last updated 08/07/2022

What is investment planning? (Learn to Plan like the Pro’s)

There is no argument that investment and investment planning are important.

But investing your money is not something you can undertake willy-nilly. It’s something you have to plan and it involves more than talking to an investment planner.

What does investment planning involve?

Investment planning is the process of identifying your financial goals and determining all possible sources of income from which a portion can be saved to achieve those financial goals.

Financial goals

There are several life realities at the root of investment goals.

  • Emergencies

Life is unpredictable and an emergency can happen any time, like unemployment, a natural disaster, or a pandemic, which may cause sudden financial difficulties. Should something happen, you can have peace of mind that you can continue to cover costs. An initial $500 to $1,000 is a good goal to start with, but you should aim to have at least three months’ worth of expenses saved up.

  • Pay off student loans

Paying for college tuition, campus housing and living costs usually requires taking out a student loan, which you need to pay off as soon as possible. If you can eliminate those loan payments, you’ll have cash available to meet your financial obligations and start saving for retirement. To achieve this goal, you can consider refinancing your loan into a new loan with a lower interest rate.

  • Credit card debt

Credit card debt can be a big drag on monthly expenses and prevent you from having any money to save. Paying off credit card debt is an important aspect of finances, as is a commitment to limit its use.

  • Buy a home

Buying a home is a major expense that you have to plan for. It will also require planning to afford a vacation home. Also, once you own a home, there are always maintenance projects that can be quite costly.

  • Children’s education

Right from day one, you need money to pay for your child’s education, from kindergarten through school, and if you don’t want your child to be stuck with student debt, you’ll need to save for their college education.

  • Retirement

Saving enough money to retire in comfort is an important long-term financial goal for most people. For most people, this means saving 10% to 15% of every paycheck in a retirement account like a 401(k) or 403(b) to which employers also contribute.

Creating a financial plan

A well-thought-out investment plan will help you reach your financial milestones.

1.Set your financial goals

The first step is to set your financial milestones, dividing them into short-term, medium-term, and long-term goals.

Short-term goals include starting an emergency fund, saving for a vacation or a wedding, or buying an item like a laptop or a smartphone. Paying off credit card debt is also a short-term financial goal, or at least you should commit to paying it off in two years at the most.

Getting life insurance and disability income insurance, paying off student loans, buying a car, saving for a down payment on a home and paying off debt all fall under medium-term goals.

Retirement fund, paying off a mortgage, starting a business and saving for a child’s college tuition are examples of long-term goals.

2.Prioritize your goals

You’ll need to balance your short-, medium- and long-term goals.

Experts differ on how to go about it, but all agree that basic living costs like food and shelter come first. Get an emergency fund going, pay off debt and start contributing to a retirement fund immediately.  When that is done, decide how to allocate the rest of your money.

3.Assess your current financial situation

You need to calculate how much you need to save each month, but before you can do that, you need to determine how you are spending your money and how much you have available to save.

Work out how much you will need by the time you are 65 and how much you will need to contribute each month to meet that goal.

If the amount is not affordable for you at the moment, you can adjust the amount you set aside at a later stage when you earn a higher income.

NerdWallet has a 50/30/20 budget calculator to help you figure out how much you can save based on your income.

As a general rule, it’s wise to cut back on unnecessary purchases and rather set extra money aside for your financial goals.

4.Choose your investment strategy

Will you go for save, low-risk investments, or will you opt for high-risk investments?

For most people, personal risk tolerance is directly related to their investment time horizon. In the case of long-term goals, they might be more risk tolerant and go for aggressive, higher-risk investments like index stocks or mutual funds.

If the time horizon for your investment is relatively short, you might choose lower-risk, conservative investments.

People with a higher net worth and more capital available, can afford to have greater risk tolerance than people who don’t have a lot of disposable income, even if they are older individuals with a shorter time horizon.

As a general rule, the higher-risk investments yield higher returns, and lower-risk investments yield lower returns – they are more stable, and there is a low chance that you would lose money.

Government bonds are a low-risk investment. You earn interest on your investment, but it doesn’t grow much in the short term.

On the other hand, shares are a higher-risk investment as the stock market can fluctuate considerably in the short term.

5.Learn about investment options

Investing is not something you should attempt without understanding the different investment vehicles available.

When you understand the different investment options, you can make investment decisions that suit your financial situation and risk tolerance.

In addition, if you are informed, you don’t need to depend on the advice of intermediaries who charge a commission on investment advice. If you are not interested in learning about investment vehicles, or don’t trust your understanding of them, it’s best to consult a financial advisor to help you decide which investments to make to meet your financial goals.

Investment vehicles

  • Stocks

Stocks, also known as shares or equities, represent an ownership stake in a publicly-traded company. If the company does well, the stock price will go up and you can make money when you sell your shares.

