An investment plan is crucial to reaching your financial goals. Your plan will guide your choice of investments and rebalance and monitor them on an ongoing basis to maintain an appropriate risk level for you.
Your investment plans should reflect both your individual circumstances and long-term goals, and should include setting clear goals, timelines, and risk tolerance parameters. The initial steps include outlining these aspects
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Define Your Financial Goals
Step one of a successful investment plan involves setting financial goals that are realistic, measurable, attainable, relevant and timely (SMART). For instance, purchasing a car within several years to retiring comfortably in several decades are all viable goals to set.
Deliberately selecting investments with appropriate levels of risk will help ensure you achieve the results you seek from your savings efforts. Knowing what your plan B will be in the event that investments fail to bring the expected benefits is also essential.
Once your financial goals have been set, the next step should be assessing your current financial status and calculating how much disposable income is available for investing. A budget can help by tracking monthly disposable income after expenses and emergency savings have been deducted; this will also enable you to identify which accounts can help save and set target investment amounts; finally you will create a risk profile and determine an asset allocation suitable to achieve those goals with minimal risk exposure.
Define Your Timeline
An investment plan can help you reach financial milestones and plan for life’s unexpected surprises, but remembering to follow through on it is what distinguishes true investors from speculators.
Before embarking on an investment plan, take an accurate stock of your finances. This means examining both your disposable income after expenses and emergency reserves have been deducted, and your ability to invest within your monthly budget.
Step two is to determine your timeline or goal horizon. This will enable you to decide how quickly your investments need to grow, as well as what level of risk you are willing to accept. For instance, if your retirement goal is 30 years out then more volatile assets could be acceptable, while for home purchase plans sooner may necessitate more stable options like bonds.
Define Your Risk Tolerance
Once your goals have been set, it’s important to establish your tolerance for risk in pursuit of them. How would it feel if 20 percent of your investments lost value this year?
Your risk tolerance, combined with your investing time horizon and financial goals, should determine how aggressive or conservative your investment strategy should be. Furthermore, it also affects asset allocation – the mix of stocks, bonds and short-term investments that comprise your portfolio.
For example, if your goal is retirement 30 years later, taking more risks might make sense since there will be time to recoup losses in the market. On the other hand, saving for something quicker like buying a home or funding your child’s college tuition might require taking a more conservative approach as you won’t have as long to weather market declines before reaching your goal.
Determine Your Asset Allocation
Once you understand your financial goals, time horizon and risk tolerance it is critical to devise an asset allocation that suits you. Your asset allocation consists of stocks, bonds and short-term investments which make up your portfolio.
Asset allocation decisions can have a dramatic effect on long-term returns and impact how much volatility you’re comfortable accepting. For example, if you are saving for retirement with 30 year time horizon, more volatile stocks might be appropriate as there will be enough time for market fluctuations to play out over this period of time.
Once your plan has been implemented, be sure to periodically rebalance your portfolio to stay in line with its asset allocation target. Rebalancing should occur either on an established schedule such as quarterly or annually or whenever stock investments become more than 60% of your total portfolio.
