How to Build an Investment Plan That Works for You

To make a solid investment plan, you have to know why you are investing. Once you know the objective, figuring out which 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.

Which Purpose Are You Pursuing? 

Investments must be chosen with the 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 or 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—a retirement income plan. This type of plan projects your future sources of income and expenses and then projects your financial account values, including any deposits and withdrawals. It helps you identify the point in time when 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.

How Much Can You 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 low or no minimum investment amounts, and then set up an automatic investment plan that 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.

When Will You 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 from the one you would have if you were 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. Assuming that 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 five years or more in the market.

How Much Should Risk?

Some investments entail 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 about buying only high yield investments. There is no such thing as high returns with low risk.  It is better to earn moderate returns than to swing for the fences. If you decide to swing, remember, you can miss, and you can experience big losses.

What Should You Invest In?

Too many people buy the first investment product presented to them. It is better to lay out a thorough list of all the choices that meet your stated goal. 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

Suppose 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 your 401(k)
• Time-frame: first anticipated withdrawal at age 65, for $10,000, then $10,000 each year thereafter
• Risk: 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.

Frequently Asked Questions (FAQs)