Having an investment plan that is realistic and actionable is crucial to meeting goals. You wouldn't build a house without a blueprint, so why should your investments be any different? Despite the importance of setting a plan, some beginner investors still open accounts and then immediately decide what kinds of stocks, bonds and mutual funds to buy and sell.
For the vast majority of us, investing is not a game. At some point in the future, we intend to spend the money in our investment portfolio for some purpose like paying bills during retirement, sending our children to college, or perhaps both. Some of us may have other types of expenditures on our minds, or even future philanthropy.
With a goals-based approach, investing becomes a means to an end, not an end unto itself. The nature of your goals will determine the right type of investing for you to pursue.
What makes a good plan?
Having an investment plan is vital, but your plan needs to be good if it has any chance of helping you succeed. A good plan needs to be:
It's also important to understand that a complete plan doesn't have to be complex. Instead, a complete plan needs to include just a few items:
- Your important goals, how much money each goal will cost, and when that money is needed. Let's use retirement as an example since that's most people's No. 1 goal. When do you want to retire? How many years do you expect to live in retirement? How much money do you plan to spend each year in retirement? This is the type of thinking you need to spend some time on.
- A review of your current situation. How much money have you already accumulated toward your goals, and how is it being invested?
- Assumptions about saving and spending. For future goals, your plan needs to include an assumption about how much you'll be contributing towards those goals over time. If you're nearing retirement, you'll need to decide how much you'll be withdrawing from your portfolio each year.
- Risk tolerance. A complete plan will also include the level of risk that you're willing and able to tolerate with your investments.
- Return expectations. Finally, a good investment plan contains some sort of expectation regarding the returns that your investments will generate. These return expectations aren't year-by-year forecasts. Instead, they represent long-term averages that are expected to hold true over time.
Realistic and actionable
Merely having a plan doesn't cut it. Your plan needs to be realistic and actionable, something that you can actually make happen.
Unfortunately, at times, realism seems to be in short supply. Here are two examples:
- As mentioned before, being able to retire is the No. 1 goal of most investors. In order to retire, determine how much money you need to sustain yourself during your retirement years. Given the importance of that number, it's disappointing that the most popular method of figuring out the needed amount is to guess.1
- Another example2 suggests that 69% of workers expect to continue to work for pay in retirement, but only 25% of retirees actually do.
When you sit down to sketch out your investment plan, be sure to ground that plan in facts.
You also want to make sure you draw up a plan that you can actually put into action. A plan that requires you to save 20% of your pre-tax income is going to be hard to put into action for most people. Rather than establishing a plan that requires Herculean feats on your end, make sure that all of the steps in the plan are doable.
If you're still not convinced of the importance of creating a plan, consider this: Professional investors consider creating an investment plan vital for performing their fiduciary duty to clients. In fact, 89% of employer-sponsored retirement plans have an investment policy statement3 (which is just a fancy name for one form of the type of plan we're talking about).
There's also empirical evidence that thinking about your long-term goals ahead of time actually works. For example, in one survey4 of Americans who had recently retired, 54% of those who had thought a lot about retirement before they actually retired reported that their retirement years were going better than their pre-retirement years. Only 18% reported that their retirement years weren't as good.
These results are in sharp contrast to those reported by recent retirees who spent virtually no time thinking and planning about retirement. Among this group, only 11% felt their retirement years were superior to their pre-retirement years. A whopping 57% felt their so-called golden years were actually worse.
In a different survey,5 retirees were asked about their overall level of satisfaction with their retirement. 69% of those who had planned ahead reported being very satisfied. Of those who had done little planning, only 25% reported being very satisfied with their retirement.
Why does planning work?
There are three reasons why planning can be so effective:
- Planning identifies what's important. Thinking about your future is a good thing. Doing so helps you figure out what's truly important for yourself as well as your family. Once you've decided what's important to you, you can ensure that your financial resources are directed towards those important goals.
- Planning resolves conflicts. Typically, when you sit down to make a list of what's important, you get a long list. A key aspect of the planning process is to set priorities.
- Planning prevents backsliding. To a certain extent, a plan is a set of rules you make today in order to govern future behavior. During the inevitable ups and downs of the market and the normal chaos of daily life, it's easy to lose sight of the long term and make decisions based on short-term, often unimportant, and even destructive considerations. A well thought out plan gives you a reference point, keeping you focused on the right things.
Preparing a complete plan founded upon realistic assumptions about your situation is that vital first step on the road to becoming a successful investor.
1. Ruth Helman, Nevin Adams, Craig Copeland, and Jack VanDerhei, "Perceived Savings Needs Outpace Reality for Many," Retirement Confidence Survey, March 2013.
3. International Foundation of Employee Benefits Plans.
4. Annamaria Lusardi, "Saving for Retirement: The Importance of Planning," Research Dialogue, TIAA-CREF Institute, December 2000.
5, Harold W. Elder and Patricia M. Rudolph, "Does Retirement Planning Affect the Level of Retirement Satisfaction?" Financial Services Review, 1999.
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