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I suppose I am becoming more conservative in my old age. I hear that happens. Maybe all this talk about our liquidity ratio has gone to my head. Or maybe this is just a victory lap; a cheap symbolic token for me to pat myself on the back and say, “Nice job Max, you finally made it.”
Either way, after being highly invested in stocks/equities through most of the longest bull market in history, I am building a new foundation. I am calling it “Max’s opportunity fund”, and it will live in our liquid taxable investment portfolio. It is part of an overall effort of cleaning up our personal finance house ahead of 2021.
So, what is it and why do we need it?
Building the Opportunity Fund
I picked the nice round number of $100,000.
Now, I normally wouldn’t advocate for such a large, somewhat conservative investment. But they say if you expect to need your money within the next five years, the stock market isn’t always the best place for it. I have heard this advice from more than one personal finance guru, and I happen to agree with the thinking. Although the general long-term trajectory of the stock market is up, it can be a wild ride. Selling assets in a down market can play mind games on even the most stoic of investors.
I think there is a good chance the Max Out of Pocket crew will need to access a sizable chunk of our liquid portfolio in the next five years. So, I have created a fund to make sure we have those assets handy when we need them. I almost got original and called it the “Let’s Do This!” fund but that just didn’t have the ring I was going for.
I started building this fund earlier in 2020 and recently completed the cornerstone of our liquid investment portfolio.
I sold this holding for a $22,000 long-term capital gain, all proceeds going into our opportunity fund. It is almost obnoxious I could clear $22,000 without lifting a finger. Okay, I guess I did lift a finger to click the mouse, twice.
To me, that’s a ton of money. But I am well aware this is small-time compared to people who have serious money. This $22,000 would cover almost half of our annual budget and I know seniors who live on a fraction of this every year. In fact, my own disabled sister lives on about $13,000/year from Social Security. I’m guessing that’s the going rate.
Not to be Confused with an Emergency Fund
The opportunity fund is not to be mistaken for the emergency fund. An emergency fund really can’t be accessed for any reason except for a true emergency. Scary things like layoffs, accidents, health scares, deaths in the family, or illness might be a reason to tap into an emergency fund. Our $51,436 emergency fund represents a full year of expenses and it sits safely in a short-term bond fund. I call it a fully funded year. Overkill? Yes. Opportunity cost? Yes. But it helps me sleep at night.
I moved our emergency fund from Vanguard’s money market to this short term bond fund. I couldn’t stomach $0.42 monthly returns on $50,000.
The opportunity fund, on the other hand, comes with built-in flexibility. Certain predetermined parameters allow us to access money from the fund. Although we keep it in conservative bond investments, we are willing to accept a little more risk with this fund as compared to our emergency fund. So instead of short-term bonds, we go with intermediate-bonds.
What can we use it for?
So, what can we use this money for? As you might expect, Max has drafted bylaws for that. These will be finalized by 1/1/2021.
This isn’t vacation money. It’s not fun money, either. We pay for that type of stuff through our normal budget and generally don’t need to plan for it. In fact, we lived it up in 2019 on $51,436 which included a trip to Ecuador (to hang out with other personal finance masterminds) and the Galápagos Islands, a new computer, US citizenship, and over $1,700 on our damn cats. We will come in under that in 2020 even after paying $7,000-$8,000 for Mrs. Max OOP to study abroad.
So if you set up an opportunity fund, it is a good idea to also set up some rules to make sure you do not accidentally spend down the fund in Las Vegas. I have gone ahead and laid out some “triggers” that will allow us to access this money in 2021.
- Buying a house
- Long-term rental in another country; “restart money”
- Starting a business
- Re-invest in the stock market in the event of a market correction of 10% or more
- Short term loan for retirement contributions or a car purchase
I think these are clear and easy to understand, but let’s expand a bit.
Buying a House
Buying a house allows for 100% depletion of the fund. It is the most likely scenario where we would tap into this little nest egg. Frankly, a potential home purchase has been my primary motivation for establishing the fund in the first place.
The Max Out of Pocket crew has been renting a modest place in the mountains for the last four years. We pay $12,000 per year in rent. Since we rent, we do not have any home equity. Unlike most of my peers, if we decide to buy a house in the future, we will not have a house to sell that will provide capital for the purchase. We recently went through that process when we sold our place in North Carlina to move to New England.
Having $100,000 readily available for a house makes me feel better about the prospect of dipping back into the real estate market. Buying a house is stressful enough on its own without having to worry about what investments you are going to sell to fund the purchase. This fund will prevent me from the emotional roller coaster of potentially selling stock market investments in a down market to support the purchase. Without it, I could even see delaying a home purchase all together in a bear market. The opportunity fund positions us not to need to worry about any of that.
