Monday, April 29, 2013

Creating an Investment Policy Statement

Now that I'm on the path to being debt-free by the end of 2013, I've begun to look at life post-debt. What are my savings goals? How will I use all of the money that has been going towards debt repayment?

Prompted by The Boglehead's Guide to Investing (learn more here and here), I felt I needed to create an "Investment Policy Statement."

What is an Investment Policy Statement (IPS)?

An Investment Policy Statement defines general investment goals and objectives. It also serves as a guidepost for future investing, identifies goals, and creates a systematic review process.

Where do I begin?

With GOALS. In order to know how you should be saving (what investment vehicles to choose, for example), you need to understand why you are saving. When I did this exercise I came up with 4 goals.

For now, these goals will be on hold until AFTER I pay off my remaining student loan. That is the true emergency right now!

1. Protect myself from unemployment or sudden emergencies. In other words, have a solid emergency fund. My current e-fund covers about 2 months of living expenses. I feel that I need 6 months of living expenses in order to be secure if I lose my job or have an unexpected emergency (medical or otherwise).

2. Own a modest house/condo and pay for it in cash. By "modest" I mean that if I never get married or have children, I'm talking two-bedroom max. I don't need a lot of space. Paying for it in cash is a lofty goal yes, but I don't plan on living in DC forever (hello Seattle or Denver - you have been looking mighty captivating lately!). I am also so anti-debt that I can't imagine paying a mortgage.

3. Retire between 45-50. I say "between" because I like to give myself a timeframe instead of an exact age for retirement. I also don't expect to just "retire" in the traditional sense. I always need to be doing something, so in retirement I imagine doing side/odd jobs that I truly enjoy.

4. Pay for 2 years of higher education for my future children. I don't plan on having more than three kids, by the way. This one is also a bit of an unknown entity. Who knows if I can even have kids? And who knows how many I will end up having? That is why this is number 4 on my list of goals. I really do want kids, but I need a bit of help (cough - husband - cough) so this one is a bit vague.

What comes after goals?

After you determine your goals, you need to spell out your investing philosophy. Here is mine: Buy and hold long-term, all market index strategies with very low expenses.

No way do I want accounts with high fees that earns more for the manager and takes away from my invested money. If you want to learn more about index funds, I highly recommend looking at the philosophy of John Bogle. Read the book or browse the wiki.

Philosophy, got it. Now what?

Determine your asset allocation. This step is important, but also confusing. At least confusing to me. I took an online survey via Vanguard to help me determine my ideal asset allocation. The results: I want to have an asset allocation of 30% bonds and 70% stocks. 

I want to be invested in this ratio until I own property or turn 40, whichever comes first. At 40, I'll rebalance so I am 40% bonds and 60% stocks. A good rule of thumb is to have your age in bonds. Since bonds are lower risk, you want to gravitate towards them as you age.

I've determined that my assets should be diversified in both domestic and international equities (stocks), and US government and corporate bonds. I admit that this is the most confusing part. Do I need TIPS? REITs? What do those even mean? (TIPS are a type of bond, REITs are real estate). I need to do more research here. 

Also important - determine what asset classes you want to avoid. I don't want to be involved with high-fee funds (not giving you more money, Wall Street) and I don't want annuities. Annuities are typically hard to get out of, once you have a certain amount in them. And the percent of return is also determined by the company's (such as TIAA) board.

Now that I know my asset allocation? What funds do I choose?

My guideline for choosing funds is that they be low-cost mutual funds that provide maximum diversification across classes. This means I'll be going with index funds via Vanguard or Fidelity.

What are my target allocations?

The last step is to determine what funds to invest in and how much money you will contribute. Right now, I am regularly contributing to 2 non-taxable accounts (Roth IRA and 403b). The Roth IRA has more in it, which means I'll be doing most of the diversification in that account. The 403b will likely be mostly bonds since I want the lower percentage of my investments in bonds at this stage.

I can't forget about my e-fund, though. I'm looking in to higher interest-baring accounts right now. Currently, I am with Capitol One 360 (formerly ING Direct) and I get about 0.8% interest on my savings. Terrible, I know, but there isn't much above 1% right now.

I've done the IPS, how does this help me towards my goals?

For me, my goals determine how much money I put towards my different accounts. Since my first goal after debt re-payment is to build my e-fund, then I'll be putting extra cash towards that before I contribute more towards my retirement. I'm not going to stop saving for retirement, but I might not get around to fully funding my Roth until after I get that e-fund up.

My second goal of owning a home is going to be balanced with my third goal of retiring early. My strategy will be to do both at once, contributing as much as possible to a savings or several CDs that will go towards buying a home. But I can't forget about retirement savings, because you MUST invest early if you want to see returns later.

Hopefully, by the time I reach my fourth goal of helping pay for a few years of my kids' higher education, I will have a spouse to help contribute to that as well. So I'm being honest here, I don't have an exact plan for that. The goals preceding this one are much more imminent and in my control than my potential child's higher education.

Confused yet?

If you are, there are many, many resources available to you. I'm still doubting these choices and they could change with more research.

Check these out if you want more information:

Boglehead's forum
Mr. Money Mustache forum The Boglehead's Guide to Investing Bogleheads wiki

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