was our biggest point of contention when developing our asset allocation and IPS. I’ve never liked holding cash because of the drag on investment returns. It seemed wasteful to have money sitting around when we had abundant cash flow and a high savings rate when both of us were working. My wife has always loved the feeling of security a large cash cushion provides.

We generally kept our cash reserves at about 6 months living expenses when both of us were working. After much debate, we decided to build savings up to 12+ months expenses in anticipation of losing my income when retiring and having the unknown expenses associated with moving across the country.

This worked out very well, as having cash on hand allowed us to move quickly on buying our new home, which we then used as a rental for a year. However, this left us cash poor for most of the last year. We agreed this added unnecessary stress to our lives.

Assets Not Included in Our Allocation

Our Home

Part of our plan will be to own our home. We currently own our home outright, valued at approximately $250k. This also will not be included in our investment plan, asset allocation, or our assets factored into reaching financial independence (FI).

When developing our IPS, our thinking was heavily influenced by Rick Ferri, CFA. In his book, “All About Asset Allocation”, he wrote that your primary residence should not be included as part of your portfolio because it is illiquid, produces no income, and typically appreciates only at about the general inflation rate.

Still, our home is a large piece of our net worth. So I’ve started to look at it as a potential investment. We bought our current home, in part, because it could be used as an AirBNB rental to produce income if needed or desired.

Harry Sit recently wrote an interesting article titled “You Can’t Eat Your House. Or Can You?” He points out there are various ways you can use the equity in your home to produce income. They include utilizing a reverse mortgage, selling and downsizing, or moving to a less expensive area in retirement to free up cash. There is also the option of using a home equity line of credit (HELOC) or a cash out refinance.

We still don’t include our home in our allocation, and are not currently using it to generate any income. Home equity has never been directly factored in when calculating the assets we would need to retire. However, home ownership does lower living expenses and provides an inflation hedge, because we won’t have to pay rent.

We view our home as a back up to our investment portfolio. Still, the change in perspective has given us more confidence given all the options that owning this asset provides.

College Savings

We will keep an account for our daughter that will be used to fund college. These funds will be invested in taxable accounts. We’ll continue to consider tax advantaged accounts if the tax savings outweigh the restrictions on the accounts. These funds will be held in a separate account and will not be considered as part of our investment asset allocation or assets factored into reaching FI. This will eventually be her money, but we will have control over how it is used.

Since developing our initial IPS, we’ve saved aggressively for our daughter’s college education. We’ve reached our funding goal, and have stopped saving for her since I’ve stopped working. This money remains invested in a taxable investment account, so theoretically this is another backup that we could tap into without penalty if needed. However, that would be a last resort.

I won’t comment further on college savings at this time. I have a full blog post planned outlining how we saved for college and why we elected to bypass tax advantaged college savings options.

Social Security

We will periodically monitor our Social Security benefits. Given the long time frame until we are eligible to claim benefits and the political uncertainty around Social Security, we won’t factor these benefits into our plan. Instead, we’ll consider benefits we eventually receive as a bonus and backup to our plan.

Not much to add here. We’re still 20-30 years from claiming Social Security benefits.

I’ve become more interested in Social Security over the last few years while helping my parents with their finances and serving the needs of the audience of this blog. I still don’t give Social Security much thought with regards to our plans.

Asset Allocation

We will begin with an asset allocation of 80% stocks, 15% bonds and 5% cash distributed across these different accounts.

Stocks

Domestic

  • 35% Vanguard US Total Stock Market Index Fund (VTSAX)
  • 10% Vanguard Small Cap Value Index Fund (VSIAX)
  • 10% Vanguard REIT Index Fund (VGSLX)

International

  • 10% Vanguard European Stock Index Fund (VEUSX)
  • 10% Vanguard Pacific Rim Stock Index Fund (VPADX)
  • 5% Vanguard Emerging Markets Index Fund (VEMAX)

We continue to hold 80% of our portfolio in stocks. The only change we’ve made to our stock allocation is shifting 5% of our portfolio from VTSAX to VEMAX. Thus 50% of our portfolio is held in domestic stocks with 30% international. 30% of our portfolio is in VTSAX, with 10% in each of the other funds.

All our funds are in Vanguard Admiral shares, the lowest cost share class available to retail investors with Vanguard.

When starting to manage our portfolio, we considered all our old actively managed funds as part of our VTSAX allocation until we were able to gradually sell them off in a tax-efficient manner.

While invested in my 401(k), I didn’t have the option to invest in the exact funds specified in our IPS. I used the Vanguard S&P 500 (VFIAX) index fund as a proxy for VTSAX and the Vanguard Small Cap Index Fund (VSMAX) as a proxy for VSIAX.