Max’s opportunity fund represents a 20% down payment on a $500,000 (USD) house in the United States and a $660,000 (CAD) house in Canada. It is unlikely we would ever drop that much on a house. I think $200,000 to $300,000 fits much better into our reasonable standard of living. That entry point would put us at close to a 50% down payment.
Re-start Money Abroad
Although we currently live in the United States, Mrs. Max OOP has ties to both Canada and Australia. She is a citizen of both countries and recently added a US citizenship to the shelf. Some people collect coins, she collects citizenships. With her US citizenship in the bag, we have a renewed sense of flexibility.
We have seriously considered moving to both places. It just so happens Mrs. Max has been living in Canada for more than 3 months. She will be back in a few weeks.
Australia would likely be a short term “experience” move for a year or two versus putting down real roots. Canada would be more of a long term move with an intent to settle down.
One problem with moving to Canada or Australia is my skillset does not seem to be as marketable in those two countries. Apparently, healthcare finance is a lot less complex when it is nationalized, and you don’t need to overpay people like me to manage the financial system.
I don’t think my salary would even come close to what I am making here in the United States. So, if we were ever to make a move like this, I would want it completely pre-funded for a few years. This fund would help shelter us from stock market volatility. It would give us time to establish ourselves without putting ourselves at risk with an unfavorable sequence of returns.
A move elsewhere in the United States would likely be fully funded by my future employer, so there would be no reason to tap into the opportunity fund.
Starting a Business
This one seems somewhat unlikely to happen within the next five years, but I suppose it is possible. Mrs. Max OOP has picked up a completely new skillset over the last few years. Opening a butcher shop would carry a lot of risks, and I do not have a good feel for the initial capital investment. It does seem like $100,000 would be a good starting point. I have lightly googled it and it appears to be in the ballpark.
We both like the idea of working for ourselves, but there is a lot to explore here. If there was a formal plan drafted to open a shop, there would probably be a full year of saving ahead of this project in addition to the opportunity fund.
Outside of that, I no longer have a ton of ambition to start my own business. I would rather leave that risk with a corporation and just enjoy the work.
Stock Market Investments
This one is a little gray and some will accuse me of trying to time the market and laugh me out of the room. They would probably be right. As I write this, the stock market is sitting at or close to an all-time high. The Shiller P/E ratio, an indicator I like to keep an eye on, is also double the average. I won’t get too much into the technicals, but the stock market is currently priced at 33 times the inflation-adjusted earnings from the last 10 years. There are plenty of good reasons for that, such as a favorable corporate tax rate and free money from the fed. I am sure there are others, and I am not an expert.
The market seems expensive, but we have been saying that for years now and nothing makes this year any different than last year.
I have no idea if the overall market will go up or down from here. But I do know if it goes down by 10% (meets the definition of market correction) or more, my opportunity fund’s “bylaws” allow me to make a large purchase of the total stock market index. Here are the details: The first purchase must be $10,000 or more, with $1,000 dollar cost averaging allowed thereafter. Only 50% of the fund can be used for this type of purchase. It must be paid back with future income as quickly as possible. We don’t allow purchases of individual stocks, only large sections of the entire stock market.
Short Term Loan
This is another one that can also get tricky if we don’t define it. There are only two reasons that would allow a short-term loan from the fund.
Mrs. Max OOP and I both currently drive aged-out Hondas. Mrs. Max OOP’s 2007 Civic seems solid, and she has been driving it since 2007. Her goal is 250,000 miles or more.
My 08′ Odyssey just passed 200,000 miles and is a little more questionable. I bought it from a colleague at work a little under market back in 2015. I have gotten hit with a few $500+ repairs over the years and I just put new breaks on it last week.
They recently passed inspection (hence the new rear breaks) and I suspect both will make it through 2021 considering almost all our transportation is within a few miles of the house. That said, buying a new vehicle has been in the back of my mind for over 6 months. I have been considering a mid-sized SUV. If we decide to purchase a new vehicle in 2021, our rules say that we can access up to $30,000 from the fund if financing options do not make sense. This will require payback as quickly as possible through regular income.
Secondly, I am allowing a lump sum withdrawal of up to $12,000 to fund our Roth IRA accounts in 2021 should we decide to do that all at once. Again, it will require payback a quickly as possible through regular income.
Where do we keep the opportunity fund?
We are holding our opportunity fund at Vanguard in an investment-grade bond fund with intermediate-term maturities. Unlike stocks where we own part of a company that produces revenue and earnings, bonds are a debt owed to the bondholder. Max is essentially the bondholder. Kind of like my Series I Bonds, but the government owes me that debt.
