Creating an Investment Plan

There has been some good posts and resolutions from personal finance and investment bloggers as a result of Cash Money Life’s Financial Resolution for 2008 request. It has had me thinking about writing a post about how to define investment goals and objectives. Patrick presented a very common way to help prepare goals using the SMART methodology (which I use in my job to help employees set performance objectives). I beleive that well constructed goals are only one piece of an overall Investment Plan. In this post I want to present a common method for developing an investment plan.

Step 1: Determining Your Investment Goals

You’ll never get to where you want if you don’t know where you are going. The first step in developing an investment plan is understanding what your goals are. I suspect for most of the readers on this site it will be saving for retirement, but it can be other things such as saving for a house or the Porsche Cayman you have been lusting over (or is that just me). When we are talking in terms of retirement, investment goals are crucial because your retirement lifestyle depends on what you save today.

The goal you set is typically the dollar value you want to have at some point in time. This is where the difficult can really come into play – do you really know how much money you are going to need in the future? Do you also know how much you will receive from the government (CPP, social security)? Probably not but that does not mean you try. There are a couple of tools on the web to help you come up with ‘the number’ (my favorite is the one at Yahoo!):

Yahoo! Retirement Planner

MSN Retirement Planner

TD Canada Trust RSP Contribution Calculator

Step 2: Determining Your Investment Risk Profile

This has everything to do with determining your comfort with risk which in turn will help you achieve an asset allocation that will allow you to sleep at night. If you are someone who would be very distraught if your dividend investments lost 20% overnight (see Citigroup) then you need to have something in your portfolio to help offset that volatility such as money market funds or cash. An investor’s profile can be anything from aggressive to ultra-conservative. The trick is finding the one you truly are – do not lie to yourself when determining your risk profile and answer with what you think you should answer, but rather what you truly beleive.

The simplest and most user friendly risk profile tool I have come across is at the TD Canada Trust website. It will also suggest an asset allocation that is aligned with your risk profile – so let’s talk about that first.

Step 3: Determining Your Asset Allocation

This is the direct follow-on from Step 2 and involves identifying what your asset allocation should be given your Investment Risk Profile. I have said many time on this blog that asset allocation is the most important investing decision you will make. The same tool you used above from TD Canada Trust can be used to determine an asset allocation for you. Another one is located here (it is Java based).

Step 4: Build Your Portfolio

With your risk profile and asset allocation plans in place, it is now possible to select the investments to meet your plan objectives. If you are new to investing or don’t have the time to select individual securities, then index funds are the best place to start.

Step 5: Rebalance your Portfolio to Your Asset Allocation Yearly

The key to using an asset allocation is ensuring that you keep your investment in line with it year after year. For me, what this means is allocating new funds that enter my account in to the assets that I am low on. Sometime this means I am buying Canadian equities, other times it means I am buying small-cap index funds. This should happen each and every year you invest.

This is the same process that I went through, and actually revisit regularly. Things change in life and I need to ensure my investment plan keeps up with those changes. For example, now that I have kids I have put some investment focus into their college funds. The true value is having the plan which leads to less chance of making rash decisions if and when emotions try to dictate my investment tactics.

(Photo Credit: sanja gjenero)