If you haven’t already heard it from us, you’ve likely heard it somewhere that investing is an important way to build wealth. “Investing” is a broad term though, and it means something a little bit different for everyone. Not to mention there are a ton of different strategies, philosophies and recommended products out there depending on where you look. Here I’ll give step-by-step instructions on how to build an investment plan that works best for you.

Before getting into things, I want to emphasize one point in particular: 

The best investment plan is one that keeps you invested. 

Time in the market builds wealth—not timing the market. Successful investing is not about getting rich quick from hot stocks or new and exotic investment products; it is about understanding your goals and timeline, knowing your comfort and capacity to take on risk, and designing a plan that’s simple and easy to commit to for the entire duration. 

So, How Do you Build an Investment Plan?

1. Identify Your Personal Goals

In order to have a successful investment plan, you need to know why you are investing in the first place. The trusted method of making your goals SMART (specific, measurable, attainable, relevant and time-based) applies really well here, because it helps ensure that your goals are realistic. Of course, life changes, and it’s important to have some flexibility built in; but ultimately you want to make sure that your goals are not so vague that you lose focus and motivation. And you especially want to understand your time horizon, which is the length of time you expect to hold the investment until you need your money back.

My favorite way of approaching investment goals is by categorizing any kind of goal you may have into three main buckets: safety, income or growth. 

• Safety is simply to maintain a certain baseline level of your wealth.
• Income is to get your assets to a point where they can provide you with active income that you can live off of.
• Growth is to grow the value of your investments over the long-term.

Once you have a handle on your goals, you can think of each of your investment accounts as being assigned a job of working towards those particular goals. For instance, the job of most people’s 401k is to grow, grow, grow as much as possible until they’re ready to retire; then its job is to preserve the wealth built up so that it can be safely drawn upon for income needs. 

Identifying your goals and understanding why you want an investment plan in the first place are critical, because without that knowledge you’ll be charting a course with no destination. 

2. Decide How Much Risk You Should Take

What we mean when we say “risk”

When I speak of “risk” in this context, I mean a few things. First, there’s the risk of how volatile your investments will be, meaning the degree to which your portfolio value declines in market downturns and rises in periods of growth. As long as you’re careful not to depend on withdrawing your money in the throes of a major downswing, volatility is more of a risk to your psychological comfort than it is to your wealth. 

Second, there’s the risk of you making a sudden departure from your investment plan due to emotion. For example, if you think you’re likely to panic and sell investments when the market starts to fall, that is a risk to consider. 

Third, there’s the risk of not meeting your goals due to investments not being aggressive enough. For example, investing for retirement that’s 20+ years away will require you to choose a more aggressive tilt towards stocks, because bonds will mainly only serve to preserve your capital, not grow it.

The reality of investing is that there’s a clear tradeoff between risk and reward, meaning that if you want higher investment yields over the long term, you’ll need to take on a higher risk of your portfolio dropping in value in the near term. If you want low risk, you should be prepared to experience less growth. 

Risk Tolerance and Risk Capacity

The key concepts to understand when making a decision on how much risk you should take are your risk tolerance and risk capacity. 

Risk tolerance is the psychological aspect of investing that relates to your comfort level in taking financial risk. It’s your willingness to lose some or all of an investment in exchange for greater potential returns. Investors generally differ in the level of risk they’re comfortable taking. Some embrace risk while others tend to avoid it at all cost. For example, can you stomach watching your investment portfolio drop by 30% (like it did in March of 2020) and be able to hold your course without panicking? If that sounds unbearable to you, you likely have a lower tolerance for risk and will be better off holding a greater proportion of lower-yield investments that offer more stability.

