Why You Need an Investment Plan

Before implementing an investment strategy, it is important to have an investment plan in place. While these may sound like the same thing, they are actually very different.

An investment strategy is simply a set of rules to help dictate the investment selection in your portfolio. Some examples of this would be the long term value strategy followed by Warren Buffett or the risk hedging strategies followed by many Wall Street hedge funds. 

An investment plan, on the other hand, is defined as the handling of investable assets in coordination with your goals and objectives. You should set clearly defined goals and objectives prior to proceeding with any investment strategies (this is a step that is taken early on through a discovery meeting when you work with a financial professional).

Don’t get us wrong – a solid investment strategy is very important, but for a strategy to be truly successful it needs to have a plan to help guide it.

Think of it like completing a jigsaw puzzle. Sure, you can dump the pieces on the table and start going to work. Eventually, you will get a few pieces to connect, then a few more, and after a while you will have a completed puzzle. However, it is much easier and more efficient to complete the puzzle when you take time to study the picture on the box first and use it for reference as you solve it.

The investment plan is the box to the puzzle. It tells you what the bigger picture looks like so you can more easily put the pieces together, often resulting in a more desirable outcome over the long run.

So what are some common pieces to review when building a solid investment plan?

Risk Tolerance

Your risk tolerance can be broken into two sub categories: ability and willingness. The ability to take risk refers to your portfolio’s capacity to accept risk. This can be affected by things such as your time horizon and liquidity needs (see the next bolded point below). Your willingness to take risk is more of a psychological measure. This refers to how comfortable you feel taking risks and how well you are able to handle fluctuations in your portfolio. These two sub categories don’t always match up, so it is important to consider both together.

Time Horizon / Liquidity Needs

Your time horizon determines how long you plan to hold an investment while liquidity needs measure the amount of money you need from your portfolio in the short term. While these are technically separate topics, they can often go hand in hand. For example, if you have an immediate liquidity need, such as taking ongoing distributions to pay for living expenses during retirement, your time horizon is likely relatively short. However, there can be exceptions to this. Notably, if you have a special one time expense (like paying for college) but plan to let the remainder of your portfolio continue growing, you may have an immediate liquidity need while still maintaining a longer time horizon.

Asset Location

Taxes can cause a major drag on returns over time if investments are not properly allocated. It is important to focus on your take-home (after taxes) return when constructing an investment plan, which is where asset location comes into play. Asset location refers to how you distribute your portfolio across various account types, such as tax-deferred, tax-exempt, and taxable accounts. By efficiently allocating among these various types of accounts, you have the ability to minimize the tax drag on your portfolio and increase its overall value. While there are many factors to consider when maximizing asset location (required minimum distributions, nature of trades placed, classification of holdings, etc), a strong understanding of Traditional vs Roth IRAs is a good place to start.

Behavioral Biases

Not surprisingly, behavioral biases can be a leading reason for investor underperformance. Some examples of normal biases held by many people include the herd mentality (blindly following the masses, or the herd, because “everybody else is doing it”) and hindsight bias (overestimating your ability to predict future events after looking back in the past once certain facts and outcomes are already known). While it can differ based on your specific personality traits and preferences, it is widely agreed that biases can have an impact on how we invest. Having an investment plan in place can help you overcome these normal biases, resulting in a better chance for long term success.

While these are some of the major considerations when developing an investment plan, this is not an all inclusive list. Other common factors to examine include legacy desires, regulatory constraints, and other unique circumstances.

Without taking a holistic approach to investment planning, it can be very difficult to manage your portfolio in an efficient manner.

This is why it can be so beneficial to work with a financial planner – to ensure you have a solid investment plan in place and to help you stay the course when implementing the plan over the long run. 

Derek and Ben

Co-Founders and Owners of Aspire Wealth