High Income Parents Investment Policy Statement

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When someone goes to a financial advisor she often will ask you a bunch questions about your investment goals, retirement goals, and risk tolerances. She will give you a questionnaire like this one to assess your risk tolerance. Then she will ask what you expect out of your investments and your short-term, long-term and your ultimate retirement goals.

Then she asks you to gather all your investment information and the records of your accounts where you are currently stashing your money. This will cause you to go through all your accounts and see what they contain as far as stocks, bonds, and alternative investments. 

Once you go through all this, she will write out a potential investment policy statement (IPS) and go through it with you. She’ll take your answers and go through potential investments and the way to achieve the goals you stated before.

If the adviser is on her game, she would analyze the tax implications of what you hold in each account and look for ways to match your investments with your goals.

This is supposed to promote trust between the two of you and get you both on the same game plan regarding your financial goals.

I’ve gone through this process before. The nice thing about carrying out this process is once you’ve gathered all the information your advisor requests, you can write-up your own IPS.

Then with the right investment vehicles, you can carry out your plan yourself.

 

DIY

I’m a big fan of managing your own investments. If you are the type of person that can write out a plan and stick to it, you have the potential to save a lot of money. A typical investment adviser might charge 1% of the total funds managed. This is a called a percentage of assets under management adviser. When looking at this type of arrangement, on the surface this could look like a great deal. The more your account grows, the more your adviser’s fees grow. You are a team!

There are a few problems with this:

  1. The best type of advice your adviser gives will typically be very similar if he is managing $50,000 or $5,000,000, at least when it comes to asset allocation. A low-cost, well-diversified three fund portfolio works well in both circumstances.
  2. If you are the type of person that could use some more hand holding for a higher portfolio then an adviser could add benefit. Typically, as your investment knowledge grows, you can more accurately examine your own motives and risk tolerances. Then you can divert your investments to match those tolerances. Only you can decide whether an adviser would fulfill that role and I understand if that helps you sleep at night but to pay an annual percentage for staying the course on an investment strategy get very expensive.
  3. The typical arrangement of a 1% fee of assets under management is a very high percentage of your profit. Think about this.
  4. If you have a well-diversified portfolio you might hope to achieve a 7% return annually over the next 30 plus years (before inflation).
  5. Historically inflation has eaten up 3% of that return so that leaves you with 4%.
  6. If you give your adviser 1% each year, that is 25% or your annual return. I don’t know about you but that is a pretty hefty price that I’m not willing to pay. That’s 1% not going into your accounts. Each year, you lose the ability to reinvest that money and take advantage of compound interest. 
  7. Instead of a 7% return, you are only getting 6%. Here is a graphical representation of that over a 30-year investment career.
High Income Parents Investment Policy Statement

$806,536 difference! If your adviser had just ten clients like this, the adviser has a better retirement than you!

 

If you invested $50,000 a year at a 7% return, My overall current expense ratio of 0.06% would save me $806,536 over that time. 

 I guess that is why Fred Schwed wrote the book Where Are the Customers’ Yachts?: or A Good Hard Look at Wall Street. This is why I do my investing myself.

 

Fee Only Advisers

In this day and age you can find advisers for much less that this, and if you need one, I would advise finding one that is fee only. That means he only charges for the advice given. You might have to pay a retainer or an hourly rate but this is usually much cheaper over the long haul.

If you do most of the heavy lifting, you only have to get advice when you can’t find the answer to your question. When you are getting started, finding a highly recommended fee-only advisory and listening to his recommendations could also be a valuable exercise, if only to see how the process works. 

 

The HIP Investment Policy Statement

Before we dive into this, I want to let you know that this IPS is longer than one I would write just for myself. I incorporated some thoughts into the decisions that I have made so that you can better understand my thought process.

Your own IPS doesn’t have to be as long and wordy as this one.

So, It is high time that I presented the High Income Parent Investment Policy Statement.

 

What are the current assets of my portfolio?

This is where I list my total assets. Currently, they consist of a solo401k, a Roth IRA for me and my wife, my group 401k, HSA, and a taxable account. I also have a rental property. 

How much do I plan to invest each month?

My goal is to save 50% of my after tax income each month. This can fluctuate from time to time if I have a large expense like I have now with my current home remodel. That will hopefully be the last large expense until my kids are starting college. Even then, most of those college expenses should be covered with the 529 plans and by my children’s income during college.

How many years will I be Investing?

My goal is to invest in accumulation mode over the next 12 years. My youngest child will be going to college that year and if my investments go according to plan, I should be able to alter or eliminate my work schedule to decrease responsibilities and time demands.

What is my asset allocation?

High Income Parents Investment Policy Statement

 

How much of a loss can I accept over certain time periods?

This is an interesting question because historically this portfolio has had a standard deviation of 14.1%. I think every investor has to come to grips that everything they do could result in total loss. Even if you stash all your cash in your mattress you could have a situation like in the Weimar Republic.

Also, if you are shorting stocks as an investment strategy then you could lose more than you have.

All these are pretty rare and there would be other amazing events going on in the world, but as far as I’m concerned nothing is off the table.

You can’t really prepare for these events though so I stick to the things that are more probable. 

I think a more proper way to think about this is that stocks can lose half their value (50% drop). This has happened 3 times in the last 90 years. The S&P has dropped 30% nine times and 20% twenty-one times since 1928.

