Brett Klamer
Table Of Contents

Financial Policy Statement

A guide to personal finance.

Investing

Investment Allocation

The most important investment consideration is the asset allocation which will allow you to sleep at night. For example

  • Cash = 10%
  • Bonds/TIPS = 15%
  • Total US Stock = 50%
  • Total International Stock = 25%

Example Holdings

Cash

An investment class which will always return your dollar, but not much more. Usually loses to inflation.

  • Vanguard
    • VMMXX - Prime Money Market
  • Fidelity
    • SPAXX - Gov Money Market
    • FZFXX - Treasury Money Market
  • Other
    • Bank Savings
    • Bank CDs

Bonds

An investment class which is expected to return more than cash, but is generally more stable than stocks.

  • Mutual Funds
    • Vanguard
      • VBTLX - Total Bond
      • VWIUX - Muni intermediate term bond
      • VIPSX - Inflation-Protected Securities
    • Fidelity
      • FXNAX - Total Bond
      • FLTMX - Muni intermediate term bond
  • ETFs
    • Vanguard
      • BND - Total Bond
      • VTEB - Muni long term bond
      • VTIP - Inflation-Protected Securities
    • Fidelity
      • FBND - Total Bond
      • AGG - Total Bond
      • IUSB - Total Bond
      • MUB - Muni intermediate term bond
      • TIP - Inflation-Protected Securities
  • Other

US Stocks

An investment class which provides reasonably high reward for reasonably high risk.

  • Mutual funds
    • Vanguard
    • Fidelity:
  • ETFs
    • Vanguard
      • VTI - Total Stock
    • Fidelity
      • ITOT - Total Stock

International Stocks

An investment class which provides reasonably high reward for reasonably high risk.

  • Mutual Funds
    • Vanguard
      • VTIAX - Total International Stock
    • Fidelity
      • FTIHX - Total International Stock
      • FZILX - Total International Stock
  • ETFs
    • Vanguard
      • VXUS - Total International Stock
    • Fidelity
      • IXUS - Total International Stock

Replicating an index

How to fix your terrible employer provided investment options.

Morningstar provides market cap distributions for funds.

Let’s use OLS!

vtsax <- c(Giant = 41.18, Large = 30.42, Medium = 19.65, Small = 6.49, Micro = 2.26)
vfiax <- c(Giant = 50.12, Large = 33.81, Medium = 15.73, Small = 0.34, Micro = 0)
vexax <- c(Giant = 1.12, Large = 13.94, Medium = 37.10, Small = 34.99, Micro = 12.86)

mod <- lm(vtsax ~ vfiax + vexax)
summary(mod)
## 
## Call:
## lm(formula = vtsax ~ vfiax + vexax)
## 
## Residuals:
##    Giant    Large   Medium    Small    Micro 
## -0.12341  0.17522  0.01865 -0.09445  0.02399 
## 
## Coefficients:
##              Estimate Std. Error t value  Pr(>|t|)
## (Intercept) -0.128412   0.232845  -0.551   0.63668
## vfiax        0.822544   0.005030 163.512 0.0000374
## vexax        0.183858   0.007077  25.978   0.00148
## 
## Residual standard error: 0.167 on 2 degrees of freedom
## Multiple R-squared:  0.9999, Adjusted R-squared:  0.9999 
## F-statistic: 1.891e+04 on 2 and 2 DF,  p-value: 0.00005289
# Or, more simply
X <- cbind(vfiax, vexax)
Y <- vtsax
round(solve(t(X) %*% X) %*% t(X) %*% Y, digits = 2)
##       [,1]
## vfiax 0.82
## vexax 0.18
df <- data.frame(
  Size = factor(names(vtsax), levels = c("Giant", "Large", "Medium", "Small", "Micro")),
  vtsax,
  vfiax,
  vexax,
  replicated = round(predict(mod), 2)
)

df[c("vtsax", "replicated")]
##        vtsax replicated
## Giant  41.18      41.30
## Large  30.42      30.24
## Medium 19.65      19.63
## Small   6.49       6.58
## Micro   2.26       2.24
df <- gather(df, key = "Index", value = "Percent", vtsax, vfiax, vexax, replicated)

ggplot(df, aes(x = Size, y = Percent, color = Index, group = Index)) + 
  geom_point() + 
  geom_line()

VTSAX and replicated overlap in the plot above.

