But you shouldn’t just jump into it willy-nilly. As with most things in life, it helps to have a plan. Creating an investment plan can help you figure out how to go about reaching your goals and keep you on track when you’re tempted to abandon the effort.
Here are five steps you can take when putting together an investment plan that gets you to the finish line.
How to create a successful investment plan
1. Begin at the end
“I consider the end first,” said Larry Ludwig, a long-term investor and founder and editor-in-chief of InvestorJunkie. “What’s the purpose for this money?”
Ludwig said it makes sense to consider a separate plan for different goals.
“Investment planning for something like retirement is different than planning for college savings for your kids,” he pointed out. Therefore, think about how the money will be used in the end and figure out your needs.
Say you want to help your child pay for two years of college. You estimate that will cost about $35,000. If you start saving when your child is born, you have 18 years to reach that number.
How much do you have to invest each month to reach $35,000 by your child’s 18th birthday? With a modest six percent annual rate of return, you can accomplish your goal by setting aside $100 a month for 18 years.
Starting with the end in mind is an important part of smart investing for the future. Use our investment calculator below to break down your end goal and see how much you should set aside every month.
2. Know your timelines
Once you have an idea of your needs, it’s time to figure out your timeline. “You need different time horizons for different goals,” said Ludwig.
It’s not just about how long you have to save up, either. Ludwig pointed out that you need to consider how long you will be using the money you’ve saved, too.
If you decide to save up for a down payment on a home, you withdraw all the money you need at once. Chances are, you save up over the course of three to five years using low-risk investments such as cash and bonds. Then you liquidate your account to make the down payment.
With college savings, though, you withdraw money over the course of four to eight years. You save up using a mixture of stocks and bonds, and then your child has to be careful about withdrawing the money so it lasts as long as college does.
For retirement, said Ludwig, you really need to pay attention. “This is a situation where you’re saving up for maybe 20 or 30 years,” he explained. “And you might be withdrawing for 30 or even 40 years, depending on if you retire early and how long you live.”
In the case of retirement, it’s important to consult with a financial professional who can help you map out a withdrawal plan that will help your money last as long as you need it to.
The earlier you start and the more consistent you are, the better off you’ll be — no matter your investment plan.
3. Allocate assets according to your risk tolerance
Next, decide on an asset allocation that makes sense according to your risk tolerance. Ludwig said that your risk tolerance depends on how long you have to invest, as well as how you feel about the situation. The longer you have until you need the money, the higher your risk tolerance.
“I like to put my money into buckets,” said Ludwig. He thinks in terms of short-, medium-, and long-term goals when setting up his buckets.
For money he needs in the next five years, Ludwig knows he has a low risk tolerance. There isn’t much room for error, so that money is invested mostly in cash and bonds, with few stocks. The longer the time frame for the money, the higher the proportion of stocks.
Your investment plan should call for rebalancing your buckets as your goal approaches. Ludwig, for example, started a 529 for each of his three children when they were born. Starting with 100 percent in stocks makes sense. However, each year he rebalances so that he sells enough stock to change the composition to bonds by five percent.
By the time his children are 18, their 529 portfolios will have shifted so that 90 percent of the assets are in bonds, and only 10 percent are in stocks.
This gradual shift works for retirement as well. Figure out how to make that shift as you go along, based on which bucket the money is in.
4. Use dollar cost averaging
One of the best tools you can use is dollar cost averaging to consistently work toward your goals.
With this strategy, you invest a set amount of money each month. You might not have as much as you need right now, but start with what you have and increase the amount you invest over time.
Map out how you can step up the amount you set aside for your goals. If you will pay off a student loan soon or are expecting a raise at work, plan to put that extra money towards your investments.
The idea is to commit to putting extra funds toward your investment plan as they are freed up. Build that into your investment planning, and use dollar cost averaging to achieve it.
Ludwig also warned against over-diversification as you get started.
“It’s tempting to slice and dice, but you don’t have the assets for that,” he said. “Keep it simple. For most people, a stock fund and a bond fund is fine to start. You can diversify further as your portfolio grows and you have more assets.”
5. Tweak as needed
At the end of the day, your investment plan doesn’t need to be set in stone.
While you want to stay on track, you can also tweak as the situation changes. If you want to move up your time frame or you decide you need to save more, there’s nothing wrong with taking stock and changing things.
However, it’s important to take an analytical approach when you make changes. Don’t make changes based on what’s happening in the market. Smart investing requires that you keep your emotions in check and don’t respond to market events.
As you create your investment plan, you’ll feel better about the future. With a roadmap to build wealth, you can confidently start investing and working towards your goals.
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