This means I will likely see these happen at least one, three and seven times if I had a 100% stock portfolio in my investing lifetime.

Adding a bond allocation will smooth this but I am prepared to stomach any of these returns at this time.

 

What are my financial goals?

My financial goals are:

  1. Accumulate enough to spend $120,000 in today’s dollars annually in retirement.
  2. Help pay for children’s college through 529 plans.
  3. Pay off the mortgage and be completely debt free.
  4. Educating my kids to plan for retirement and handle their own finances responsibly before going on their own.

 

What’s Important to me as an investor?

I want to accumulate enough funds to retire at the level discussed, be debt free in retirement and help my kids get a college education.

 

What type of investments do I want?

I want diversification across domestic and international markets, capturing as many companies as I can with the lowest expenses.

 

How do I feel about trading?

My trading philosophy is that it should be minimized. Trading incurs costs and taxes. The less I do it, the better.

Tax loss harvesting is an exception where I may save taxes in a higher bracket today to pay in a lower bracket in the future. This type of trading could save money long term in my taxable account. Since I currently get 100 free trades a month I won’t have any commission expenses. 

 

How do I feel about costs?

Costs should be kept as low as possible. This is the one item that has shown to improve investor returns over the long haul.

 

How do I feel about taxes?

I want to minimize taxes as much as possible now as a high income earner. I am betting that I will be in a lower tax bracket in retirement. If this changes, I will change my investments to maximize deferring taxes. 

 

What will I invest in?

My investment vehicles namely mutual funds and ETF’s are widely traded, tax efficient, and closely correlate to the index they track. Most likely I will buy Schwab and Vanguard funds as they best meet my criteria. I will not buy securities on margin and I will keep my cash holdings to a minimum so that the maximum amount of my money is working for me at any one time. 

 

How often will I check my investments?

I will monitor my portfolio monthly, especially to see if there are tax loss harvesting opportunities. I will also rebalance anytime my asset allocation is outside my predefined bands.

 

How will I track my investments?

I will determine how well my investments are doing by yearly calculating my return with the XIRR function

 

What is my drawdown strategy?

In retirement, I plan to minimize taxes by withdrawing the appropriate amount of funds from each investment account type. This includes tax-free Roth IRA’s, tax-deferred IRA’s and taxable accounts. Depending on the spending for that year these amounts may fluctuate. 

As for which assets to sell each year, there are several theories on this but I like the CAPE Median theory. You could also just sell equal amounts of each asset. These two strategies give a similar chance of success with a 4% withdrawal rate. 

Depending on how early I retire, I would like to be closer to a 3.5% withdrawal rate if I am in good health and under 50. 

 

What about if you are married?

It is a good idea to look at this annually and see if you are following your own advice. If you are married you should be on the same page with your spouse about your investing objective. If both of you are earning incomes you could each write an IPS and see how they differ. Then when you sit down and go over them, you can offer advice, encourage each other to stay on track and see where you can help each other accomplish your goals.

 

Now it’s your turn.

 Sit down tonight if you haven’t already and go through the headings explored here today. Answer the questions and get started accomplishing your retirement and investing goals.

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Tom
Tom is a doctor, husband and father of five with a passion for parenting and finance. When he isn't skateboarding, riding BMX, or jumping on the trampoline with his kids, he is reading and writing about personal finance. He helps high income parents educate and mentor their kids to become financially, emotionally, and intellectually self sufficient.

8 Responses to “High Income Parents Investment Policy Statement

  • Great summary. I keep on procrastinating on putting my investment policy statement down on paper, despite reading many bloggers’ excellent articles.

    • Thanks for reading. After sitting down and typing this out it helped me realize some more things I need to do. One is to run some scenarios to help reduce taxes in retirement based on which accounts I withdrawal from.
      It is also apparent that it’s somewhat fluid and this will be amended as life, work and family evolve.

      Tom @ HIP

  • I don’t have it in writing either. I do have some goals though:
    1) Pay off the house in 10 years to be completely debt free. Then consider going part time in my mid-40s.
    2) Save 2 million once debt is gone for an easy retirement. On the other hand, if I enjoy work still I can ride it out until I am 60 at part time and get a pretty sweet pension.
    3) Spend less then I make. Invest the difference.

    As for asset allocation, I am currently stock heavy and use my debt pay down as my “bonds”. They are a guaranteed return on investment.

    • I’ve been letting my bond allocation drop a bit recently as well since I view my mortgage the same way and I’ve been paying more towards that. The after tax interest rate is only about 2% though so it’s not much different than just buying bonds.

  • I’m a firm believer as well that many people can DIY their own investment plan with minimal (or no) help from a paid professional. I have a solid financial plan, but the investing side isn’t my forte. I need to get an investment policy statement in place ASAP, but I’ve been putting it off. Great suggestions!

    • We’ve had a pretty smooth ride for a while in the markets but the IPS gives us something to refer to when the going gets tough. I think that is one of the aspects that helps me the most. Thanks for stopping by Kathryn!

      Tom @ HIP

  • This is an awesome idea and something that my wife and I definitely need to do. We’ve talked about these things but never put them on paper. This will be a fantastic exercise. Thanks for sharing!!!

    • You can refer your wife to me if you get in trouble. Tell her I put you up to this. 🙂

      Seriously though it is a great excuse for both of you to get on the same page and talk through your retirement and financial goals. Have fun!

      Tom @ HIP

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