The only portion of our stock portfolio not currently held in these funds is a few shares of SPDR Portfolio Total Stock Market ETF (SPTM) held as a proxy for VTSAX in our HSA account. If we continue to be eligible for an HSA in the future, I would anticipate future contributions going to this fund.

Bonds

Domestic

-10% Vanguard Total Bond Market Index Fund (VBTLX)

-5%  Vanguard Intermediate TIPS Fund (VAIPX)

I’m not excited about holding bonds. Given our time horizon and low interest rates, I’m far more concerned with the inflation risk of bonds than the volatility of stocks. My wife liked the idea of having some bonds in our portfolio, so we settled on this allocation.

We’ll likely increase some of our allocation from stocks to bonds as we get older, need the income, and/or the risk/reward ratio of bonds becomes more favorable.

On paper, we settled on a ratio of 2:1 Total Bond Index to TIPS when designing our portfolio. But we never purchased the TIPS until earlier this year when rolling over my 401(k). Prior to that we didn’t have a space in our portfolio to hold TIPS in a tax and cost efficient manner.

My wife’s 401(k) is currently 100% bonds, invested in the John Hancock Total Bond Market Fund (JTBMX). Our HSA is also predominantly bonds, held in SPDR Portfolio Aggregate Bond ETF (SPAB). Prior to leaving my job, I held a portion of my portfolio in the Federated Total Return Bond Fund (FTRBX) until rolling my 401(k) over to an IRA. Each of these funds are held as a proxy to VBTLX.

Cash

5% Held in online savings and money market accounts.

This is the portion of our IPS we’ve followed least strictly. Our cash holdings have typically been less than our target allocation. We built up a sizable cash position last year, then put it to work to purchase our new house, leaving us with less cash than we’ve ever had.

We currently hold about 7% of our portfolio in cash. This is because we just closed on the sale of our house and need to allocate the proceeds. The first $11,000 is set aside to fund Roth or Traditional IRAs for my wife and I for 2018.

We’re still discussing how much cash to hold on an ongoing basis. We’ll likely keep about a year to 18 months expenses in cash, putting the rest into taxable investments.

I still struggle with having cash sitting on the sidelines. However, we’ve had to scramble to produce cash to cover expenses on several occasions over the past few months until the sale of our house closed.

This brought me around and made me appreciate the importance of simplicity and the feeling of security that cash provides. Score one for my wife.

Changes to Allocation

  • We will adjust our allocation only when we mutually agree and only when something fundamentally changes to the point that it would be beneficial to do so. Examples would be shifting to a more conservative allocation as we meet investment goals, exiting an asset class if it no longer meets our investing objectives, or adding asset classes if they become available in a cost efficient way as we combine accounts over time.
  • If we choose to shift our allocation from stocks to bonds (or bonds to stocks), the relative percentages within each category will be kept the same.
  • If we exceed 2 years of expenses in cash, we will shift excess money into bonds.

Since we transitioned from two incomes to one and were rolling over my 401(k) account at the end of last year, we thought it made sense to revisit our plan. The only changes we made were to add TIPS, increase our allocation to emerging markets, and get our cash holdings in better alignment with our stated allocation as mentioned above.

I suggested shifting an additional 10% of our allocation away from the Total Stock Market Index Fund to the Vanguard Value Index Fund (VVIAX). I wanted to hold more value stocks when building our portfolio, but we didn’t have a good place to hold them for cost and tax efficiency at that time.

By dumb luck, this has worked out in our favor thus far. The total market has outperformed the value index in recent years. Still, I thought with current high stock valuations, this would be a great time to shift some money from the growth heavy total market fund to the value fund.

My wife did not like the idea of adding another fund to our portfolio. Per our written policy, if we couldn’t both agree to a change, we wouldn’t make it. So we didn’t.

Cost/Tax Control Strategy

  • For cost and simplicity, we will use Vanguard funds whenever possible to meet our goals. When this is not possible, we will use the closest alternative that meets our investment objectives.
  • We will attempt to choose index funds and avoid any actively managed funds unless none are available to meet our needs (in work sponsored retirement accounts).
  • We will consider funds only if the expense ratio is less than .3% annually unless there is no other option available (in work sponsored retirement accounts).
  • We will make every attempt to locate assets in the most tax efficient places. (Bonds, index funds with higher turnover, and REITS in tax sheltered accounts, broad stock index funds and cash in taxable accounts.)
  • We will limit transaction fees by rebalancing only once annually. Rebalancing will be done on May 1 each year after filing our previous year tax returns, at which point we will make our ROTH IRA contribution for the year.
  • We will limit capital gains taxes by rebalancing within our tax advantaged accounts. We will sell funds in our taxable accounts only for tax-gain or tax-loss harvesting when to our benefit.

