Unlike a comprehensive financial plan, which covers many topics and can easily take an experienced professional many hours to create, an investment plan for a regular investor is relatively straightforward. And if someone is managing your investments, it can also help you evaluate your current plan and see whether you are getting the knowledge and service you are paying for.
A written investment plan is also called an investment policy statement (IPS). It should become the foundation of your investment strategy and serve as a guide to the planning and implementation of it. Creating a simple investment plan for yourself is as easy as following the five steps outlined below.
1. Determine Your Investment Objectives
Write down your general investment goal, like saving for a down payment on a house, generating additional income in retirement, etc. Quantify your goal down to some specific numbers to get a defined overall performance objective. For example, a 5% compound annual growth rate is required to allow you to retire in 2030 based on your current financial plan. Document your risk profile by taking into consideration your willingness to take risks, your ability to take risks and the actual amount of risks you need to take to achieve your investment goal.
2. Describe Any Relevant Constraints
Determine what your time horizon is for investing in this goal since it will affect your investment strategy. For example, you probably don't want to invest in stocks if you need the money to pay for your kid's college tuition in a couple of months. Specify any liquidity needs you may have while investing. You need to make sure that those needs could be met by either liquidating some investments ahead of time or simply putting enough cash or cash equivalents aside.
Identify any potential tax consequences when making investment decisions for this goal. Some investment gains may receive favorable tax treatments if they meet certain requirements, and the same investment can have different tax treatments when invested in various accounts. For example, interests from municipal bonds can be tax-free if invested in a taxable account but could be taxable when included in a retirement account.
Make sure you are qualified to invest in the investments you choose. For example, certain investment programs may require you to be an accredited investor or qualified purchaser to participate. List any other special criteria you may have when making investment decisions, such as investing solely in companies meeting certain environmental, social and governance (ESG) standards, investments that do not use leverage, and investments that hedge foreign currency risks when investing in foreign investments, etc.
3. Define Your Investment Strategy
Define an appropriate investment strategy based on the objectives and constraints you wrote down in the steps above. For example, take into consideration your timeframe. If you want to invest long-term, ensure the types of funds you are investing in are long-term funds. If you want to make low risk investments, choose funds with lower risk. If you want to make sure your investments comply with your ESG standards, do your research to guarantee these companies fit within these parameters.
There are many different investment philosophies, and many more subsets of investment strategies under each philosophy. Even further, there are countless different ways to implement each specific investment strategy. Don't waste time trying to find the best one, because there isn't a best strategy to follow. In the end, no one can predict the future and you should focus on what you can control instead: your financial goals, diversification, cost of investments and your investing behavior. The best investment strategy is always the one you understand and can stick to for the long haul.
4. Establish Processes and Rules
This is a crucial step. You should explicitly define processes and rules regarding trading, performance measurement and evaluation, risk assessment, portfolio rebalancing, and even tax-loss harvesting, if necessary. For instance, you could create a rule to buy or sell only when specific criteria are met and rebalance when specific percentages are deviating from the target allocation.
The biggest benefit of having a written investment plan is it can be used as a policy guide to prevent you from doing something emotional but not prudent during periods of market turmoil. Regardless of your investment strategy, stay disciplined and avoid making investing behavior mistakes. That is one of the most important things you could do to get a better investment experience.
5. Assign Responsibilities and Hold Yourself Accountable
Last but not least, you should assign the responsibility of creating, implementing, monitoring and reporting to someone who is capable and trustworthy and have them hold you accountable. You can assign all the responsibilities to yourself or give the IPS to your significant other and ask him or her to hold you accountable. People who have someone managing their investments for them should hold the professional accountable based on the IPS created for you. In the end, no matter how great of an investment plan you have, it is worth nothing if you do not follow it.
One last thing worth mentioning here is that for people who are using robo-advisors, you have probably realized that you do not get a written investment plan to follow. Their default process of identifying your objectives and constraints is also very simple and limited. Go through the process mentioned above, create your IPS and only treat the robo-advisor as an investment strategy with some portfolio management responsibilities.
A written investment plan is not a regulatory requirement in the industry, and many financial advisors do not provide it to their clients. However, like a comprehensive financial plan, you should have one, or even have one for each investment goal. A well-written IPS can provide you the guidance you need and give you peace of mind when you feel like you don't what to do with your investments.
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