Follow this simple investing strategy to create a portfolio right for your needs
Putting together a simple investing strategy that you don’t have to worry about has been the driving reason for this blog. I’ve spent decades investing and working with everyone from individual investors to large venture capital firms. One thing I’ve learned is that investing doesn’t have to be stressful or difficult. It doesn’t have to be something that takes hours every week and it doesn’t have to keep you up at night.
Creating an investing strategy that will meet your goals is easier than you might think, so easy it may even seem too simple to be true.
Building a Simple Investing Strategy and Why Most Investors Lose Money
Despite all the analysis of investments on TV and across the internet, investing really isn’t about picking stocks and companies – it’s about YOU!
The stock market and other investments are going to provide a return for a certain amount of risk. Some investments may (or may not) provide awesome double-digit returns but the risk of losing your money is also very high. Other investments will almost certainly provide modest single-digit returns. The only question you need to be asking is how much risk will you take for how much return?
Most people miss this point and just invest haphazardly across a bunch of stocks. They end up getting beaten and bruised by the market because their investments aren’t customized to their needs.
That’s why the first step in any investing strategy is to create a personal investment plan. This written plan is going to look at how much money you need for your specific goals and how much risk you’ll be comfortable with in investing. It’s only by knowing these two key elements that you’ll be able to pick the right investments for you.
Step 1: Simple Investing Strategy – Creating a Personal Investment Plan
A personal investment plan is one of the most important concepts in personal finance. Unfortunately, it’s also one of the most neglected. Instead of taking the time to figure out what people really need to reach their financial goals, it’s far easier to just throw out stock recommendations and create hype.
That’s why the average investor return was just 2.6% annually for the decade to 2013, even as the stock market returned 7.4% and the bond market offered a 4.6% annual return over the period.
Investors don’t know where they’re going so they trade in and out of stocks, hoping to magically appear at their destination in retirement.
A personal investment plan is your roadmap to meeting your financial goals.
That roadmap starts with finding your destination.
- Estimate how much you’ll need in retirement and for different financial goals.
- Be sure to include any large expenses like education and financial gifts.
- The general rule is that you’ll need 80% of your current income in retirement. This estimate may not work for everyone but it’s a good place to start.
- You can use the investment calculators on this blog to estimate your income and other financial goals. Check out the retirement planner calculator to determine whether you are on track saving and how much you should invest each year to meet your goals.
You’ll also need to look over your budget and decide how much you can save towards your financial goals each year. Your monthly savings might rise and fall slightly but you just want a rough estimate of how much you can save.
A lot of people don’t realize how moderate of a return they actually need so they load up on risky stocks, hoping for double-digit gains every year. They end up taking too much risk and panic-selling when the market crashes. Creating a simple investing strategy is about only taking as much risk as you need to meet your goals.
If you can easily meet your financial goals with less risky investments, why not put most of your money in those investments and not have to worry what happens to the stock market?
The final piece of your personal investment plan is finding the level of risk you’re comfortable with taking in investments.
Are you comfortable with big changes in your wealth or would you rather a slow and steady approach? Are you a gambler or someone that prefers the insured and certain path?
There are Risk Tolerance questionnaires available on the internet. I’ve put together a simple 10-question survey to help you find your risk tolerance. Answering the questions will take less than ten minutes and will guide your simple investing strategy.
Putting your Needs in Action with a Simple Investing Strategy
Use the annual return you need and your risk tolerance to decide how much of your total portfolio you need in different asset classes.
There are five general asset classes – stocks, bonds, real estate, commodities and alternative investments. Each asset class is comprised of investments that share common growth drivers and is different from the other assets. There will be some overlap between assets, for example real estate and commodities both react similarly to inflation but they are clearly different in most respects.
Within each asset class, investments are further separated into groups that share similarities. Within bonds, you can invest in foreign or domestic issues, debt specific to an industry or different types of debt. Commodities can be agricultural, precious metals or metals used in industrial production.
The asset classes are important for a couple of reasons:
- Different assets offer different returns for different levels of risk. I’ve included a comparison chart of risk and returns. If you have a low tolerance for risk and do not need a high return to meet your financial goals, you’ll want to invest mostly in assets on the left-side of the chart.
- Investing in different asset classes helps to diversify your risks. Even holding some of the more risky assets may not be too risky if you also have other assets like bonds and real estate. Some prices will be going up while others go down depending on the economy and other factors. The result will be a smoother, upward climb in your overall wealth.
Diversification is the key to investing, even the most simple investing strategy. The idea of diversification is that not all investments will react similarly to changes in the economic environment or sentiment for stocks. By combining different investments within a portfolio, you can smooth out your returns even over the worst of times.
Of course, there is a price to pay for lower risk in your portfolio. If you were to invest in only one stock and it soared three-fold, your returns would be amazing. If you spread your investments over ten stocks or three times that number, your averaged returns across the portfolio would be less spectacular. The price of averaged returns is well worth it because you remove the risk of catastrophic loss if any one stock stumbles.
Most investors really only need a mix of stocks, bonds and real estate to meet their financial goals. Investing in commodities and stock options opens your portfolio up to more risk than they are worth and I would recommend against it.
How much you invest in each asset class is going to change as you get older because your risk tolerance will change. As you get closer to needing the money from your investments, you won’t be able to withstand the greater risk in stocks.
Look at this example as a guide for changing your allocation in stocks, bonds and real estate.
Step 2: Creating your Stock Investing Plan
Once you know how much of your money you want to put in stocks, it’s time to think about which stocks you should buy.
We carry the idea of diversification into stocks as well. The stock market is separated into nine different sectors of companies.
Companies in each sector serve or produce a common product category. The sectors are further separated into hundreds of industries which all focus more closely on a common product or service.
You will want to invest in a mix of stocks from all the sectors but may want to invest more in specific sectors depending on your risk tolerance.
Stocks within utilities, healthcare, and consumer staples tend to be less risky than other sectors. Stocks within technology, consumer discretionary and financials may be more risky but may also provide higher returns.
When deciding how much of each stock to buy, I would generally start with around 2% or 3% of the total amount you want to invest. That means even a total loss in one stock will not be catastrophic to your portfolio. It also means that a stock has to nearly double before it gets to be too large a percentage of your portfolio and you need to sell.
That’s enough for this week and our simple investing strategy. You should have a good idea of your financial goals and how much you need to invest. Using the idea of risk tolerance and return, you should also have an idea for how much you want to invest in the separate asset classes and within stocks.