We’ve been happy watching our taxes and expenses progressively decrease since managing our portfolio. We sold off our old actively managed funds at opportune times. Since selling off our last actively managed fund, we’ve paid no short or long-term capital gains taxes on our portfolio.

We’ve eliminated these taxes by holding tax-efficient index funds in our taxable accounts and rebalancing only in our tax advantaged accounts. Index funds still produce taxable dividends. Our lower household income means future dividends will likely be taxed at 0%, further lowering taxes.

We further lowered expenses when rolling over my 401(k) plan earlier in the year.

I’ve made two tax loss harvesting transactions since beginning to manage our portfolio. The first was in mid-December 2015, selling off funds we held in taxable accounts that had dropped in value. I moved that money back to the original funds in late January 2016 after the markets fell more. I harvested enough losses in those transactions that we still have a small loss to carry forward on our taxes this year.

Now that our income is lower, tax loss harvesting doesn’t make much sense for us. As we continue to have less earned income, we may start looking for tax gain harvesting opportunities.

Future Contributions

  • We will contribute the maximum amount to our work sponsored tax-deferred accounts each paycheck.
  • We will make the maximum allowable annual contribution to our Roth IRA accounts.
  • After maxing out our tax deferred accounts and Roth IRA, we will invest any other available money into our taxable accounts monthly via automatic transaction.

These were no brainer decisions when we were both working. Maxing out our 401(k) accounts offered substantial tax savings. Our combined incomes were always too high to also contribute to a deductible IRA, but well below the limit where Roth contributions were restricted. This made the Roth vs. Traditional IRA decision easy.

As we transition to early retirement, we’re reconsidering this portion of our plan. Now that we have a lower income and lower tax rates, the deduction for investing in a 401(k) isn’t as valuable.

My wife’s 401(k) plan also has high management fees. Her 401(k) makes up only 4.3% of our portfolio, but accounts for 38% of our investment fees! However, not utilizing her plan means losing both the ability to defer taxes in the current year and the free money of her employer match.

Our goal in this phase of part-time work/semi-retirement is to keep annual recognized income low enough that qualified dividends will be taxed at 0%. We’ll continue analyzing our numbers and determine the best way to use our tax advantaged accounts.

We elected to make the maximal allowed contribution to her 401(k) account this year, and we’ll likely utilize each of our Roth IRAs. We won’t make our 2018 IRA contributions until sometime in 2019 when we can know with certainty whether traditional or Roth makes more sense.

Going forward, we’ll continue to monitor whether it makes sense to continue contributing to her 401(k), as the fees may outweigh the tax benefit. Most likely we’ll decrease the contribution to the level of the employer match.

Portfolio Monitoring

One area we neglected in our original IPS was monitoring our portfolio. I’ve since added two categories to monitor.

The first is fees. There are many things out of our control when investing. Fees are one of the few things we can control, so we focus on getting fees as low as possible without adding complexity.

The aggregate expense ratio for all our investments is currently .12% to hold a widely diversified portfolio. As soon as we are able to get my wife’s 401(k) rolled over, that number will drop to about .1%.

The other metric we’ve begun monitoring is the tax status of our investments. Two articles got me thinking about this. The first was Darrow’s post on this site, A Surprising Contender for Tax Efficient Retirement Saving. The other was Physician on FIRE’s My Money Is Worth More Than Your Money.

Not every dollar you have on paper gives you the same spending power in retirement. A dollar in a Roth account is worth a dollar, because it has already been taxed.

Tax-deferred accounts will be taxed at ordinary income tax rates in the year money is withdrawn. A dollar in a tax-deferred account can be worth anywhere from $1 to less than $.60 at the extremes depending on your personal federal and state tax situation.

Taxable accounts tend to be treated more favorably than tax-deferred accounts for most early-retirees because they’re taxed at capital gains rates. But again, the value of your dollars is dependent on your personal tax situation.

We still focus on limiting our current year tax burden, with an eye on getting more money to Roth and taxable accounts. Those dollars will be more valuable when we start drawing down our portfolio.

We missed out on years of tax-deferred savings and Roth contributions by following conflicted financial advice. Still, we’re happy with our tax diversification. Our current breakdown is 46.7% tax-deferred, 43.5% taxable, 9.5% Roth, and .3% in our HSA.

Investment Returns

So what have our returns been since we began managing our investments? I have no idea. We don’t monitor investment returns.

We’ve decided on a buy and hold approach to investing. This means accepting the returns the markets give us.

It’s tempting to calculate returns, but I think calculating investment returns would have more potential for doing harm than good. So I don’t do it.

