If you’re looking to build an investing plan, you’ll want to focus on the most important factors that can determine your success. A successful investing plan can be concentrated down to a few key elements, allowing you to focus on doing the real legwork to make the plan succeed.
Here are three key steps to build your ultimate investing plan.
How to build your investing plan
When it comes to building wealth through investing, you have three key questions that you need to answer as you grow your nest egg:
- How much do you want to invest? You need money to make money, and if you’re starting from scratch (or close enough), then you’ll have to save. The more you invest, the faster you’re going to be able to reach your wealth goals.
- How much risk do you want to take? If you want to invest in riskier assets such as stocks and stock funds, you’re going to reach your goals faster than if you invest in safer assets such as bonds or CDs.
- How soon do you want to be wealthy? If you have more time, you’ll be able to grow your wealth even more. If you have a limited amount of time, you won’t be able to grow your assets as much.
These three factors — your capital, your potential returns and your time — work together to determine how much wealth you can grow. For example:
- If you want to save less money, then you can take more risk in your portfolio or take more time letting your money compound. If you want to save more, you can take less risk or use less time, or some combination of the two.
- If you want less-risky investments, then you can save more or give them more time to grow. If you’re willing to make riskier investments, you may be able to save less or take less time to reach your goal, or some mix of the two.
- If you want to be wealthy sooner, you can save more or take on riskier, high-growth investments. If you’re able to spend more time building your wealth, you can save less or take on less-risky investments, or a combo of both.
These are the three key levers that you have at your disposal to build wealth, and your decisions on these variables are the deciding factors in your investing plan. Unfortunately, you can’t get wealthy quickly by saving little and taking little or no risk. But if you save diligently, invest in some higher-risk, higher-return investments and give yourself plenty of time, you can build real wealth.
You can break down each of these three levers into even more manageable steps.
1. Determine how much you can save
Figuring out how much you can save is not just a question of how much you sock away from your paycheck every two weeks, though that’s likely the most important aspect. It’s also about using other strategies such as tax-advantaged accounts to get more money that can compound.
So, yes, work first on building that budget so that you can live below your means. Saving will give you the raw material to build your wealth, and you can’t build wealth until you have at least a little bit of it. Determine how much you can invest regularly and then focus on achieving that goal.
Of course, you can save not just from a paycheck but also from any investments such as stock, investment funds or bank accounts that generate income for you. Every source of income is a potential source that you could save and invest to generate even more wealth.
Tax-advantaged accounts can help here, allowing you to save even more without the drag of paying taxes on your income. For example, an employer-sponsored retirement account such as a traditional 401(k) allows you to save with pre-tax income, meaning you won’t owe taxes on your contributions. Then your money can compound tax-deferred until retirement, perhaps for decades.
Another key advantage of a 401(k) is that many employers match your contributions, up to a few percent of your salary each year. So it’s an easy way to get free money for your investing plan.
You’ll need to work through potential sources of savings to determine what you really can invest. The more you’re able to save, the less time and risk you’ll need to take to reach your goal.
2. Decide how much risk you’re comfortable with
Are you willing to stomach the volatility in stocks for the potential high returns that come with them? Or do you prefer the relative safety of bonds, even if the returns are low? Or would you prefer to split the difference and have a more balanced portfolio with moderate returns?
Your comfort level with risk helps determine how fast you can compound your money. Many individual investors can get thrown by the volatility of stocks, but a broadly diversified portfolio of stocks such as the S&P 500 index has generated very strong returns. In fact, this stock index of America’s top companies has returned an average of about 10 percent annually over time. That blows the returns of bonds out of the water and outperforms CDs, too.
If you’re willing to take on more risk, then you can generate much higher returns through the magic of compounding. And here’s a place that time helps out investors, giving them the ability to ride out the market’s short-term volatility on the way to much better long-term gains with stocks.
You must understand how much risk you’re willing to accept as part of building an investing plan.
3. Decide how long you have to build wealth
Your runway for your investing plan has a huge effect on your total wealth. Even just a few more years of compounding at the end of a working career — when you may already have a nice nest egg built up — can dramatically increase your wealth. So the longer you’re able to let your money compound, the more likely you’ll be able to walk away with a sizable pot of gold.
Of course, deciding how long to invest is not always an option. Some investors get in the game with just a decade left before retirement and have to scramble to get their investments in order. But if you have the option to give yourself more time, then you’ll be much better off doing so. With more time, you can make lower-risk investments and still reach your investing goals. Plus, you don’t need to save as much each year to reach the same goal, making the process even easier.
If you have more time to work your investment plan, you give yourself much better odds of reaching your goal, or at least allow yourself to take less risk in getting there. Not saving enough for retirement is regularly one of Americans’ top financial regrets, according to Bankrate surveys.
Work backward to discover your investing plan
So those are the three levers you have to work with, but you’ll need to come up with how much money you’re looking to amass. (Here’s one way to figure that out.) When you have that number, then you can work backward using the three variables above to figure out how to reach the goal.
For example, if you know you have 30 years until you need your money and your goal is $1 million, then you can use an investment calculator to optimize how much you need to invest and the level of return that you need to achieve in order to get there. You can tweak how much you can invest each year and the level of returns needed, adjusting each to find a workable solution — one that doesn’t require you to save too much nor earn outsize returns each year.
You provide the time and the money to invest — where can you find the potential investments? For the higher-risk, higher-return component of your portfolio, consider investing in broadly diversified index funds based on a major index such as the S&P 500. The best index funds offer low costs and deliver strong returns over time, albeit with some volatility from year to year.
If you’re able to accept lower returns in exchange for lower risk, then it could make sense to add in a bond fund to create a more stable portfolio. Bonds tend to be less volatile, but they usually offer a lower overall return, making them a typically more conservative investment.
Bottom line
Focus on the three key levers above — how much you save and invest, how much risk you’re willing to take and how long you’re able to invest — and try to optimize your approach in each. You have greater chances of reaching your investing goal if you don’t have to “shoot the lights out” in any category.
Editorial Disclaimer: All investors are advised to conduct their own independent research into investment strategies before making an investment decision. In addition, investors are advised that past investment product performance is no guarantee of future price appreciation.
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