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How to create a five-year personal investment plan
A personal investment plan serves as a roadmap for the short-term and long-term financial goals you might have and how you might achieve them through investing. It will help you to understand how much to save or invest to achieve your financial goals, while also planning for retirement. No matter what your risk tolerance or time scale is, you can use these six steps to create your own five-year personal investment plan.
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What is an investment plan and why is it important?
An investment plan lays out what your financial goals are and a plan for how you will achieve them, based on your own preferences, such as risk tolerance and time horizon.An investment plan helps you stay focused on what you want to achieve, build wealth, and prepare for retirement or other large upcoming expenses. In addition, it provides you with savings, may improve your standard of living and helps you to budget.Another benefit of having an investment plan is that you take advantage of tax-efficient vehicles, such as a stocks and shares ISA.
How to create a personal five-year investment plan
Create a personal investment plan by following six simple steps. Every investor is different and may create a slightly different plan because their goals, risk tolerance and time horizon are different. But ultimately, each investor can follow these same steps to build their own five-year plan.
1. Budget and see what you can invest
Creating a budget that lays out income and expenses allows you to see what you actually have to invest. You may have a lump sum already, or you may want to deposit funds into an investment account monthly. In either case, knowing how much you can invest will help with the rest of the steps.Also, creating a budget may reveal expenses that aren’t necessary. If you need to increase your savings or the amount that you invest, you could consider cutting back on any of these unnecessary expenses.
2. Write down your financial goals
Your financial goals provide at least two uses in our investment planning:
Goals help you stay focused. To achieve what you want, it may be best to follow a plan.
Goals also help with creating your portfolio (step four). If your goals are focused on accumulating wealth, for example, then that will result in a different type of portfolio than someone who has the goal of safety in mind.
A plan may include both long-term and short-term goals. Long-term goals may include a comfortable retirement, paying for your children to go to university or buying foreign property.Short-term goals may include any big expenses or goals that we want to accomplish in the next five years, such as saving for the deposit on a new house or car. Setting money aside for trips or other large upcoming expenses would be other examples.While short-term goals would be the immediate focus of a five-year plan, it's also good to keep the long-term goals in mind and direct some cash towards them, where possible. Learn about types of short-term investments.
3. Consider your risk tolerance and time horizon
To start investing in a way that is right for you, you need to consider your goals, risk tolerance and time horizon.Risk tolerance refers to how comfortable you are with risk. Investing all your money in the stock market may not be ideal for risk adverse investors as the volatility in the stock market can range from 10% in most years to up to 50% at times.At this level of volatility, stocks have returned an average of 8% to 10% per year over the long run. If you were to invest entirely in bonds, for example, there would be much less yearly volatility. The returns are close to 5% per year (average) over the long run, according to Morningstar.Time horizon refers to the timeframe over which an investor plans to stay invested. Typically, the shorter the time horizon (or closer to retirement), the less risky investors become. Those that have a longer time horizon (or that are further away from retirement) can afford to take on more risk since they don’t need the funds right away.All these factors play into deciding an investor’s portfolio allocation.
4. Decide on a portfolio asset allocation
Portfolio asset allocation is how much capital an investor decides to put into the various assets within their portfolio. Three popular investment assets for portfolios can include:
Stocks or stock ETFs
Bonds or bond ETFs
Cash
Additionally, some investors choose to include these two other investment options:
Real-estate investment trusts (REITs), which provide exposure to the real estate market but trade like stocks or ETFs on the stock exchange
Precious metals or precious metal ETFs
The allocation is the percentage of the portfolio that is allocated to each asset. Here are some common portfolio allocations for a passive investing strategy, according to examples by the Corporate Finance Institute:
The 100% stocks allocation is typically for the risky investor with a long-time horizon, whose main goal is high return potential.
The 20% bonds, 70% stocks and 10% cash allocation is typically for the moderate-risk investor with a long-time horizon, who wants good return potential with a bit more stability than 100% stocks.
The 40% bonds, 50% stocks and 10% cash is typically for the investor more focused on price stability and/or getting closer to retirement.
The 60% bonds, 30% stocks and 10% cash allocation is typically for the investor who is more risk-averse or who is nearing retirement.
Add in REITs or precious metals, if you like, by reducing exposure in other areas. The more conservative an investor is, or the further into retirement they are, the percentage of bonds held could be increased further.The long-term returns, as well as the asset allocation, can help forecast how long it will take to reach your short-term and long-term goals.
5. Open an investing account to implement the strategy
Once an investor’s asset allocation is decided on, you can then open an account and begin implementing the plan. Consider opening a stocks and shares ISA which a tax-free wrapper for your investing account.Take the total amount you have to invest and then multiply the allocation percentage by that number. For example, if you have £50,000 and decide to put 50% into stocks and 50% into bonds, then £25,000 will be allocated to these two categories.Consider learning more about how to invest in stocks before purchasing individual securities. Do you want to focus on dividend stocks for income, blue-chip stocks for stability, or do you just want to buy stock index funds?Many passive investors, who don’t want to actively manage their portfolio, opt for stock index funds. The same goes for bonds. Many opt to buy a diversified bond ETF over picking individual bonds.
6. Rebalance the portfolio as your goals, time horizon or risk tolerance changes
Portfolios are rebalanced when they drift away from the ideal allocation you have chosen. For example, if you chose 50% bonds and 50% stocks, and at the end of the year stocks account for 60% of the portfolio, you can sell some stocks and buy some bonds with the proceeds to bring the allocation back to 50/50. Investing strategies and goals may also change over time. You may decide to make your allocation more conservative or riskier. Rebalance as necessary. You should check in on the portfolio and consider rebalancing it at least once per year.
*Tax treatment depends on individual circumstances. Professional clients only. Capital at risk.
A pension can provide money in retirement. You don't have to save up every penny that you need your pension to pay you because you will also be able to reinvest the interest on your savings (this is called compound interest). You may also be able to use money from sources outside of your pension. For example, if you need £5,000 per month when you retire in several years, but you can pull £2,000 out of a pension, then you only need £3,000 per month from other sources or savings.
You could start by budgeting to see how much capital you have to work with and what you can afford to invest monthly going forward. Consider if now is a good time to invest for you. If it is, start considering your goals, risk tolerance, time horizon and asset allocation.