Knowing I beat an arbitrary benchmark may make me feel smarter than I am and lead me to start tinkering with the portfolio. Knowing I applied extra effort and paid more fees to under perform a benchmark may tempt me to bail on our strategy at the wrong time. Either scenario is possible any given year.

I’m happy to be willfully ignorant of our returns. We focus on the things we can control, such as limiting portfolio fees, taxes, and complexity while building a portfolio that should do well in a variety of scenarios.

Otherwise, we let the chips fall where they may, confident that our plan will work out over the long term.

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Comments

  1. This is a very good article and it reminds me that I have some work to do with my asset allocation. 6-12 months of expenses in cash should definitely be sufficient for you guys but I understand the feeling of security from having more. I have always planned to keep 6 months in cash but always seem to let my high yield savings account balances creep higher and higher… I just looked and I about 5 years of expenses in cash right now 😩☹️. I tell myself it’s because of the security of having a lot of cash but it reality I think it’s because I’m subconsciously scared on a correction right after I put the money in. Just goes to show that implementation of a plan can be hard even when you have the knowledge so having a written plan to refer back to is a great idea!
    I hope things are going well for you guys in Utah!

    • Chris Mamula says:

      Knowing what to do is one thing, doing it is another as you know from your work with patients in the physical therapy field. Putting things in writing doesn’t guarantee you’re behavior, but it does seem to make a difference. Research on goal setting has shown repeatedly that writing your goals down increases the odds you’ll achieve them.

      Loving life in Utah! Hope your travels are going well.

  2. Agreed, very good article and one that gets the brain cells ticking about my own situation. Thank you for being so open.

    Somewhere around Changes to Allocation or possibly Portfolio Monitoring I might suggest adding Withdrawal Rate. This is a major factor within an investment plan for those of us who are “retired-retired” and with little outside income. IMHO for those of us who have retired after the Great Recession we’ve had it pretty easy, with market returns allowing many to have a net-positive portfolio return even after annual withdrawals. The party has to end sometime (maybe even this year) and the true test will be how we manage our respective investment plans and withdrawals through the next downturn.

    • Chris Mamula says:

      Thanks Ken. That is a great suggestion to put our withdrawal strategy into writing.

      We started down this path with the idea of using a guardrail approach, with pretty wide limits on either side, knowing we plan to continue to earn some income. We set our upper guardrail at 5% withdrawal rate for a given year (not thinking this is sustainable over any extended period of time, particularly with current interest rates and valuations). We set our lower guardrail at 0% (having enough income that we don’t need to touch investments at all). If we’re outside of the guardrails, we’d have to sit down and discuss future spending and earning options.

      In year one, we’re on pace to actually have a positive savings rate due to my wife’s income, me teaching a rock climbing class for one final semester this past spring, me starting to make a small income from the blog faster than anticipated, doing better with the sale of our home than anticipated, and successfully renting our new home for the past year.

      Since we’re outside of our guardrails, current discussions revolve around whether we’re both still doing what we really want to be doing in life. If so, we’ll need to decide how to keep saving or if we should increase spending, if not we’ll need to decide where we cut back on our money making efforts. Stay tuned!

  3. AZColorado says:

    Chris this is a great and timely post for us – thank you. I would be interested in how you and your wife might change your allocation as you enter your 50s, 60s and beyond. We are going to spend the next several years in semi-retirement before pulling the plug on work altogether, and are 49 and 51.

    • Chris Mamula says:

      Excellent question and something I think a good bit about. I think if you would have asked me this question a few years ago when we were on track for a more standard retirement with no work and no income, I would have given the stock answer that we’ll get more conservative and shift toward bonds. If we can delay spending from our portfolio for a few years (or even decades if we continue making money doing things we enjoy) our portfolio may grow to the point that we could live off only dividends without touching our principal. In that case, we may just leave our portfolio as is or even go all in on stocks. It’s ironic, but the people who can least afford the risk of stocks probably need to take more risk to get by without having their portfolio eaten by inflation. The people that don’t need to take the risk of stocks can afford to hold more stocks and have great potential upside to grow their wealth to pass on to future generations or give away. It is a fun problem to ponder.

  4. Chris, with planning to hold only 18 months in cash, it seems you are not currently worrried about sequence of returns risk when living off your portfolio, but will this change in the future when your wife is no longer working and bringing in current income? 18 mos. seems reasonable for everyday emergencies and unexpected expenses, but not a hedge for when you are actively pulling from your portfolio to live on.

    Thanks for sharing your IPS. With 1.5 years before my retirement date, I’ve done a lot of retirement planning and taken action steps, but mostly the plan is still all in my head and not written down. However, I’ve recently decided to again manage my own investments, and plan to put an IPS in writing to help keep the overall goals in mind and keep the pieces working together. Thank you for the blueprint!