Investment-grade bonds are considered a lower risk, low reward situation.
Vanguard Intermediate-Term Investment-Grade Fund Admiral Shares (VFIDX)
These are Admiral Shares, so you need at least $50,000 to access this fund. The expense ratio is only 0.10%. It does have a little brother that is a little more expensive but gets you the same thing for only a $3,000 investment.
The fund invests in corporate bonds, pooled consumer loans, and U.S. government bonds. You know, boring, but stable stuff. Intermediate-term bonds like these tend to have a higher yield than the money markets and short-term bonds. That said, the share price can fluctuate more as interest rates move. The average term of the bond in this particular fund is 5 – 10 years. The companies who issue the bonds have really solid credit quality and a high likelihood of having the ability to pay back the debt.
Look at these credit ratings:
In other words, not completely risk-free, but it should let me sleep at night.
Past Performance is Not Indicative of Future Results
Here is how $10,000 would have grown over the last 10 years.
There is certainly an opportunity cost to our opportunity fund. (Like what I did there?) If the overall stock market puts up another 30% gain in 2021, I will be leaving almost $30,000 on the table. But it is a price I am willing to pay to build some additional flexibility and stability to our personal finances. I have already missed out on over $5,000 in gains since I sold that $75,000 mentioned above. I don’t really care; we already have enough money.
$100,000 x 30% gain = $30,000
It’s kind of like staying at a lower stress job when you know you could make a higher salary somewhere else. My hypothetical yield as I write this is only 1.54%, suggesting we will only net about $1,500 on this over the next year.
$100,000 X 1.54% = $1,540
A Few Other Rules
This fund will generate about $100-$150 a month in interest which will be automatically reinvested into the fund.
Lastly, this fund will be reviewed no more than annually to make decisions on whether the balance should be increased, decreased, or moved into a more conservative fund. We do not want to be looking at this balance too often since that will defeat the purpose of simplifying my financial life.
Creating this foundation is part of a deliberate effort to simplify my personal finance life and open some capacity for other things. I am even formalizing an investor policy statement for 2021 and cleaning up my medical office building portfolio.
Building up enough assets to be able to carve a fund like this out of our portfolio took years of hard work and focus. Mrs. Max OOP is a part-time teacher with a very modest salary, and I just started making what I would call good (not great) money 3-4 years ago.
It is important to recognize that $100,000 will always be a shitload of money to me. It doesn’t take much to make me happy, and we could probably live off it for 3-4 years if we really had to.
Additionally, It would be remiss of me if I didn’t mention that this is part of a broader target allocation strategy, but we can cover that another time. I generally wouldn’t recommend putting such a large allocation like this into such a conservative investment, but our situation and needs are unique.
I like the opportunity fund concept. When you need access to capital, it takes stock market volatility out of the decision-making process. The last thing I want to worry about when pursuing an opportunity is the fact that I am selling depreciated stock market assets to fund the purchase.
It may sound like Max is becoming soft or a bit too conservative, particularly considering I have not retired early and plan to continue working full time. Or worse, maybe I am trying to time the market. That is not necessarily the case. My risk tolerance is quite high for everything outside of our emergency fund and opportunity fund. If anything, having a solid foundation like this makes me even more confident in investing all future income in more aggressive stocks and equities. There is no more decision point to future investments; it’s automatic. All future investments go into stocks and equities. I know I can’t time the market.
An opportunity cost comes along with this fund. We get some protection from inflation, but that is about it. There is also a tax drag on the fund. These are all things I have thought through, and am willing to pay for.
Do you have an opportunity fund? What else am I missing? Healthcare is my thing, but I am starting to get the sense there are people reading this that really know their “personal finance”.
This is not a recommendation to do anything like this with your own personal finances. This decision will most likely leave THOUSANDS of dollars on the table over the long term. I’m fine with that, we already have enough money.
I like the idea of your opportunity fund. I haven’t formalized a fund like that but I also don’t shovel every last penny into investments, generally keeping a bit of cash hanging around. Some would say it’s not 100% efficient, but I’m okay with that.
I’m jelly of the multiple citizenships. I would totally jump at the opportunity to live long term abroad, even if it’s only for a year or two. That’s a real achievement unlock. My career is in tech so I could in theory work anywhere, but I haven’t put in the time to navigate the ex-pat rules, etc. I can foresee myself being more likely to push on this as the kids start aging out of the house. Doing ex-pat seems much more doable with only a couple left at home, as opposed to all six.
