Your Investment Plan

As with most things in life, your investing will be more successful if you begin with a plan.  Think of your investment plan as a sort of roadmap that will lead you to your goals without exposing you to undue risks.  The most important part of your investment plan will likely be your asset allocation.  An asset allocation is merely the percentage of your money that you will put into each asset class that you plan to hold in your portfolio.  Within the basic asset classes of stocks, bonds, real estate, commodities, and cash there are many options with different risks and potential benefits.  What most investors fail to understand is that holding different asset classes is much more important than the choice of particular securities.

Most investors fall prey to some very common mistakes.  I hope that you’ve learned that you can’t time the markets, and trying to do so will likely decimate your portfolio.  Academic researchers have shown that investors that trade their portfolios based on short-term performance usually sell securities to buy new ones that end up performing worse than the securities that were sold.  Asset allocation is about the long haul.

Perhaps the most misunderstood aspect of portfolio design is that a basket of different assets from different asset classes performs differently than the sum of the individual parts.  Many investors spend very little time considering individual assets and seem to pick randomly from menus if stocks, bonds, and mutual funds without any regard for fees, expenses, and taxes.  More critically, investors often do not consider how various assets will perform taken together.  The aggregate performance of your assets is the primary concern.

Investment plans will change over time.  When unpredicted changes occur in life, you may need to reconsider your goals and objectives.  As you grow older, you will want to adjust your risk, albeit according to the plan.  As you learn more about investing and portfolio risk management, you may want to make subtle adjustments to your plan that either increase returns or reduce risk.  What you must never do is adjust your plan due to market conditions.

This is a hard rule to stomach, and those talking heads on television can be very convincing (or very, very scary).  You must resist the urge, only selling and buying according to your plan.  No matter how good of a job you have done managing your portfolio risk, you will have down days.  Bear markets will hurt both your feelings and your bottom line.  When this happens, turn off the television and go for a walk.  Spend some quality time with a friend.  Just do not trade your portfolio.

To keep yourself honest, I suggest you put your investment plan into writing.  Perhaps you can use the first page of your favorite mutual fund’s prospectus as a template.  Also, consider writing an investment policy statement, which will include your assessment of your financial needs, your investment goals, your asset allocation, a narrative describing your investment choices, and why your investment plan will result in your reaching your goals over time.

Any time you get the urge to trade your portfolio, read your investment policy statement.  If you are still convinced, then rewrite the statement to include your new insights.  The odds are that this will force you to realize that your fears are transient and that you are making a mistake in altering your allocation.  The best plan in the world will not help you if you do not stick to it no matter what.

By “never trade your portfolio,” I don’t mean that adjustments and maintenance are not required.  Some investors tend to overtrade, and some tend to “set it and forget it.”  Both are bad ideas.  You will indeed perform scheduled maintenance on your portfolio just as you would your car.  Asset allocation is usually expressed as a percentage of your total portfolio value that you will invest in each asset.  Those percentages will change as time passes and the value of each asset goes up and down, and profits are reinvested.

Always reinvest all cash payments such as bond coupon payments and stock dividends.  Most plans will require a shift in those percentages over time.  This means that you will periodically readjust your portfolio to keep it within the parameters you set in the plan.


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Last Updated: 6/25/2018

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