  5. What asset allocation do you recommend for investment assets for a retired person at age 68? Own home ($685K value). Zero debt. Thanks.

    • Chris Mamula says:

      Randy,

      Not to come off as flippant or disrespectful, but I wouldn’t recommend an asset allocation as everybody’s situation is personal. A portfolio and investment plan is a mix of your personal math, emotions, and other factors such as SS, inheritances, pensions, willingness/ability to earn income as needed, desire to leave a legacy, health issues, etc., etc. My goal with this post is to provide a framework to start thinking through developing an IPS and asset allocation specific to your situation. Unfortunately, I don’t believe there is a one-size-fits-all correct answer. Hope that helps.

      Best,
      Chris

      • I agree with Chris that to each person needs to customize their own allocation but IMO, Chris’s allocation is an excellent “textbook” model. I’ve deviated from Chris in a few ways even though I feel our situation is similar (except me and my spouse are still W-2 employed):

        1) I have a bigger cash cushion for psycological comfort reasons. It probably drags on my total return but it help me sleep better at night. I also have my house paid off and given both my spouse and I still work, we could leverage our home and buy more equities with acceptable risk to most likely earn more but don’t want to (at the moment).

        2) I have and continue to allocate 10% or so to actively managed individual stocks. It’s my gambling money and keeps me entertained. I track returns on this part of my portfolio more diligently but for the bulk of my portfolio, I don’t track it carefully as it’s well diversified with low cost index funds (and active funds since I don’t want to pay the higher capital gains during my work years) so I agree with Chris it probably does more harm than good to track these assets.

        3) I’m more aggressive on equities (40% international with a larger share in emerging markets than typical, own individual stocks and sector ETFs) and hold more cash. Even if both of us lose our jobs, we can live off our cash and “safe investments” for 5+ years (you don’t need that much if you don’t have a mortgage and ACA is still around. Worst case, we’ll tour the world later and do more road trips in the US in the meantime). This enables us to be aggressive with the rest of our portfolio and still sleep fine at night. If we didn’t have reliable income that exceeds essential expenses, were less focused on capital growth and more on asset preservation, were not able to tolerate an extended downturn in the market, our portfolio mix would be different. I’m conciously more aggressive in the marekt than Chris, but at the same time more conservative via a higher cash cushion.

        To each their own but I wholeheartly agree that Chris’s model is a fantastic baseline to start from.

        • Chris Mamula says:

          Thanks for the kind words and agree 100% that their is no universal right/wrong model for everyone, but there is a right or wrong (more likely several better or worse) solutions for different individuals.

      • Thanks for responding, Chris. You are right – it is an individual decision based on a number of factors. At my age and retirement status, I can’t afford to take another major recession like we experienced in our most recent. While I regained those losses and and went on to enjoy the gains of our current bull market; I have now pared back my equity holdings considerably. The equity I do own is all in equity indexed funds; the rest of our portfolio is in a combination of various bond funds, individual corporate bonds, cd’s, and some individual municipal bonds all geared to generate income. The older I become, risk tolerance decreases and preservation with some return is now my goal. Thanks!

        • Chris Mamula says:

          It’s definitely wise to take your time and figure out your risk tolerance and needs before trying to develop a plan that works for you. Sounds like you’re considering the right things and figuring out a plan that works for you.

  6. Chris – I had the same discussion with my wife re. bonds, but fortunately managed to convince her that stocks were preferable given our time horizon – at the time we were in our 40’s with expectancy that at least one of us could live to be 90+. Now we’re semi-retired and managing our income from our portfolio as well as some small business income, and one pain point is the annual capital gains distributions from mutual funds that count as taxable income. You don’t get these with ETFs, so if I had a do over now, I would definitely consider the ETF equivalents.

    • Chris Mamula says:

      Alistair,

      We hold index mutual funds, not ETF’s. (With the exception of a very small portion of our portfolio in the HSA). We have been able to eliminate capital gains taxes through careful asset location. We hold our REITs, Bonds, and Small Value index in tax advantaged accounts. We hold only the broad based index funds in our taxable accounts. They have very little turnover, and what they do have Vanguard manages to eliminate capital gains with the way they manage the funds.

      It may be too late to switch things around without tax consequences now if you have large capital gains, but if markets drop it may be worth considering in the future. Hopefully this will help people just now building a portfolio.

      Best,
      Chris

  7. Chris-

    Good article on an important topic. Thx for constructing this post!

    We’ve had an IPS for several years and, still use it since retiring. I think that an IPS is a foundational document and everyone serious about retirement (especially ‘early’ retirement) should have one. I noticed a few factors that your IPS does not address (unless I missed them), which I suggest would be good to include.

