Financial freedom can be yours. But you won’t just fall into it. You need a Financial Plan.
You can write one yourself or work with an advisor. Feel free to copy and modify mine if you like.
Here is my Investment Policy Statement (IPS) as an example.
FINANCIAL PLAN PURPOSE:
Investment policy statement and personal finance philosophy.
The purpose of investing is to preserve capital and to produce a reasonable return on investment.
These investments will provide a measure of financial freedom and financial independence. Financial independence supports recreational options, employment options, and financial integrity.
Our preferred use for disposable income (other than investing) is to obtain education, travel, and uniquely memorable experiences. Money spent on consumer items or status-seeking is largely squandered.
Complete retirement will never be the goal. But an unexpected forced early retirement should not be financially devastating.
The asset allocation should include at least 3-5 loosely or non-correlated assets. Two of those will be bonds and stocks. Bonds produce stability and stocks produce growth over a long timeframe. Real estate, commodities, and private placements are also good options.
80-90% must be passive investments such as index mutual funds.
5% or less can be actively managed as a separate brokerage account. This can be more speculative. This helps me test investment ideas without excess risk. This trading account must consistently demonstrate excess risk-adjusted returns (beat the S&P500 index). Otherwise, it too should be passively managed.
Costs must be minimized. This includes fund expenses, trading fees, taxes, etc. Expense ratios should be comparable to those of broad-based low-cost passive index funds. Higher fees are justified only when there is proven risk-adjusted outperformance.
Investments should be for the long-term with an expected time horizon of at least 3-5 years.
I will invest approximately 38% of my gross income per year into long-term investments. This is done by the “pay yourself first” approach. Investments will be deducted from each paycheck.
We will maximize IRA annual contributions and convert them to Roth IRA.
We will maximize employer retirement plans (like 401K and 457b).
We will not go into debt for consumer items or depreciating assets or even for housing.
We will pay off credit card bills each and every month in their entirety.
Homeownership is a blessing and a luxurious expense. We can afford that. We will keep in mind that a house is a liability (an expense that costs money), not an investment.
We will maintain an emergency fund covering at least 6 months (preferably 9-18 months) in cash or a money market account. For example, $10k per month x 6 months would be $60k minimum balance. This will provide peace of mind and will also prevent us from needing to pilfer from our retirement funds, or selling stocks, in case of an emergency.
We will continue to invest at least $5k per year for 529 college savings. This optimizes our state’s tax credit.
We will continue all major medical, umbrella, homeowners, automobile, long-term disability, and term life insurance policies.
The asset allocation for equities will run between 25% and 75%, averaging 50% (40-60%) depending on market levels/fundamentals and investor sentiment. A contrarian asset allocation is preferred. For example, lower stock allocation when the market is high and investing in stocks is a popular, enticing, glamorous thing to do. This will be achieved not through an attempt at prediction or market timing but rather through periodic rebalancing.
Acceptable options would be 40:40:20 or 1/3: 1/3: 1/3
Bonds 40%: Stocks 40%: Other 20%
Bonds 33%: Stocks 33%: Other 34%
Either result in a 50%: 50% (1 to 1 ratio) of stocks to bonds.
All accounts will be reviewed quarterly. Rebalancing may be needed once per year. We would consider rebalancing based on the 5/25% rule. The asset allocations are changed only if they are off the target by either 5% from the target (absolute) or 25% from the target (relative).
Although this IPS lays out a “do-it-yourself” approach, professional services are valuable. We will continue to consult financial and legal professionals when helpful. Costs of services will be scrutinized to compare with the value of guidance received. Those professionals may include CPA for taxes annually; Attorney for liability, asset protection, and estate planning; mutual fund managers; rental property managers; and a fee-only CFP for periodic assessments.
Now it is your turn. Dust off your financial plan. Or create one from scratch. What do you like or not like about my plan?