Would you ever begin building a house without architectural plans? Would you ever drive a road to an unknown location with no road maps, directions or a GPS? Hopefully, if you answered “no” to these questions, you would also answer “no” to beginning to buy and sell investments without some sort of financial plan in place. A solid financial plan is after all the road map to your financial future.
Many people love to buy and sell investments, but not enough of them do the proper planning beforehand. A good financial plan should provide the road map that your investment plan can be based upon. Without such things as long term goals, required rates of return, financial constraints or the proper risk measurements that a financial plan can provide, there is really no basis for what investments are selected by an individual. To make the most effective investments, financial planning is required.
Did you know that proper financial planning may uncover many financial issues that an investor may not have considered, such as financial goals? Are they realistic? Are you saving enough to hit these goals? Based on these goals, is your required rate of return too aggressive for your risk temperament? Sometimes investors think they will simply save more later to hit their goals, but they have no idea what that “later” entails or when it will be. That’s where the planning comes in.
Once all of your goals and issues have been laid out in a financial plan, then you can begin selecting the proper investments to coordinate appropriately. For example, an investor who has a very low required rate of return may not need to be as aggressive in investment selection as originally thought, and could choose investments that are much more conservative in nature and that won’t jeopardize long term planning goals with high-risk investments.
In your financial plan, the relationship between the required rate of return and how it affects the investment plan is a very important one. Most investors do not know what their required rate of return is. We will save a deeper explanation of this for another article, but basically, it is the return necessary for all of a client’s investments and future savings to achieve the future cash flows as desired. The reason this is so important is that it will help guide the investor to the appropriate investment selection/allocation for achieving their long term goals.
Conversely, if the return needed is unrealistic, it will then tell the investor that they need to go back and come up with more realistic goals and constraints in their financial plan. These changes could be anything ranging from spending less, saving more, or retiring at a later date than originally planned.
To put it simply, the bottom line is that an effective investment plan will always be preceded by a good financial plan. Make sure you have both. If you have questions or aren’t sure where to begin, contact us. We can help!