6 second take: Smart investing requires a degree of planning and patience. Here are five steps to take to refine your portfolio for solid, long-term growth.
Investing is a process of determining what you want to accomplish, financially, and designing and implementing how to get there. It is repeatable and reliable — when done properly. For many investors, understanding the process of how investing works can help them manage appropriately for where they are in the investment life cycle.
The work to be done up front is not the same as the work to be done later on.
There are different forms for how the investment life cycle is broken down, from the simplest “plan-accumulate-spend,” to models with a multitude of steps. For most situations, the five-step model provides sufficient detail for action without being unnecessarily cumbersome.
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The Five-Step Model to How Investing Works
The five steps of this model for managing investments across their life cycle are to plan, design, implement, review and monitor, and achievement and review.
The model follows the time horizon of investing from the conceptualization stages of goal determination through to the spending phase of goal achievement. It provides sufficient detail to be actionable at each step without being overwhelming. And it can be used for simple near-term goals or out to the largest single goal most people face, funding their retirement.
Step 1. Plan
Planning the goal is often an iterative process, as it needs to be done within the context of where you are starting from and the resources you have to work with. Often, our initial vision for a goal may not be achievable in the form we thought we wanted without modification.
Typically we start by envisioning the end objective, whether it be the education we want to provide our children, the home or vacation home we would like to own, or what we want for retirement. In some cases, there are multiple stakeholders, such as a spouse or partner, or a child who may have ideas on their educational desires.
We also need to establish our context by developing a clear and accurate picture of where we are presently. This is our starting point. Having a clear picture of where you are starting from is essential in determining what you need to do to get to where you are.
The process is iterative as there may not be sufficient resources to achieve the goal as initially envisioned. When this occurs, there are four basic options to adjust the planning to find an achievable outcome.
- You can reduce the dollar amount of the goal. Funding a smaller goal consumes fewer resources.
- You can delay the goal. This works better for discretionary goals such as a vacation home. It may not be a valid option for other goals, such as education planning.
- You can allocate more resources. There are multiple ways to do this. You may be able to allocate resources earmarked for other goals, if the present goal is more important. You may be able to make larger ongoing contributions to the goal, perhaps by reducing expenses elsewhere.
- You can be more aggressive in your investment approach. An overly conservative investment approach generally also means the ability to accomplish less financially. There is a trade-off between taking a degree of investment risk and increasing the likelihood of achieving your goals.
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In most cases, a combination of some or all four of these methods will produce the most palatable option to get what you want. It is also important to recognize that not being able to be on track for all your goals right from the start does not mean you need to ditch the goals permanently.
Sometimes we have to walk before we can run; we may be able to achieve more than we think as we get better at the process and find we can free up more resources than we thought.
Step 2. Design
The plans drive the investment strategies. Knowing where you are and where you need to get to drives what you need your investments to achieve. The strategies you use will also be dependent on context.
For example, if your goal is to save up for a new car in two years, you would likely take a conservative approach; there is no benefit to assuming investment risk for short-term goals.
On the other hand, if the goal is retirement accumulation, the degree of risk you are willing to assume is key to goal achievement. It will drive what strategy to employ, whether that be through the use of a model portfolio or an asset allocation strategy.
Strategies are driven by history, what we know serves as our basis for making informed decisions today. It is not that we expect history to repeat, but rather that history gives us context to use in our current environment to design the strategies most likely to get us to our goals without undue risk.
Step 3. Implement the Plan
Where strategies get us to specific investment categories, implementation is where we select the specific investments within those categories. For example, our strategy may dictate we have a certain percentage of our portfolio in large capitalization international stocks, implementation is the step in which we select the specific investment vehicles for that allocation.
Implementation often involves determining allocation of currently available funds as well as ongoing contributions. There are multiple things we need to pay attention to in the implementation phase.
