Have you ever heard about people that lost all of their money in the stock market? What about people that had their entire retirement wiped out in a market crash? I used to hear these stories all the time and to be honest, it seemed pretty scary!
I mean what was I supposed to do, bury my money in a desert rather than risk it in the markets?
Investing is not the same as saving. When you save money, there is little to no risk of it being gone when you need it later. With investing, you need to understand that there are risks. Knowing how to manage those risks starts with making a plan.
Before I tell you how to make an investment plan, I’d like to share a story. It’s a story I have not told many people although the cats out of the bag now I guess. About 8 years ago, I had about $1000 of cash saved up and thought I would try investing in this thing called the stock market.
Investing With No Plan
I did two things with this money. First I joined a hyped-up email list that promised me that the list owner had software that was about to predict a huge penny stock opportunity.
The second was I looked for a company that I thought was too big to fail and invested in it. How did it work out?
Investing with a Stranger’s Advice
The email list creator (I do not remember his name) sent messages to his subscribers every few days about how his program was close to releasing a stock pick. This stock pick would spike in value soon after it was released based on its behavior in the “charts.”
I waited for weeks. Next, he sent out a message that he didn’t want to release the stock pick that he’d been talking about because the program prediction wasn’t accurate enough and he didn’t want to lead his subscribers to a bad pick. He said he would announce a better pick in about a month that he was more confident with.
I waited for the month to go by.
Finally, another email arrived that he was only a day or two away from releasing the pick and that as soon as we open the next email, we should buy the stock that is recommended and hold it until it reaches 10 times its value and then sell it. The email went on to say that the stock would rise in value for at least 3 to 5 days.
The last email was release and the stock was announced.
I invested $500 and watched it wither away almost instantly to about $100 before I was able to salvage some of my money back. It was heartbreaking. I felt like this guy:
The worst part? The stock was announced on my wife’s birthday. She still remembers. Needless to say, I don’t subscribe to email lists that promise the moon anymore.
Investing in Companies that Can’t Fail
The next thing I did was analyze stocks and look for stocks that took a recent hit in the news and would more than likely climb back up because of how strong their presence was in their industry. I decided on Sirius XM. After all, the stock had taken a real beating and was trading for mere pennies.
I knew that most new cars were built with Sirius pre-installed and that they had a massive amount of satellites already in space. How could they possibly fail? They had just bought out XM and they were the only satellite service available. I thought, why not give investing a shot.
I bought 1000 shares at $0.18/share. That’s only $180. I watched over time as it started to climb but didn’t expect it to climb so fast. I didn’t know how much I wanted to make with it but I knew I wanted to make a lot of money! It hit $1.00/share and I couldn’t believe my $180 investment had turned into $1000 in such a short time.
Then the stock slid in price back down to $0.84 and I started to panic. I sold it and was very pleased with the fact that I more than quadrupled my investment. It felt pretty good and I like I had a pretty good handle on this investing business.
Imagine being in my shoes. I had no investing plan and didn’t have any clue what I was doing. I wanted to make money and I fell for two of the biggest mistakes that beginning investors make.
Greed took over causing me to jump into a trade. Then the fear of losing what I had earned crept in and I sold before I could even think about it.
I was still lucky. It was a winning investment and to this day it is one of my favorite purchases. However, I didn’t have a plan in place on how long I wanted to leave my money in the market.
It was about two years later that I started looking at stocks differently and realized the power of the stock market and compound interest. I decided that my goal was long-term growth and to save money for at least 10 years down the road.
Now when I invest in a company, I rarely sell stock within a year and aim to hold stocks for 3-5 years or in some cases even longer. My portfolio though will continue to grow with a long-term mindset.
Whatever happened to Sirius?
Well, had I left those 1000 shares in my account rather than selling them, they’d be worth over $7,000 today. That’s why it’s important to have goals.
Benefits of Investing with an Investment Plan
When you invest with purpose, you leave less room for errors. Does a plan guarantee success? Of course not. Anytime you are investing, you take on a certain degree of risk. A sound investment plan does help reduce that risk though.
Some of the benefits of having an Investment Plan are:
- More steady contributions to your investment
- Confidence in your ability to invest
- Reduced anxiety when there are dips in the market
- Progress towards your goals are more apparent
- Less emotionally driven responses
As the adage goes, if you fail to plan, you plan to fail.
7 Steps To Creating an Investment Plan
In order to develop an effective investment plan, you must:
- Meet investing prerequisites (have an emergency fund and have money set aside for investing that is not needed for routine basic needs)
- Establish goals
- Determine Your risk tolerance based on your goals
- Choose a Strategy that meets your goals and risk tolerance
- Choose the stocks that fit your strategy
- Diversify your portfolio
- Manage your portfolio for success
Define Your Investing Goals
The first thing you should do is define your personal goals for investing. The best way to do this is to ask yourself why you are investing. Retirement, a wedding, financial independence, a second property, your children’s college fund are all examples of personal goals.
Next determine how long are you planning to be in the market? This is a time-frame goal and is important because it lays the groundwork for determining risk later.