  • Bonds

Bonds are issued by a business or government agency. When you buy bonds, you are essentially lending money to the entity, which you will get back with interest later. Bonds offer lower returns but are a safer investment than stocks.

  • Mutual Funds

A mutual fund is a type of financial vehicle that pools money from different investors, investing it in securities like stocks, bonds, commodities, currencies and derivatives.

Through mutual funds, individual investors gain access to portfolios of equities, bonds, and other securities managed by professional fund managers. Each investor or shareholder gets a proportional gain or suffers a proportional loss depending on how the fund fares.

Mutual funds carry many of the same risks as stocks and bonds, but they are diversified, which lessens the risks. Investors make money when the value of the underlying stocks, bonds and other bundled securities in the fund goes up.

  • Exchange-Traded Funds (ETFs)

Exchange-traded funds (ETFs) are also a collection of investments like mutual funds, but they can be traded directly on the stock exchange. ETF share prices fluctuate all day as the ETF is bought and sold, while mutual funds only trade once a day after the market closes.

ETFs are popular with young investors because they’re more diversified than individual stocks and it’s possible to invest in an ETF that tracks a broad index, minimizing risk. Investors make money by selling an EFT when its value has gone up.

  • Annuities

An annuity is a type of investment that people use for retirement. Annuities are offered by financial institutions that accept monthly payments in return for a fixed income stream payment in the future. Because annuities are low risk with low growth, they shouldn’t be the main vehicle you’re your retirement planning.

Other investment vehicles include options, commodities, and cryptocurrencies, all of which are complicated and best left to experienced investors.

6.Create an investment portfolio

When you know your goals and risk appetite, it’s time to create an investment portfolio. Your portfolio should be diversified and include a range of investment vehicles.

The main purpose of a diversified portfolio is to spread risk across different investment assets.  

Building a diversified portfolio involves asset allocation whereby the investor selects from various asset classes in the financial market and then decides what percentage each asset will represent in the portfolio; in other words, what percentage of the portfolio will consist of stocks, bonds, mutual funds, etc.

An asset allocation strategy is determined by your current financial situation, your future needs for capital, and your risk tolerance, keeping the risk/ return tradeoff in mind: the greater the chance of great returns, the greater the chance of loss.

In practice, it usually, but not always, boils down to age. A young person who has many years before retirement can afford to make riskier investments in their quest for high returns, while a person in their fifties needs to be cautious with their assets.

  • Determining how much to allocate to stocks and how much to bonds

Nerdwallet recommends the following strategy to determine how much money to allocate to stocks versus bonds, stocks being more risky. To figure out what portion of your portfolio should consist of stock investments, you can subtract your age from 100 or 110. If you are 30, you can allocate 70% to 80% of your portfolio and the rest to bonds. If you are 60, only 50% – 60% should be allocated to stocks, with a greater portion allocated to bonds.

  • Breaking down your investment further

Within stocks and bond,s you can further break down your investments. For example, a stock portion can be divided between different industries and between domestic and foreign stocks.

The bond portion can be divided between short-term and long-term options and between government bonds of corporate bonds.

7.Rebalance your investment portfolio from time to time

You need to evaluate your portfolio and rebalance it from time to time because market movements may have affected it.

You need to reassess your portfolio and determine the various asset allocations and their values according to their proportions.

Other factors that may influence your portfolio and its various allocations are your financial situation at the time, your future needs, and risk tolerance.

Any changes in these factors may necessitate you adjusting your portfolio.

For instance, if your risk tolerance has changed, you may need to change some of your investments. If you are in a position to take on more risk, you might enlarge the equity proportion of your portfolio.

Some financial advisors recommend that investors rebalance their investments at regular intervals, like every six or 12 months.

Also, as soon as there are movements in the market that cause one of your asset classes to shift by a certain percentage or more, you may want to consider a rebalance.  

For instance, if your portfolio consists of 60% stocks and has increased to 65%, selling some of your stock may bring it back to 60%.

However, selling stock may incur considerable capital gains taxes, which you should avoid. In this case, it might be an option to simply stop investing money in that stock and using that money for other investments.

8.Automatic rebalancing

If you’re not much of a hands-on investor, automatic rebalancing might be an option for you. Robo-advisors commonly offer automatic rebalancing, so you don’t need to worry about this.

Automatic rebalancing kicks in as soon as your portfolio’s allocation has moved away from your original investment target.

With automatic rebalancing, the algorithm of your brokerage or a robo-advisor step in to fix the imbalance. This entails selling off excess securities and using the proceeds to buy securities you lack, which should rebalance your portfolio.

You can choose for the rebalancing to occur at specific intervals, such as monthly, quarterly, or annually.

Bottom Line

Proper investment planning is essential for smart investments. Becoming a confident investor requires research and experience.

If it’s your first time investing, learn as much as you can about investment planning and investment vehicles. If you’re hesitant to take the plunge, consult an experienced investment advisor. Whatever you do, don’t ignore the need for investment planning.

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