I’m in the same boat on longing for living abroad. Canada is looking really good to me. I’m unsure what it would take to do so (I’d probably need to teach a few years there to get the visa?). I haven’t learned enough about the Canadian tax code to see if there are any adverse or beneficial consequences to the move. I wonder what it would take to qualify for the nationalized healthcare?
Yeah, you aren’t the only one jealous of the tri-citizen status, I wouldn’t mind going for Canadian if we land there at some point. My understanding is there is a tax treaty with Canada, but I have not read up on it much. I think the two Social Security programs even “talk” to each other to some extend. If we ever go that route, would likely hire a tax expert.
Do you have any guidelines on how much cash you are “allowed” to keep?
I probably keep around 5% of net worth in cash. It doubles as my emergency fund, kept pretty liquid. I usually draw it down a bit in the first part of the year when the 401(k) contributions amp up in my contribution front-loading scheme. And also when I true up other accounts like IRAs, 529s and true-up my matching of my kids Roth accounts.
I really enjoyed this post and it got me thinking about my simple approach. I have a very simple IPS and it basically just outlines goals, spending priorities, and asset allocation. We basically use 3-4 funds and cash. I don’t do any factor investing. I tend to keep a larger bond allocation than most as well as cash so I can hopefully avoid selling equities at a loss. I don’t have an opportunity fund, but I would rebalance through bond sales and cash. I agree with David that I’m fine losing efficiency. In my household, maximum efficiency = poor sleep.
I will likely work part-time a lot longer, but with the lower income, I like the decreased volatility bonds bring. We have limited bond space in our tax-deferred accounts so we also hold Municipal bonds in our brokerage account. The tax advantage is nice. When we buy a home, we could always sell some Municipal bonds to have a larger down payment or maybe even pay for the house in cash. Once I have a specific house in mind, I’ll run the numbers to see what we feel most comfortable with (again, it may not be the most efficient route).
If you and Mrs. Max OOP ever make it to Australia, reach out to me. I’ll meet you in person!
Keep up the great posts.
Thanks for the feedback Dr. Medimentary. I am firming up my investor policy statement for 2021 and I will likely release it in early 2021. Maybe we can compare notes. Your plan sounds simple, and that’s an important factor for me. I think defining the opportunity fund happens to be important to us now, but generally I would support a simple rebalance philosophy as you mentioned.
I thought about muni-bonds and may get there as I research more. Taxes aren’t too material for us because of Mrs. Max OOP’s marginal salary.
Keep you posted on Australia!
My favorite part of the post: “over $1,700 on our damn cats”. I share your feelings exactly about my unfrugal dog.
I’m envious of your international options. I’ve considered moving to Canada myself, but I have no idea what it entails. It seems like a great place to be. I’ve spent time in British Columbia and loved it (I’ve visited three times).
The reason your bond fund has performed so well recently is because interest rates have fallen significantly over the past several years. Given the inverse relationship between bond prices and interest rates, the past few years have been good to bond investors. Going forward, however, this same appreciation is not possible unless interest rates continue to drop. Given how low they are already, I’m doubtful that will happen. Nonetheless, they are “safe” in that they aren’t going to drop by 50% tomorrow. But the “safety” definitely comes at a potential opportunity cost over a 10Y holding period. Though generally, I share your thoughts entirely on the insanity of asset prices and the lack of good options.
My vote is continue to rent for $1k/month. The equity in your $12k/year rental home is your oversized investment portfolio as renting freed up cash flow for you to invest as you didn’t have to replace the A/C unit like I just did or hemorrhage almost $10k/year of non-tax-deductible property taxes. The only reason I like owning a home is the hedge it provides for future real estate fluctuations. But it seems like you could achieve this hedge without owning an actual home (e.g. REITs).
Our cats hit us even harder in 2020. But one of them finally kicked the bucket so we will show a nice recovery in 2021 for that line item. Mrs. Max OOP picked those furry friends up when she was in her 20’s, so they came with her. We will not be re-up on any animals for the foreseeable future.
I own a decent REIT allocation that I suppose serves as the hedge you mentioned. I think our rent is a little under market right now, but they do have a AAA platinum tenant who pays rent a week or so early every month and rarely calls for issues. In my mind, that has to be worth something and likely why I have not seen increases.
Have a good Christmas!
You certainly have a detailed vision for the allocation of your money, Max. I’m the same way – it does help me sleep at night too. You know a lot more about the stock market than you give yourself credit. Your New England house is beautiful! I’m sure there are some great memories there. And congrats on having that Odyssey last for so many miles – so impressive!
Thanks for the comment. Yes, we have enjoyed our time up here thus far. Particularly the skiing and hiking!
Hope you are doing well,