Investing has much more of a “Wild West” flavor these days, what with $0 commissions, online message boards and so-called “meme stocks” posting four-digit percentage gains over a short period of time. But the underlying principles behind successful long-term investing remain the same. First and foremost among those is the importance of having an investment plan. Just like you wouldn’t take a journey without a road map — or at least Google Maps or Wyze — you shouldn’t take an investment journey without planning where you want to end up. Here are the key steps in creating a solid investment plan that can help keep you on track to reach your goals.
Other Options: 13 Ways To Invest That Don’t Involve the Stock Market
Define Your Investment Objectives
The first step in creating an investment plan is to define your objectives. Since you can’t reach your goal without knowing what it is, chart out exactly what you want to get out of your investments. For example, are you just starting out and seeking aggressive growth to maximize your assets? Are you retired with a sizable nest egg and looking to live off what you’ve earned? Generally speaking, investment objectives are broken down into growth, income, preservation of assets and speculation, but the reality is that most people draw from a combination of these. Tailor your objectives to your own personal needs, not some generic model.
Determine Your Risk Tolerance
Everyone wants to earn as much as possible from their investments, but no one wants to lose money. Unfortunately, you can’t have it both ways. Each investor has to strike the careful balance between risk and reward that works best for them. If you’re not willing to lose any money at all, for example, your investment universe will be limited to low-risk, low-return options like U.S. Treasury bills or CDs. If you want the high returns that the stock market can offer, you’ll have to be willing to lose a significant amount of capital in exchange.
One thing to note about risk tolerance is that saying you can accept a 20% drop in the value of your investments and actually experiencing it are two different things. If your risk tolerance is tilted toward the higher end of the spectrum, be absolutely sure that you can stick with your investment plan even when things look bleak.
Set Your Time Horizon
Your time horizon goes hand in hand with your objectives and risk tolerance in determining what types of investments you should own. Generally speaking, the longer your time horizon, the more aggressive you can be with your investments, as they’ll have a longer time period to recover from any short-term losses. Common time horizons include 30-plus years for retirement, 10-plus years for college funding and five-plus years to save for a housing down payment.
Outline the Parameters of Your Investment Policy
Once you’ve created your investment policy, it’s important that you stick to it. One of the main reasons you should write down your strategy is so that when the markets turn ugly, you don’t panic. Most bad investment decisions are based on emotion, and when there’s a frenzy in the markets — either on the downside or the upside — many investors without plans act irrationally, selling at market lows and/or buying at market highs. If you feel yourself getting caught up in the market emotionally, take a look at your investment plan and stick to the instructions you laid out during more rational times.
Choose the Right Broker for You
Once you’ve got the parameters of your investment policy sorted, it’s time to choose the right broker to serve your needs. Stock traders might gravitate toward $0 commission brokers so that fees don’t weigh down their investment returns. However, those with sizable portfolios looking to balance needs ranging from estate planning to tax avoidance and retirement saving might want to pay up for a full-service fiduciary financial advisor. Remember that cost is only part of the equation when choosing a financial advisor; make sure you find one that fits your specific investment needs.
Rebalance — But Only When Necessary
Over time, your investment plan is likely to get out of balance. For example, if you’ve got 5% of your portfolio dedicated to speculative investments and those have gone up 1,000%, they may now amount to one-third of your entire portfolio. In that case, rebalancing is critical so that you don’t have such huge exposure to what should be a small amount of your portfolio. But it’s equally important to avoid rebalancing too frequently. Rebalancing often involves an additional cost, in terms of fees or commissions, but even if it doesn’t, you may face potential tax consequences. You also want to give your investments time to work together, rather than rebalancing them every time they get out of whack by just one percent, for example.
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