Risk capacity is the amount of risk that you can take in order to reach your goals, and it’s determined by your time frames, your need to draw on the assets, and your financial resources. Think of risk capacity as more of a physical limitation. For example, if you have little cash reserves in the bank for an emergency and/or will be needing the money in a short amount of time, that will reduce your capacity to take on risk, and you should consider safer, lower-yield investments like bonds. On the other hand, if you have a sufficient cushion in savings and have a long amount of time before needing to draw on the assets, your capacity to take on risk will be much higher. 

3. Keep Your Investments Simple and Boring

Once you understand what your goals are and how much risk you can take on, it’s time to decide which investment products you’ll actually use. The most successful investment plan will be one that is simple, boring, and keeps you invested for the long term. 

In his book, A Wealth of Common Sense, Ben Carlson points out that “complexity tends to be the default option that gets used to persuade investors to buy unnecessary investment products while the vast majority of people really just need to understand more conventional options to succeed.” Unless it’s your full-time job and/or passion project to manage a complex portfolio of investments, you don’t need to get fancy. A simple mix of diversified stock and bond index funds and/or ETFs that stay in line with the overall growth of the market is sufficient. A simple approach that allows you to be as hands-off as possible and accumulate long-term wealth slowly will help you avoid big losses and ensure financial security. 

As the late Nobel Memorial Prize winning economist Paul Samuelson said, “Investing should be more like watching paint dry or watching grass grow. If you want excitement, take $800 and go to Las Vegas.”

4. Create an Investment Policy Statement and Stick to It

The investment policy statement (IPS) is a written document that outlines how you would like to implement your investment plan and maintain your investment portfolio over time. This is something we put in place for our clients so that we know which rules to follow that are in alignment with their goals, values, and unique circumstances. The purpose of the IPS is to keep you out of trouble and on the right path by ruling out any decisions made based on emotions. 

Here are some key questions that an IPS answers:

• What is my target asset allocation and when will I rebalance? For example, if my target allocation is 60% in stocks and 40% in bonds, I will reallocate back to that weighting if either of those deviate +/- 5% from their target.
• What’s my risk profile and time horizon for each investment account within my portfolio?
• How much short-term liquidity do I need for emergencies and day-to-day spending?
• What’s on my list of investment products or strategies that I will never invest in?

Once the IPS is in place, follow your guidelines and stay the course. 

One last thing to note, which ties back to the “simple and boring” principle, is to automate things as much as possible, including any recurring deposits into your investment accounts. Automation sets you up far better for success rather than having to decide each month to make that deposit, because the friction of having to do it manually increases the odds of you deciding to stray from your plan. 

5. Monitor on a Regular Basis

After you build your investment plan and implement it, don’t exactly “set it and forget it”, but rather have it built into your schedule to monitor it regularly. Set a time, possibly once a month or once a quarter, when you check the performance of your investments and see if you need to rebalance back to your target allocations. For example, if you decided on having 60% of your portfolio in stocks and 40% of your portfolio in bonds, and a few months later your stock portion has grown such that it now constitutes 65% of your portfolio, you may follow the guidelines in your IPS to sell some of those stocks and reinvest them into bonds to bring it back into a 60/40 balance. Again, this is something that’s policy-driven so that emotion is taken out of the equation. The goal is to have an investment plan that keeps you invested for the long-term, so you don’t want to run the risk of your future self thinking that you can time the market by doing something different “just this once”. 

Life circumstances also change and so will your goals. It might be the case that you feel you want to retire sooner than expected, and to do so you’ll need to change your investment plan for certain accounts to be something less risky and more stable. 

Your investment portfolio is a tool that can help you achieve your personal goals and live the life you want, and the plan to grow your investments should be simple and easy to follow. These five steps of building an investment plan are exactly how we approach building investment plans for our clients. You can think of them almost as a continuous loop, with step five leading right back to step one. Life changes, people change, and an investment plan can (and should) be flexible enough to honor that. Knowing why you want to invest, how comfortable you are with taking risk, keeping things simple, adhering to an investment policy, and regularly reassessing portfolio performance are all the key ingredients that help keep you invested. 

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