How to Invest and Why You Need a Plan

What makes rich people rich? Looking at the spending pattern of various income groups in the US, it’s clear: Savings. The real difference between rich and poor is that the rich spend more of their income on savings (pensions and insurance) and education.

Source: WSJ, Department of Labor,

When creating wealth, preserving it, and passing it on to the next generation is the formula for financial success, it is surprising that fewer than 20% of Americans have a written plan when it comes to investing and even retirement. [1].

The paradox in human behavior is that we are perfectly rational and capable of planning an important event in our lives, but this is generally forgotten when it comes to investing. In fact, you will find that only a third of investors have a written plan that guides their investment strategy and retirement plans.

Why do you need a plan?

The investment world is a harsh jungle, a world of murky waters where the smartest and most organized survive and succeed while the rest are eaten up. A written plan short-circuits our normal response to something as emotional as money. It prevents us from turning to our gut feelings and emotions. Instead of following the herd mentality that can lead you to make unwise investment decisions, a plan will force you to stick to a rational strategy that is based on fundamental investment principles. Some of the difficult emotions that you will have to overcome while investing include:

1) fear of failure

2) The tendency to continue with a certain approach just because you started it

3) Personal issues such as relationship problems at home.

It is also important to note the main reasons why investors fall prey to the market and lose their precious funds:

1) Omitted facts and figures mislead investors into investing in a structurally flawed company or financial instrument.

2) Overconfidence makes some investors think that they are invincible and that they can always beat the market.

3) Everyone wants to be seen as a champion, the successful general capable of leading an army to victory. This can cause you to make investment decisions that are not based on rational thinking but on a desire to impress your friends, coworkers, or family.

By having a written investment plan and actually following what it says, you have dramatically increased your chances of winning and increasing the size of your savings or investment portfolio. The following are simple steps to create a plan and avoid the herd mentality and instinctual urges that make us foolish when investing:

1. Set specific and realistic goals

For example, instead of saying you want to have enough money to retire comfortably, think about how much money you will need. Your specific goal may be to save $ 500,000 by the time you are 65.

2. Calculate how much you need to save each month.

If you need to save $ 500,000 by the time you are 65, how much will you have to save each month? Decide if this is a realistic amount for you to set aside each month. Otherwise, you may need to adjust your goals.

3. Choose your investment strategy

If you are saving for long-term goals, you can choose more aggressive and riskier investments. If your goals are short-term, you can opt for lower-risk, conservative investments. Or maybe you want to take a more balanced approach.

4. Develop an investment policy statement.

Create an investment policy statement to guide your investment decisions. If you have an advisor, your investment policy statement will describe the rules you want your advisor to follow for your portfolio. Your investment policy statement must:

Specify your investment goals and objectives,

Describe the strategies that will help you achieve your goals,

Describe your expectations for return and your time horizon.

Include detailed information on how much risk you are willing to take,

Include guidelines on the types of investments that make up your portfolio and how accessible your money should be, and

Specify how your portfolio will be monitored and when or why it should be rebalanced.

A smart investor with a written plan and strategy has already won half the battle without making a single financial decision. By implementing the plan and adhering to the established trading rules, the smart investor will avoid the pitfalls caused by human emotion and behavior and end up winning big.