Principles for a Sound Investment Plan

To the ill-prepared or ill-informed, investing may seem to be a daunting task. Many people find it difficult to overcome their hesitation about investing even when the need to prepare for their future is obvious. The following investment principles can help even the most reluctant investor develop a sound investment strategy.

Step 1: Set Investment Goals/Objectives Vice Performance Goals

Many people describe their investment goal as “to make money” or “to earn 12%.” These are not really investment goals but performance goals. Investment goals should address how you, the investor, plan to use your investment earnings in the future. Will it be for a child’s education, purchase of a house, a dream vacation? Performance goals will set themselves based on your investment goals, your investing time period, and how much you can afford to invest regularly.

Step 2: Know Your Time Horizon

Your investment plan will be heavily influenced by the time period that you have to invest before reaching your goal. The longer the time period, the more that you can afford to take short-term risk for greater potential return and the smaller your regular investment can be to produce the same result. Conversely, the less time you have to achieve your goal the more concerned you must be about short-term risk in order to protect your investment and the more you must invest regularly to reach your goal.

Step 3: Develop a Plan to Achieve Your Objectives

Without a clear plan it is easy to make mistakes and derail any progress toward your goal. Developing an investment plan is not a straight “run through the numbers” game. It is an series of trade-offs between: the acceptable risk, desired return, investment time period, expected performance, and how much you can afford to invest on a regular basis. As you develop your plan, you may find it necessary to revise your initial assumptions (such as time period, amount to invest regularly, etc.) in order to achieve your goals. When developing your plan you should consider the following factors:

  • Pay Yourself First

    Establish a regular payment schedule to your investments. Treat this payment schedule with the same sense of obligation you would a car loan or any other type of financing. If you get a raise, use a percentage of it to increase your regular investment payments. Throw in a portion of any bonuses you receive as a bonus to your investments.

  • Understand the Risks

    Understand that greater returns involve greater risks. The safest investment may not be an effective way to achieve your investment goals because its return may be too low. Most people think of “risk” simply as the possibility of losing money. However, there are actually several different types of risk that may impact you depending on what type of investment you choose. You should know which ones are relevant to your investments and how to rate them. The various types of risk include such things as currency risk, credit risk, interest rate risk, and inflation risk. Risks should not be intimidating; just respected and understood. In the case of risk, what you do not know can definitely hurt you.

  • Diversify

    Diversification is an important tool for reducing the overall risk of your investment portfolio. But, it must be properly understood and applied in order to be effective. Holding mutual funds in two different fund families does not constitute diversification if the mutual funds invest in the same type of stocks or bonds. Diversification can be accomplished in many ways. You can, for example, mix: stocks and bonds, domestic and foreign investments, sectors of the economy such as telecommunications and healthcare, or any combination of the above. Remember, diversification means that the various components of your portfolio have different risk and return characteristics. But, they should all still be consistent with your goals and objectives.

  • Keep Cost in Perspective

    Just because your paying less does not mean that your money is being invested better. Even in investing, the old adage, “you get what you pay for” often rings true. Be sure that you understand the costs associated with your investment and how they are applied. Low or no cost up front may mean high cost on the back end. Also, consider the level of service your investment firm provides and make sure that you are paying for actual value received. Do not pay extra for services and options that you do not need.

  • Consider Inflation

    When determining the return necessary to achieve your goals, do not forget to account for the eroding effect of inflation. If you do, you can still fall short of you goal no matter how well you stick to your plan.

  • Be Persistent

    Perhaps the most important thing, once your plan is developed, is to stick to it. Do not change the way you invest based on short-term swings in the market or feelings of optimism or pessimism. You should only change your plan if one of your fundamental factors changes, such as your investment goal or your investment time period. However, you should periodically re-evaluate your investment vehicles to ensure that their objectives and performance remain consistent with your plan. But, once again, do not throw them out due to a short-term decline.

Once you have thought through your personal situation (i.e., your objectives, time period, amount to invest, and acceptable risk level), you will be much more comfortable choosing where and how to invest, and the answers will seem much clearer. One last tip to remember, you do not have to make all the decisions alone. It can be very helpful, not to mention financially beneficial, to discuss your plan with a financial professional. Even if you have to pay a little for the advice, you will be better off in the long run if you establish a solid investment plan from the start. We at CGMA are here for you. Please contact us for a free initial consultation.

Diversification and asset allocation strategies do not assure profit or protect against loss.

The CGMA Group, LLC is made up of respected advisors based in Maryland who serve individuals and companies throughout the United States with a focus in the Baltimore-Washington region.

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