    1. Risk Tolerance: I don’t see anything that directly addresses your risk tolerance. I suppose AA gets close but, that is really the ‘output’ from your risk tolerance. An example would be what % NW loss you could tolerate in a market downturn; from there, many key decisions (and factors of your IPS) flow. For example, AA, whether you’re a “Safety First” or “Probability” based investor, what your backup plans are, etc.
    2. Income Streams: I don’t see enough in the IPS about guaranteed income streams and how they would factor into your retirement. You talk about this in response to some comments but, I think it’s a vital part of any IPS. If you’re a Safety First retiree, guaranteed income streams are essential. But, even if you’re a Probability retiree, guaranteed income streams (which ones you have and/or want) are almost always an important part of your IPS. For example, many Probability based retirees like to have guaranteed income streams for ‘essential’ expenses; their IPS should address how they plan to do that. At a minimum, almost everyone will get SS, and should discuss in their IPS when they plan to take it.
    3. Backup Plans: I don’t see enough about what you’ll do ‘when’ (instead of ‘if’) TSHTF. Having a cash buffer, which we also do, is not adequate for all scenarios. IMO, more backstops are necessary. Will you return to work? Cut back expenses? Annuitize part/all of remaining wealth?
    4. Medical & Long Term Care: I don’t see anything addressing this, and it is absolutely vital.
    5. Legacy: I don’t see anything about your desires to leave wealth to your child(ren), favorite charity or, nothing at all.
    6. Warning Signs: While this is not absolutely required, we have some ‘Warning Signs’ as part of our IPS. For someone as astute and active in financial/retirement planning as you, noticing warning signs will happen automatically but, we like to write them down in our IPS.

    Thx again for the great post!

    • Chris Mamula says:

      Thanks for the feedback and contributing to the conversation Mark. Obviously agree an IPS is very important if not mandatory for DIYers. To your critiques:
      1.) Agree we don’t explicitly explain our risk tolerance in our IPS, but it is incorporated through our plan from our asset allocation, to decision to keep options open to earn income, to owning home to control our biggest expense and hedge inflation, to not considering our home, SS, future income, and potential inheritences in our plan (all are back-ups/ bonuses) to name just a few. Risk management is vital to anyone attempting to manage their investments and finances in general.
      2.) As you mention, this post and our IPS focus more on investments. The robust discussion in the comments has already given me some things to think about for our personal situation, and demonstrates the need to further explain on the blog to help others.
      3.) I consider this one in the same with risk assessment as outlined in number 1.
      4.) Agree we don’t address in the IPS. I’ve addressed that here though. https://www.caniretireyet.com/flexible-health-insurance-early-retirement/ Unfortunately, there is no good universal long-term solution for health care for an early retiree, so I’ll continue to explore options and write about them in the future.
      5.) Legacy: Agree we didn’t address this. We consider our giving part of our spending which we track and plan to continue indefinitely. We have no goal for leaving a legacy to our daughter or charities after we die. If there is money left, great. We have a will to address this. However, we’re more interested in giving now and helping our daughter develop into an independent adult who doesn’t need anything from us.
      6.) Agree we didn’t include warning signs in our IPS. I’ve addressed that in more general terms in prior writing and more specifically in response to Ken above.

      Thank you again for reading and taking the time to provide excellent feedback!

      Cheers!
      Chris

  8. jon Pitale says:

    Thanks so much for this, and your other, posts. They have really helped shape and hone my thinking around investing over the years. My one child just turned 3 and I was wondering if, in a not-too-distant post, you might address your thoughts/research around college savings.

    I’ll be researching in the meantime as well 🙂

    Thanks again for your continued sharing!
    Jon P

    • Chris Mamula says:

      Thanks for the kind words Jon. Saving for college while saving for early retirement is already on my list of future topics to address.

      • Interested in this post as well. I’m struggling with the dilemma of optimizing between too little and too much. I only have one child that will go to college (we have another child with special needs and won’t go to college). Dad and Mom are done with education. We have enough in a 529 plan for our college bound child to cover all expenses for 4 years at an in-state university. But if he get’s accepted to a top private university, we will be short maybe $150k. And if we get a lucky break and he gets a merit scholarship at an in-state school, we have a surplus. We only plan to pay for his undergrad. We think he should be on his own for grad school.

        • Chris Mamula says:

          It’s really hard to know how much is enough and at what point you’ve over saved. I like your idea of starting with the end in mind and considering what you do/don’t want to pay for. I personally think it is a good thing for a student to have some skin in the game, so while we definitely want to give her some assistance, I’m not too worried if we can’t cover 100% of our daughter’s expenses.

  9. Not considering Social Security in pre-retirement is a mistake. Financially it looks like annuity, bond like stream of income that continues your whole life even if you live to age 150. Maximizing your pay in during later years and delaying payout to age 70 are usually the best strategies. If I had to buy an annuity for my situation it would cost about sum of my real estate and financial assets. So with SS almost half of assets is in bond like fund, all financial assets in stock.