In some cases, we are investing with both taxable and tax-deferred investments. This may be the case for long-term goals such as retirement or education funding. Consideration needs to be given to which investment to place into the tax-deferred vehicles and which to have in a taxable position to minimize overall taxation.
Sometimes we are restricted by investment minimums from perfectly implementing our desired strategy.
We may be able to get around this by using investments without minimums, such as many retirement plans that don’t have minimum allocations into investment accounts.
In other cases, we may need to use a fund that invests in multiple investment classes or simply leave some classes underfunded and fix the allocations when rebalancing once we have built up our portfolio. The key is to not get overly bogged down in the details, but to get going forward — we can always adjust en route.
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Step 4. Review and Monitor
We need to review and monitor for a couple of reasons. Allocations will drift from our original allocation as some investment classes outperform others. We should have a specific predetermined method for rebalancing. This should include a method for determining when to rebalance, such as every quarter or when any allocation is X percent from its target.
We should also have a strategy for how we are going to rebalance, whether by adjusting any deviation or only those over a certain percentage. We should also have a plan for when we might alter future allocations as an ongoing aid to rebalancing and maintaining our allocations.
The reviewing and monitoring of our investments is a key and essential part of goal attainment. It is oftentimes where investors fail in goal achievement.
The reason for these failures is that they may make emotional decisions, which are typically counter to what we need to do in the situation.
Many people find it difficult to sell a portion of an investment that has been doing well and place those dollars into an investment that has not been performing well. It is hard to do if you have trouble separating emotionally from your money.
Premade decisions, in the form of a set of rules or plans, help remove our human fallibility from our investment management. This is essential if we are going to achieve very good long-term results.
Step 5. Achievement and Review
This area may also be underanalyzed, especially for smaller goals. It is common to have a detailed spending plan for retirement assets, less common to have one for a vacation home. Both may be important. Tax considerations are often a key; the timing of asset liquidation for non-retirement goals determines when they will be taxed.
It may make sense to move a portion of assets before the time of the goal to spread the tax consequences across multiple years and lower your total tax burden.
How you spend the money determines how much money you have to spend.
For goals with a lengthy distribution phase, this will overlap with the previous phase, where you will be both growing assets and using assets at the same time. For many investors, it helps to separate those assets that are being spent from those that are designated for later, clearly delineating what is in the spending bucket and what remains in the investing bucket.
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The Great Exception to How Safe Investing Works
The great exception shouldn’t be an exception, but reality often has other plans. Many people, especially early in their working years, do not have a clear retirement goal nor do they wish to invest any mental energy into establishing one. They need a work-around for the process.
If you are early in your career and don’t have a clear picture of retirement, that is both normal and fine. Those newer to the working world don’t need to get bogged down in details that they don’t care about, but they do need to make significant contributions to their goals.
Generally, allocating 10 percent of your income into a retirement fund beginning early in your career, and being moderately aggressive in your investment approach, will get you going on a solid foundation.
Then when you get to mid-career, and retirement starts to look like something you want to pay attention to, you will have a solid and substantial base from which to build using the five-step process in detail.
The great exception is not so much an exception as it is a reality: We need to build whether we are willing and able to plan or not.
The Bottom Line: How the Life Cycle of Investing Works
It seems that many people are searching for the holy grail of investing; they want the silver bullet, the perfect investing vehicle that works to enable them to achieve all their goals. They may think there is something out there that will do this; they are looking for a “hot tip” or some phantom inside route to shortcut their way to the top.
The holy grail of investing, the holy grail of goal attainment, is one simple thing: process. Investing works best when you have a process. Your goals determine what you need your investments to do, which dictates the most appropriate strategies, which determines where to best put your money.
Then time and circ*mstances influence that, necessitating monitoring and rebalancing on an ongoing basis. That simple process has helped countless people achieve their financial goals, time and time again.
Investing for goals takes time; your money needs time to work for you in order to grow. The keys to goal attainment are to start and to start wisely. You start with what you have to work with with your investments, and you do that wisely by following a proven process.
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