An investment plan is the first thing every investor should do. Why? Because it makes investing goal-oriented and protects against common investing mistakes. We listed four questions that will help you make a plan that is right for you.
Why do I need an investment plan?
A written investment plan should be found in every investor’s back pocket, both in good and bad financial times. However, its importance is emphasised even more during market turmoil. This is when the fear of a constant decrease in the value of investments can expose even the most cold-headed investor to hasty decisions.
A written investment plan helps both in understanding your own financial goals and in achieving them. With the help of a written plan, you make more mindful choices and keep your emotions under control when things get tough.
When making your investment plan, consider at least the following questions:
1. What is my financial situation at the moment?
Identify and write down what your current financial situation is. Your current situation is the cornerstone of your entire investment activity. It helps you understand your risk possibilities and what kind of amount you should invest.
Go through and list at least your monthly income and expenses as well as your assets and debts. In addition, write down how much money you can save each month.
Then, think about how much you need to save. It’s good to keep an emergency fund equivalent to 3–6 months’ expenses for unexpected expenses and life situations. When your emergency fund is in order, you won’t have to sell your investments unexpectedly.
2. How much can I afford to invest?
Once you’ve clarified your financial situation, think about how much you can invest in the stock market every month. It’s good to think of the amount as a percentage in relation to your monthly net income. For example, you can decide to put 5-10% of your net income into investments every month – depending on your situation.
You can also decide that you want to invest a larger lump sum at first and then continue to invest monthly.
3. What do I want to achieve with my investments and how long am I prepared to wait?
Clarify why you invest; are you investing to get money for some near-future project, or are you aiming for general financial security? Are you investing, for example, for a home or for retirement? Is it your intention to turn your investments into money in five, ten or fifty years?
In terms of investment strategy, it’s important to know when you plan to realise potential returns. For example, with a five-year investment horizon, it’s usually worth taking fewer risks than with a 30-year time span. In the short term, you can lose large sums, but in the long run, even large declines are usually corrected to an increase.
4. What is my risk tolerance?
It’s good to carefully consider and determine your risk tolerance before you start investing your money in the stock market. When thinking about risk tolerance, you should take into account your own life situation, such as age, work situation, savings and wealth. It’s also good to consider how well you tolerate the uncertainty associated with stock market fluctuations emotionally.
It’s generally said that the younger you are, the more risk you can take, because time is on the investor’s side and often turns losses into profits. The general rule of thumb is that you should hold a percentage of stocks that is equal to 100 minus your age. So if you’re 30, you should hold 70% of your portfolio in stocks. However, it’s argued that with life expectancy growing, changing that rule to 110 minus your age or 120 minus your age may be more appropriate.
Depending on your risk tolerance, you can also decide whether to invest in passive index funds or direct shares. Index funds get you close to the average return of the stock market. Direct shares are often more volatile and risky, but often have a higher return potential than index funds. Or maybe you end up choosing the middle ground and invest in both!
If you’re a beginner investor and want to learn more about next steps in investing, read our complete guide on How to Start Investing in the UK.
