Investing is one of the most powerful elements within the financial planning process. Investing is so important that any financial plan which omits it is doomed to fail. While you can pay a financial advisory firm a bunch of money to invest your hard earned money. I think you should learn how to develop your own investment plan. This way you can take full control of your financial future and avoid a bunch unnecessary fees.
When first starting out, many of us make the mistake of thinking that it takes tons of effort to become a successful investor. I used to spend hours researching companies and trying to craft the perfect portfolio. After a few years of traveling down that road I learned the truth; successful investors only need two things: an investment plan and consistency.
Starting Your Investment Plan
When making your plan, you will first need to understand where you are going. In a financial plan, investment decisions usually stem from the need to save for retirement. However, many couples also invest for their child's future education expenses. Your investment plan can be used to help you achieve any financial goal you have, however for simplicity we are going to use retirement as an example.
The first step when developing your investment plan is to answer the following questions. These are intended to help determine your financial goals and capital needs.
- When do you plan to retire (age and year)?
- How many years do you have to invest before you need to start making withdraws?
- How long do you think you will live after retirement (plan to live until 100)?
- How much money will you need a year in order to live well in retirement?
Once you have an idea about how your retirement (or other capital needs) will look, its time to figure out how much you will need to save and invest in order to achieve your financial goal.
Calculating Your Required Savings Rate
The calculation used to determine how much cash you will need to set aside every month is dependent on how much time you have until you need the capital and your anticipated annual return on investment (ROI). To determine your required annual savings rate, I recommend using the Excel spreadsheet function "payment" or PMT. It's simple, just follow these steps:
- Open any spreadsheet and enter "=PMT" into any cell.
- Enter your estimated annual return on investment (i.e. assume 8% or 0.08).
- Input the number of years you have until you need the savings.
- Enter a comma, this will bypass the present value parameter.
- Input your investment goal future amount (i.e. $1,000,000).
- Finally, input a zero for the last parameter.
Your final formula should look like this: "=PMT(0.08,30,,1000000,0)" which equals -$8,827.43. So in this example, we would need to save and invest $8,827.43 a year and receive 8% ROI annually in order to have $1 million in 30 years. Performing these calculations always highlights the power of compounding and starting early.
Crafting Your Investment Strategy
So you've completed the hard part; goals have been established and budget adjusted. Now it's time to put that hard earned money to work. The next step when developing your investment plan is to determine what investments strategies you will need to employ to accomplish your goal.
While portfolio creation doesn't need to be complex; it can get tricky if you let it. The development of a portfolio is beyond the scope of this post, however let the following core investment tenants guide your investment decision making:
- Build a diversified portfolio (easily accomplished with Exchange Traded Funds)
- Leverage tax advantaged accounts.
- Use direct deposit to make saving automatic.
- Remember why you are investing and your long term goals.
- Ensure your portfolio's risk profile aligns with your needs.
- Monitor your investments and adjust as necessary.
Finally, your investment plan is a living document, meaning it should be updated as circumstances change. If you develop and follow your investment plan, there is no doubt in my mind that you'll be better off for it.