How to Build a Good Investment Plan in 5 Steps

Having an Investment Plan Can Improve Your Long-Term Results

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To make a solid investment plan, you have to know why you are investing. Once you know the objective, figuring out what choices are most likely to get you there becomes easier. The five questions below will help you build a sound investment plan based on your goals.

1. Which Purpose am I Pursuing? 

Investments must be chosen with a main goal in mind: safety, income or growth. The first thing you need to decide is which of those three characteristics is most important.

Do you need current income to live on in your retirement years, growth so the investments can provide income later, or is safety (preserving your principal value) your top priority?

If you are 55 or older, before you create an investment plan, you really should make a specific type of financial plan which I call a retirement income plan. This type of plan projects your future sources of income and expenses, then projects your financial account values including any deposits and withdrawals. It helps you identify the point in time where you will need to use your money. Once you have a clear time-frame you know whether to use short, mid, or long-term investments.

2. How Much Can I Realistically Set Aside for Investing?

Many investment choices have minimum investment amounts, so before you can lay out a solid investment plan you have to determine how much you can invest. Do you have a lump sum, or are you able to make regular monthly contributions?

Some index mutual funds allow you to open an account with as little as $3,000 and then set up an automatic investment plan starting with as little as $50 a month which would transfer funds from your checking account to your investment account. Investing monthly in this way is called dollar-cost-averaging and it helps reduce market risk.

If you have a larger sum to invest, obviously more options are available to you. In that case, you'll want to use a variety of investments, so you can minimize the risk of choosing just one. The most important decision you'll make is how much to allocate to stock vs. bonds. Another key decision is whether to build your portfolio or work with a financial advisor.

3. When Will I Need This Money Again?

Establishing a time frame you can stick with is of the utmost importance. If you need the money to buy a car in a year or two, you will create a different investment plan than if you are putting money into a 401(k) plan on a monthly basis for the future.

In the first case, your primary concern is safety — not losing money before the future purchase. In the second case, you are investing for retirement, and assuming retirement is many years away then it is irrelevant what the account value is worth after one year. What you care about is what choices are most likely to help your account be worth the most by the time you reach retirement age.

In reality, significant growth typically requires at least 5 years or more of time in the market.

4. How Much Risk Should I Take?

Some investments entail what I call a level five investment risk; the risk that you can lose all your money. These investments are too risky for most people. One easy way to reduce investment risk is to diversify. By doing so you may still experience swings in investment value, however, you can reduce the risk of a complete loss due to bad timing or other unfortunate circumstances.

Be cautious of buying only for high yield investments. There is no such thing as high returns with low risk. Better to earn moderate returns than swing for the fences. If you decide to swing, remember, it can backfire and you can experience big losses.

5. What Should I Invest In?

Too many people buy the first investment product presented to them. Better to lay out a thorough list of all the choices that meet your stated goal. Then take the time to understand the pros and cons of each. Next, narrow your final investment choices down to a few that you feel confident about. Some investments are great for long-term retirement money. Others are more speculative, which means maybe you can put some "play money" or "take a chance" money into them, but not all of your retirement savings.

Putting It All Together

Let's say you are 50 years old and have $100,000 saved in an IRA. Your plan may look as follows:

  • Purpose: growth for age 65 retirement.
  • Amount to invest: $100,000 plus $15,000 a year to my 401(k).
  • Time-frame: first anticipated withdrawal at age 65, for $10,000. Then $10,000 each year thereafter.
  • Risk level: Risk level three and four investment focused on growth are fine, but as you get within 10 years of retirement, each year you will shift $10,000 to safe investments.
  • What to invest in: Index mutual funds in your 401(k) or IRA will make the most sense. They have low fees and fit the objective you have outlined.

Once you have a plan, stick with it! That is the key to investing success.

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