Contribution Hierarchy

  1. 401k
  2. 457b
  3. 403b
  4. Roth IRA
  5. HSA
  6. Taxable

As long as you are not at the top of the tax bracket now, and expect to be at the bottom of the tax bracket in retirement, any Roth option should be used as the default choice. Taxes are low right now, so there is little reason to defer to a potentially higher cost.

You can access your employers Form 5500 filing (annual return/report of employee benefit plan) at https://www.efast.dol.gov/portal/app/disseminatePublic.

What to do when you have a large tax deferred IRA and it’s preventing you from contributing to a Roth IRA? Roll it over to an individual 401k.

  1. Get an EIN https://www.irs.gov/businesses/small-businesses-self-employed/apply-for-an-employer-identification-number-ein-online
  2. Earn money through self-employment, report it on schedule C and schedule SE.
  3. Open an individual 401k.
    • The employer can contribute up to 25% of compensation, without going over the 58,000 limit.
    • The employee can contribute 100% of compensation, up to 19,500.
  4. Roll the IRA over to the individual 401k.
  5. Now contribute to the Roth IRA.

Investment Considerations

  • Expense ratios should be 0-0.2%. Anything outside of this range needs to be avoided almost always. If actively managed funds with reasonable fees are a good option, then they can be considered.
  • Utilize new contributions to rebalance the allocations.
  • Rebalance quarterly/yearly/as necessary by adjusting the tax-deferred holdings or taxable holdings (if losses or long-term gains are available). A common rebalancing point is when allocations break the 5% absolute or 25% relative boundaries.
  • Utilize cash and bonds as necessary to purchase on short term panic drops 10%+ or longer bear markets.

Tax Considerations

  • Hold tax free bonds in taxable accounts. Or, even better, just keep all bonds in retirement savings accounts.
  • Tax efficient index funds (no capital gains) in taxable accounts makes life easier during tax time.
  • A small number of invested index funds makes life easier during tax time (and general record keeping).
  • Convert traditional holdings to Roth when marginal tax rate is low (<~22%).

Financial independence

  • When investments are equal to at least 33x expected annual spending in retirement (i.e. 3%), your income generating method is no longer relevant :)
    • Expected annual spending is calculated as the average annual spending of the previous ~five years. You should multiply this by a safety factor (1.25x, 1.5x) to cover unexpected events in government policy, the financial system, and your spending.
    • Does this seem unreasonable? Fix that by spending less.
# psave = proportion of salary saved and invested
# swr = safe withdrawal rate
# return = expected investment return
# years = years until financial independence
years <- function(psave, swr, return) {
  expense <- 1 - psave
  log(((expense * (1 / swr) * return) / psave) + 1) / log(1 + return)
}

df <- data.frame(psave = seq(from = .1, to = .9, by = .1))
df$years <- years(psave = df$psave, swr = 0.03, return = 0.05)

df
##   psave     years
## 1   0.1 56.826796
## 2   0.2 41.747798
## 3   0.3 32.526332
## 4   0.4 25.676548
## 5   0.5 20.103012
## 6   0.6 15.314857
## 7   0.7 11.047237
## 8   0.8  7.138871
## 9   0.9  3.482239
ggplot(df, aes(x = psave, y = years)) + 
  geom_line() + 
  scale_y_continuous(breaks = seq(0, 50, 10), limits = c(0, 60))

Insurance

Protect your assets with insurance.

