The French writer Antoine de Saint-Exupéry once wrote, “A goal without a plan is just a wish.” He wasn’t referring to investing goals when he penned this, but he could have been.
Having financial goals is great, but without a plan for how to reach them, you have little more than aspirations. To turn aspirations into reality, you need an investment plan.
An investment plan is essentially a road map for how you’ll get from where you are today to where you want to be financially in the future. It will tell you how to invest to achieve those goals while staying within your risk tolerance.
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“An investment plan brings structure and clarity to financial decision-making,” says Ryan Patterson, a certified financial planner and chief investment officer at Linscomb Wealth. It will also help you stay focused on your goals and avoid potentially costly emotional reactions to market or economic events.
How to Develop an Investment Plan
Developing an investment plan may sound like a daunting task, but it needn’t be complicated. In fact, “the most effective investment plans are not the most complex,” Patterson says. “They’re the most realistic and sustainable.”
Here’s how you can develop an investment plan to reach all your financial goals:
— Step 1: Define your goals.
— Step 2: Assess your current financial situation.
— Step 3: Determine your risk tolerance and capacity.
— Step 4: Develop an asset allocation strategy.
— Step 5: Select your investments.
— Step 6: Start investing, then continue monitoring.
Step 1: Define Your Goals
You can’t map a route from point A to point B without knowing what point you’re trying to reach. The same is true of an investment plan.
The first step to creating an investment plan is to lay out your financial goals. These can be anything from “buy my first couch” to “save for retirement.” You can include as many goals as you’d like, so don’t hold back.
The key is to “be specific about what you’re investing for, and assign time frames and values to each goal,” Patterson says. You may only want to save for a few months to buy the couch, but retirement could be decades away. You don’t have to be exact in your time frames. Just a general idea is enough to get started.
It can also be helpful to put a dollar amount on each goal. This may be harder to do for more longer-term goals like retirement, so consider using online retirement calculators for help.
Step 2: Assess Your Current Financial Situation
Just as you need an end destination to chart a route, you also need to know your starting point. In an investment plan, this is your current financial situation.
Document your income, expenses, current savings and debt, as well as any existing investments you own. This is point A on your map.
Pay particular attention to your monthly expenses. These will dictate how much liquidity you need.
You should have enough money in cash or a cash-like account to cover six months to one year’s worth of known expenses, says Susan Green, partner and senior financial advisor at Wescott Financial Advisory Group. “You never want to risk putting funds into the market if you know you will need that money in the next few months for a known expense,” she says.
You’ll also want to create a budget to help you gauge how much you’re able to invest each month.
Step 3: Determine Your Risk Tolerance and Capacity
There are two types of risk to consider in your portfolio: your risk tolerance and your risk capacity.
Risk tolerance is your willingness to withstand volatility and possible loss for potentially greater gains, Green says. “Are you able to sleep at night knowing that X amount of your portfolio is invested in the stock market, it could potentially decrease in value and it may take a long time to regain its value and/or earn a profit?”
If you find yourself losing sleep over any drop in your portfolio’s value, you have a low risk tolerance. Alternatively, if you can sleep like a baby even after watching the stock market make double-digit declines, you likely have a high tolerance for risk.
Risk capacity is your ability to withstand investment losses without impacting your financial goals, she says. “Those with shorter time horizons and/or smaller portfolios typically have less capacity for risk than those with longer time horizons and/or larger investment portfolios,” she explains.
Each of your financial goals can have a different risk level. But overall, your investment plan should assume only as much risk as you can tolerate within your given risk capacity.
[Read: 7 High-Return, Low-Risk Investments for Retirees]
Step 4: Develop an Asset Allocation Strategy
Your asset allocation is the mix of stocks, bonds and other investments you own. It’s how you set your risk level by choosing an appropriate proportion of riskier investments (like stocks) to safer investments (like bonds).
Craft an asset allocation for each goal based on the risk levels you determined in step three. For example, a goal with a high risk level may use a more aggressive asset allocation of 80% to 90% stocks and only 10% to 20% bonds. Meanwhile, a low risk level goal should use a more conservative approach, such as 80% bonds to 20% stocks.
Outside of your individual goals, Green recommends keeping three to five years’ worth of expenses in fixed income. “If the stock market remains down for a long period of time, you can rely on this liquidity to meet your expenses without needing to sell depressed equities,” she says.
You can build this fixed-income reserve over time while also saving for your goals. Don’t put off investing for retirement because you haven’t built up a big enough reserve.
Step 5: Select Your Investments
Now it’s time to fill in your asset allocation categories with specific investments. There are many to choose from, but the best starting point is often a selection of exchange-traded funds (ETFs) or mutual funds. These are pooled investment vehicles that let you spread each dollar you invest across dozens, hundreds or even thousands of different investment securities. Each fund is run by a fund manager who does the work of selecting and monitoring the investments for you.
You can create a portfolio with only two funds — one stock fund and one bond fund — but you might want to incorporate a few more for broader diversification. Ideally, your stock investments should be spread across different geographies, industries, company sizes and investment styles, like growth and value.
“When one area of the market is down, you’ll be glad that you don’t have all of your money invested in that area,” Green says.
You can also diversify your fixed-income investments by using bonds of different maturities and credit qualities. “Higher credit qualities and shorter or intermediate-term maturities are often viewed as safer, while longer-term maturities may provide higher returns in exchange for the greater risk that comes with longer time periods,” Green says.
Step 6: Start Investing, Then Continue Monitoring
The last step in creating an investment plan is to open the necessary account and buy your chosen investments. Pay careful attention to fees as you do this. You should always know exactly what you’re paying, and aim to minimize fees whenever possible.
Once you’re up and running, keep a close — but not too close — watch over your investments. You should monitor how you’re progressing toward your goals, but there’s no need to check in every day. In fact, frequent check-ins are likely to be more detrimental than helpful. The stock market can be fickle in the near term. The most successful investors keep a long-term view and remember that today’s news headlines will be old news tomorrow.
You can revisit your plan once per year “to assess progress, rebalance the portfolio and update your plan as circumstances change,” Patterson says. As you near your goals, you may want to check in more frequently, but again, remember not to overdo it. But do remember to keep contributing. Every dollar you invest will get you one step closer to reaching your financial goals.
Consistency and patience are the keys to success, Patterson says. “Don’t try to time the market. Instead, focus on what you can control: savings rate, asset allocation and costs.”
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How to Build an Investment Plan originally appeared on usnews.com