Lastly, figure out the financial goals. How much do you need to meet your personal goal? Once you know that, you should know roughly how much it will take each year to achieve that goal.
Let’s take the above example:
- Personal – Downpayment for a house
- Time-frame – 7 years
- Financial – $20,000 target.
Then you simply calculate how many months it would take to achieve those goals. I did the math already using a compound interest calculator. it would require $187 per month based on an average market return of 8%.
You can choose a single goal or any number of goals to form your investing plan. Once you know your goals, you will have an idea of how much risk you are willing to take.
Determine Your Risk Tolerance
Generally speaking, if you want to be in the market only a short time, you’re better off not investing. Investing is best for long-term growth.
The stock market historically grows at an average rate of 6-8% per year. In 2019, the S&P 500 gained over 30% while in 2018 it lost about 4%.
Since the market is volatile and difficult to predict, it’s recommended for people that can leave their money invested at a minimum of five years and I’d prefer even 10 years.
Here’s a general rule of thumb of what you should be investing your money in depending on your time-frame goal:
- Short-Term (<2 years) – saving in a savings account, money market account, or CD
- Mid-Term (2 to 5? years) – savings (similar to short term or investing with low-risk stocks such as large-caps
- Long-Term (>5 years) – investing
Risk should also decrease as your time-frame goal gets closer.
For instance, if you were 20 years old when you started investing for retirement, you can afford to have a riskier outlook at 20 but you should have a safer outlook as you approach retirement.
If you need help determining proper risk tolerance, speak with a certified financial advisor that can be found at most full-service brokerages although they will more than likely charge you a fee. The fee may be well worth it if they can set you on the right path and help you avoid investing pitfalls surrounding improper risk management.
Choose a Strategy for Investing
When investing, there are two schools of discipline that investors subscribe to. You can either invest in faster growth or steady income.
Investing for growth means you are investing with the intention of increasing the value of an initial investment. If you want a steady flow of income from your investments that is dependable, you will probably want to look into income investing.
Growth Investing focuses on finding companies that are fresh and in the growth phase of development. Often, these are companies that are rising fast and have a lot of money being pumped into their companies to help them grow their service, product, or reach.
Growth companies often aren’t profitable yet but investors are betting on the long-term that they will more than makeup for it as time goes on.
Growth Investing usually focuses on Small Caps. To qualify as a small-cap depends on which brokerage you ask but is often assumed to mean that the company has a capitalization of < 2 billion dollars. Capitalization can be determined by multiplying the number of outstanding shares a company has on the market by its share price.
For example, a company with 10 million shares trading on the market for $30.00 per share would have a cap of $300 million.
Examples of growth stocks that you may have heard of are Trade Desk, Five Below, Zynga, and Dunkin Brands.
Income Investing, on the other hand, is investing in companies that provide dividends and tend to be large-cap well-established companies.
They do not typically grow in value as quickly; however, they provide a steady dividend to investors each year (usually distributed quarterly) and are often seen as a less risky way of investing.
Income investors love to look at dividend yields and yield rates when deciding on stocks.
Finding a stock that increases in value each year while simultaneously raising their dividends is what Income Investors live for. These are known as Dividend Aristocrats.
Here is a list of 11 dividend aristocrats published by Kiplinger that have raised dividends for more than 55 years!
Choose Stocks to Invest In
This step requires a lot of action on your part because this is where you decide how you are going to allocate your money.
You can either purchase individual stocks or choose funds that allow you to invest in a portfolio of stocks.
You can read our article on how to find stocks to invest in, where you can get inspiration to help you decide. If you want someone to give you a list of stocks to invest in, you are in luck!
There are countless shows you can watch or youtube channels where analysts give you their reasoning for buying certain stocks.
I listen to the Yahoo Finance app on my phone every morning which has shows that discuss the stock market. They often have interviews with company representatives. I’ve discovered new stocks listening to these shows. The best part is, it’s free!
Motley Fool Stock Advisor is one of my favorite services although it is a paid service that gives you 10 stocks to start with and sends new stock picks every two weeks. They have a long history of outperforming the market and I’ve had a lot of success with them.
Diversification is Key
This should be a given and I’m sure you’ve heard your parents drill into your minds, “Don’t put all your eggs in one basket!”
Diversify your portfolio by selecting multiple investments. You can select Mutual Funds or ETFs that diversify for you, invest in a robe-investor service like Betterment or Acorns, or choose your own stocks across various sectors and industries.
Just make sure you diversify so that when an event occurs that causes you to lose money in one stock, it hopefully doesn’t affect your entire portfolio!
Manage Your Investments
The last step is managing your investments. You don’t have to watch them every waking moment but you should keep an eye on your investments and adjust them occasionally.
Knowing how to balance a portfolio and minimize risk are both essential aspects of this step.
You should also adjust the risk of your portfolio occasionally as your goal approaches.
What Do I Do After I Have an Investment Plan?
You can check out our guide on how to buy stocks if you’ve never done so before.
If you already have stocks, I hope you take the advice in this post and apply it to your current portfolio so you don’t run into the same mistakes that I did early on in my investing career.
Are you excited to develop your new plan? Let me know in the comments! Until next time, let’s start investing!