    • Chris Mamula says:

      Glenn,

      You make a valid point, but as with many of the other comments above, everything with a personal plan is personal. It’s not that I’m not considering SS, it’s just that it’s too hard to predict what our benefit will be so we’re not emphasizing SS as an integral part of our plan.

      There is definitely an opportunity cost when you retire as early as I have with regards to SS (not to mention years of earning and saving), but I do have 17 years of paying into SS while working my professional job. I also worked for another 7 years between graduating high school and finishing my master’s degree at low hourly wage jobs. That gives me 24 years of paying into the system, 17 years paying in substantial amounts. It simply isn’t worth it for me to give up another 10-20 years of my life going to a job I didn’t love to earn money we don’t need to max our SS benefit.

      I understand that is not the right answer for everyone. In fact, I’d agree with you that it’s not the right decision for the overwhelming majority of people.

      To be clear, I am sharing my plan that works for me and my family. I am comfortable that it was the right decision for me, and it allows me to sleep well at night.

      Best,
      Chris

  10. I was chatting with a fellow a year or so ago who was in finance, and I said I didn’t like bonds, but I did have rental property. He said, those are bonds. I never really thought of it in those terms, but it’s not as alien a notion as I first thought. This makes me wonder if equity/bond balancing can be dispensed with by equity/income-property balancing instead.

    • Chris Mamula says:

      Steve,

      This was what originally attracted me to RE. It can produce the income of bonds, even better than bonds do, and it also provides the inflation hedge that bonds can’t.

      However, there are certainly downsides to real estate. It is not liquid so your portfolio will function differently. You can’t just sell 25% of a house to rebalance if stocks drop in value. Likewise, if stocks get out of balance, you would have to go find another rental, manage it and possibly take on debt to finance it to keep a portfolio in balance. Rental real estate is also not passive in the way a mutual fund is.

      It’s not that one asset class is better or worse. They’re just different and you need to put together a portfolio that makes sense for your needs, interests, and abilities. If you’re comfortable with real estate, I don’t see any reason that strategy of diversifying with RE wouldn’t make sense.

  11. Crash Davis says:

    “35% Vanguard US Total Stock Market Index Fund (VTSAX)
    10% Vanguard Small Cap Value Index Fund (VSIAX)
    10% Vanguard REIT Index Fund (VGSLX)”

    I would suggest you have too small a percentage in domestic equities. I would suggest 80% in domestic equities and suggest a swap to ETF’s from mutual funds. Lower expense ratios and better performance for ETF’s and better tax treatment for overall ETF redemptions with no capital gains losses. You also have redundancy with VSIAX and VTSAX. VSIAX is not needed in portfolio and has greater expense ratio as well.

    • Chris Mamula says:

      Crash,

      Building a portfolio is part science and part art. I agree that your suggestions may be right for you. I disagree they are right for me. I’m comfortable with more exposure to international funds. Will that cost me a bit more? Yes. Will it pay off over the long run? I have no idea, but I’m willing to roll the dice on that strategy. I can tell you that I’ve had no temptation to add more domestic stocks with the extended bull market and as noted in the post shifted some money away from it to emerging markets and would have shifted more to a value fund that has also underperformed if my wife was agreeable.

      RE: VSIAX being redundant with VTSAX, that is technically true as the securities in VSIAX are also held in VTSAX. However, they make up such a small percentage of VTSAX that they barely move the needle. Thus the decision to add a little complexity and cost to hold that fund.

      RE: Index mutual funds vs. ETFs, for what we’re doing the difference is negligible. As noted in the article, through asset location, we’ve already paid no capital gains taxes on the index funds in our taxable accounts. In tax advantaged accounts, there are no capital gains to pay. I’m not seeing the advantage to ETFs. It’s not that they’re a bad option either and we do hold them in our HSA. But, I doubt I’d do that differently if starting over and certainly wouldn’t go through the trouble of switching from index funds to ETFs at this point.

      Best,
      Chris

  12. Crash Davis says:

    “Will that cost me a bit more? Yes.”
    Yes, fees matter. Your performance will suffer as a result.

    “Thus the decision to add a little complexity and cost to hold that fund.”
    You are not adding complexity to a redundant equity holding. What you are is paying more for no more diversification. Investor return = market return – fees. If value funds increase performance, they will be represented in the index naturally.

    “we’ve already paid no capital gains taxes on the index funds in our taxable accounts.”
    You misunderstood the point of the capital gains comment. These capital gains in all mutual funds are as a result of global investor redemptions (investors other than you) within the fund that impact the mutual fund performance as a result. The way ETF’s are structured, there are no capital gains impacts. This is why ETF’s outperform mutual funds and have many other beneficial characteristics as compared to mutual funds. But to each is own. It’s your portfolio.

