Plan First Then Invest

First Plan, Then Invest

Your financial plan is primary and dictates every part of your financial life, including investments.
The plan tells us your goals, your current resources, your expected future resources, and your cash needs. From this basis, and only this basis, can we start making investment decisions.

Before investing one cent in the stock market, you need to know what future goal, or financial need, that investment is expected to fulfill.

Focus On The Long-Run
Over the last few months, we’ve been reminded to dramatic effect that the stock market is incredibly volatile over the short-term.
What’s the stock market going to do tomorrow, next week, or next year?
I have no clue and no one else does either. Even a given year or series of years is anybody’s guess.

Yet, we know that since 1928, a period that includes the Great Depression, about 2/3 of all years are positive in the S&P 500.
Yet, even that isn’t a number you want to play the odds with.
Since the Great Depression, there have only been two rolling ten-year periods in the US stock market that have been negative. Notably, you have already lived through them as it was two ten-year periods between the Tech Bubble and the Financial Crisis. This trend, of course, continues. Fifteen-year and twenty-year rolling periods look even better.

Put simply, volatility of returns moves inversely to time horizon. The longer the time horizon, the more confident we can be in positive stock market performance. That’s why we say to focus on the long-term, like decades, when it comes to stock investing.

Bear markets feel painful, but historically they have been blips on the radar within a long, upward trend.

Diversify
There’s a saying that diversification is the only free lunch in investing. We think that’s largely true. Diversifying your investments across global asset classes is a key step toward portfolio optimization. What do we mean by diversification? Well, instead of just owning one stock or a handful of stocks, it is usually better, from a risk/reward perspective, to own a basket of stocks. Instead of owning just U.S. stocks, we suggest owning European, Japanese, and South American companies (amongst a whole host of other countries).

Additionally, it is near impossible to know what asset class, be it U.S. Large-Cap stocks, or Japanese Small-Cap stocks will be the best performer over any period. In other words, diversification also means minimizing active bets in your portfolio to the extent possible.

Of course, the amount of diversification necessary in your portfolio is dependent on your financial plan (see: ‘First Plan, Then Invest’). Additionally, our internal approach to diversification can get technical. However, the basic concept stands. To reduce risk (i.e. volatility) in your investment portfolio, invest broadly.

Reduce Taxes
Here’s a fun fact for you: Most academic finance ignores taxation because it was largely written for large endowments and foundations that do not pay taxes. Here’s another fun fact: You do pay taxes.

Our fourth investment principle is “Reduce Taxes.” We believe taxes are wholly unappreciated by most financial advisers, leading to sub-optimal investment decisions. Every investment decision you make must be filtered through a tax planning lens to minimize the taxes you pay. Questions we ask when customizing an investment portfolio for a client include:

How can we make this portfolio as tax-efficient as possible to reduce current taxes?
Which investments should be held in which types of accounts to ensure tax-aware investing?
What actions can we take now to reduce taxes in retirement?
Less taxes paid means more money for you, your family, your enjoyment, and the causes you care about.

Minimize Costs
Whether it is trading costs or internal fees charged by mutual funds or ETFs, the investment fees you pay matter to your long-term investment performance. For example, if two funds track the S&P 500, the fund with lower internal costs will likely perform better over time. Paying attention to investment fees and minimizing them to the extent possible will serve dividends over the long-term.

Stay The Course
This is the hard one. Every other principle can be in place, but if you can’t stick with your investment strategy or financial plan through thick and thin, you will never reap the rewards. The difference between investor returns (the return the average individual investor in a mutual fund receives) and investment returns (the actual return of the underlying investment) is called the BEHAVIOR GAP. We (i.e. humans) suck at investing. We panic, we get greedy, we buy high and sell low, and we fall victim to a whole host of other behavioral biases.

We are our own worst enemies when it comes to investing. For this reason, I believe everyone should work with a financial planner.
And yes, even financial planners should work with financial planners. Why? Because to succeed over decades of investing and various markets we need to be held accountable to our goals and kept from our own self-defeating impulses.

Great financial planners aren’t immune to this when it comes to their own money. And if the experts aren’t, neither are you. So yes, build the plan, focus on the long run, diversify, reduce taxes, minimize fees, but don’t forget the last crucial step:
Stay the course.