  • Term life insurance
    1. Hold term life insurance when you have dependents and are not financially independent.
    2. Many jobs provide term life insurance. Keep a personal policy as you don’t want this tied to the job.
    3. If traveling, and while during transport, credit cards often offer automatic term life insurance if used to purchase travel method (airlines).
    4. If you are young and the insurance amount is less than one million, most insurance providers do not require physical health checks before approval.
    5. It’s usually a pretty easy process to acquire by going through a local insurance agent who can get quotes from several companies (verify these with instant internet quotes).
  • Renters or Home insurance
    1. Be sure your homeowners policy includes extended dwelling coverage as it will replace or rebuild your property even if the cost exceeds your policy’s coverage
  • Car insurance
    1. Liability coverage: If you’re responsible for an accident, your liability coverage will cover the costs of any injuries or property damage caused in the collision. If the other person is responsible, and they have liability coverage, then they will pay for your damage. Most states require you to carry a minimum amount of coverage.
      • Minimum property damage liability you should have is $100,000 (i.e. plan max).
      • Minimum bodily injury liability you should have is $250,000 (i.e. plan max).
      • Liability coverage is the most important part of car insurance and you can only further reduce exposure to this liability through umbrella insurance!
    2. Collision coverage: No matter who is at fault, collision coverage pays to repair or replace your car if you’re in an accident with another vehicle, object, or even yourself. Can be useful for filing a claim with your personal insurance company so that they are the ones who get you money from other insurance company when someone else is at fault. Collision coverage is needed to insure rental vehicles. Is quite expensive. Only needed if your car is worth more than 3x your deductible?
    3. Comprehensive coverage: This level of insurance covers your losses that aren’t caused by a car crash such as theft, vandalism, flood, fire and hail. Probably the most common use for this is to replace window glass? Usually pretty cheap. Only needed if your car is worth more than 2x your deductible?
    4. Uninsured and Underinsured coverage: It will pay you if the other person is at fault, but they do not carry insurance or are underinsured and broke (i.e. the majority of people who drive cars).
      • If you carry collision, then separate un/underinsured property damage coverage isn’t needed. If you don’t carry collision, then property damage coverage is pretty cheap for what is usually a very small maximum coverage ($7,500).
      • Minimum bodily injury liability you should have is $250,000 (i.e. plan max).
    5. If renting, credit cards often offer automatic rental insurance if used for purchase. Though, recently, many have been canceling these additional benefits. Otherwise collision coverage will be needed to cover rentals.
  • Health insurance
    1. Unfortunately health insurance has little to do with covering unexpected costs. It’s more of a middle-man payment system that, in combination with healthcare providers, means the market for healthcare is not a service/good to be purchased, but rather a rent to be extracted.
    2. If not supplied by your employer, use the ACA marketplace at healthcare.gov to search for policies.
    3. Alternative healthcare sharing accounts through faith based companies are also available. These contracts are often not as robust as traditional insurance and can have maximum payouts ($150,000) or drop clauses for who knows what (smoking, no support from pastor, etc.). They generally operate by expecting you to pay cash for all bills. After submitting these receipts, they will provide partial refunds.
  • Long-term care insurance
    1. Purchase in 50s
    2. Reassess as needed as they are currently very expensive or no longer reasonable with current healthcare inflation?
  • Umbrella insurance
    1. This insurance gives protection for you and your assets when you need liability coverage that exceeds the limits of your homeowners or auto insurance. You want an additional buffer between traditional insurance liability limits (~250-500K) and your at-risk assets (anything held outside of ERISA-qualified plans, e.g. 401k or other non-governmental retirement savings accounts) when they become large enough to be enticing. About 80% of umbrella claims are a result of car crashes. This coverage usually doesn’t cover personal business issues (malpractice, etc.), extreme sports and racing, pollution/chemical/radiation incidents, any intentional damage caused by covered entity, transmission of disease, damage resulting from serving alcohol, damage caused by mold/mildew, etc.
  • FDIC (bank) insurance
    1. The FDIC insures up to $250,000 per bank account. If you have more than $250,000 in a bank account, there are two methods for extra protection. First, you can open multiple account across different banks, or within the same bank (one spouse and one joint (2x250,000) for 1,000,000 total). Second, the FDIC will protect $250,000 per beneficiary noted as payable on death (POD; and informal revocable trust), up to five beneficeries for a total of $1,250,000 protected assets per account (https://www.fdic.gov/deposit/covered/trust.html).
  • Service/contractor insurance
    1. Before entering a business agreement, require a Certificate of Liability Insurance. It will verify the policy holder, insurance company, policy number, limits of coverage, and type of liability. Ask/require that you are added as an “additional insured” to this policy. This all must be done prior to start of work. Make sure to stipulate in the contract requirements that notice must be given before any cancellation or change in insurance status, a waiver of subrogation applies to you?, and coverage provided is primary and non-contributory. Other forms of interest are the rider and floater.

Family Planning

  • Create a will once you have dependents. Update the will and beneficiaries of all accounts with each new dependent.
    • Last Will and Testament with Testamentary Trust
    • Durable Power of Attorney
    • Health Care Surrogate Designation
    • Living Will

Other Financial Items

Last updated 2021-07-10