    • Chris Mamula says:

      Crash,

      Fees matter, but they’re not the only thing that matters. As noted in the article, my wife and I both dealt with high investing fees in our 401(k) accounts, but utilized them anyway. The fees hurt, but the tax advantages of tax deferral at the 25% rate when both working, tax free growth, and free money of employer matches far outweighed the high fees. We need to look at the big picture, not just fees. To do otherwise would be to have the tail wag the dog.

      Again a small cap value fund is not redundant to a total market fund. An S&P 500 fund is pretty redundant with a total market index, b/c their performance is nearly identical because they’re dominated by the same large stocks. A small cap value fund is not redundant. Look at past returns, standard deviations of returns, the number and type of stocks the fund is invested in, etc. They’re two completely different asset classes. We could have no overlap and choose an S&P 500 fund and a small value fund, but then we wouldn’t hold any mid-cap stocks, small growth stocks, etc which are contained in a total market fund. It’s fine if you don’t agree with our methods, but it’s important that comments are accurate so readers aren’t confused.

      Re: Capital gains, I think again we’re going to have to agree to disagree. If you go to Vanguard’s own site and use their compare function (for some reason the link won’t work, so you’ll have to do this for yourself) and compare VTSAX (total market index fund) and VTI (total market ETF) their 1,3,5,& 10 year performances are all identical both pre- and post-tax. They both have expense ratios of .04%. For our needs, the simplicity of being able to hold fractional shares and not deal with bid-ask spreads make them preferable. There are some minor differences between ETF and index funds, but IMO either is a fine choice for most investors and if this is the biggest issue an investor is struggling with, they need to know it’s not an issue and they should go enjoy their lives.

      Best,
      Chris

  13. Crash Davis says:

    “Again a small cap value fund is not redundant to a total market fund.”
    “A small cap value fund is not redundant.”

    OK, name a stock that is in the small cap value fund that is not in the total market index fund. I’ll wait for your answer.

    You could buy 10 different asset classes that compromise the total market index fund. But all that would do would increase your fees, decrease your performance, and increase your risk. None of these artifacts are preferable for any investor.

    • Chris Mamula says:

      I’m not arguing that the stocks in a small cap index fund overlap with a total market fund. They absolutely do. I’m stating that they’re a tiny fraction of a total market fund, so have minimal impact on performance. If you compare the funds you’ll see they’re not even close to the same in the number of stocks owned, top 10 holdings of each fund, median market cap, P/E ratio, P/B ratio, etc. Subsequently, returns are different. Small cap value stocks represent a unique asset class with unique risks to a total market fund, which is in essence a large cap growth fund. I pay .07% to own that fund, vs .04% for a VTSAX. If you believe your approach is better, agree you should save the 3 basis points. I don’t and think that’s a small premium to pay for the approach I favor.

      I’ve stated multiple times in the post and comments that there is no one size fits all approach. The key is to understand your own style. I have no interest in changing your style if you’re not interested. I’m certain you won’t change mine by restating the same arguments.

  14. Crash Davis says:

    “I’m not arguing that the stocks in a small cap index fund overlap with a total market fund. They absolutely do.”

    Yes, exactly, therefore the equities are redundant which you appear to deny. I do understand my own style, performance and risk. I also understand diversification which a small cap value fund provides no further diversification and is much more risky than a total market index fund and therefore redundant. As you also know, fees compound similar to gains so I prefer the lowest expense ratio total market investments with the lower risk and performance benefits. That’s a win/win/win scenario in any investor’s book.

    • Chris Mamula says:

      How can a small cap value fund “provide no further diversification” and yet at the same time be “much more risky than a total market index fund”? If they’re the same, they would have the same volatility, the same returns each year, etc. If they’re different, they would have different volatility (ie risk), have different returns year to year, etc. They can’t be both the same and different. They have different characteristics and they behave differently. If you don’t think it is worth the risk and cost to hold the fund, that is a perfectly logical strategy. To deny facts is not logical.

  15. Crash Davis says:

    “How can a small cap value fund “provide no further diversification” and yet at the same time be “much more risky than a total market index fund”?”

    Pretty obvious that a small cap value fund would be considered a sector or niche fund with limited diversification and overall greater risk to the investor and greater cost. A small cap value fund would have greater volatility as well. Are you missing something?

  16. Crash Davis says:

    “Will a bit of increased cost, risk, and diversification pay off in the long run?”

    Fair enough. But as we began with in our discussion, there is not increased diversification with your strategy as was the original point of contention. Thanks for the links.