You probably know that one of the most important things you can do to build wealth is to invest. Investing can help you take advantage of compounding returns and grow your nest egg. However, in order to succeed at investing, you need a plan.
Here are five steps to create a successful financial plan:
Step 1: Know Your Cash Flow
Until you figure out what is left over at the end of each month that can be invested, you can’t really create a financial plan. So the first step is to learn your cash flow (the cash you have left over after expenses). To do this, you could look at bank statements from prior months and add up all the cash that went in and then subtract all the cash that went out. You could use automated software or an app (we recommend Personal Capital or YNAB). Or do what I do and just use an Excel spreadsheet.
No matter how you do it, you shouldn’t move on to Step 2 until you know your monthly cash flow.
Step 2: Have a Goal for Your Money
Once you know what you have to work with each month, the next step is to figure out what the money is for. Are you investing to grow your money to buy a home? To retire? To pay for a car or college education? Or are you investing simply to accumulate wealth?
Your goal will determine your strategy, so it’s important to have an objective and visualize what the money will be used for. Investor Junkie has a great article on establishing goals.
Step 3: Set a Realistic Time Frame
As I mentioned, the goal for your money will determine your strategy. But you need to be practical when it comes to matching your goal to your time frame. For example, if you want to buy a home in the next year and are hoping to turn $5,000 into $50,000 for your down payment, that is not realistic. However, if you have $5,000, are 25 years old and want to retire rich at 65, you are on the right track! Just be sure that — no matter the goal — you have a realistic time frame.
Step 4: Establish Asset Allocation
Next, it’s time to research your investment options and decide on an asset allocation that will help you reach your goals within your specified time frame. The term “asset allocation” refers to how much of your total portfolio (investments) you will put toward stocks, bonds, commodities, etc. Each of these investments represents a different asset group, and you can divvy up your portfolio however you like.
Larry Ludwig, the founder of Investor Junkie, actually laid out his asset allocation for everyone to see. However, Larry is a business owner in his 40s investing for retirement; your situation might be very different.
An income portfolio would focus on dividend stocks, with some long-term bonds to help matters. Your retirement account or college savings investment fund might start out with a heavy allocation in stocks and then shift to bonds. Part of asset allocation is adjusting your allocation as you approach your goals so that you retain the appropriate amount of risk for your situation.
Step 5: Take Advantage of Technology
There are lots of reasons to create a financial plan with the help of a professional personal financial advisor. They are experts at asset allocation and maximizing tax savings and overall planning for one’s financial future. However, because of the fees advisors charge, many people don’t use one (and instead read articles on Investor Junkie to learn how to do it themselves!).
Thank goodness for technology. Below are free or practically free services that can help you responsibly put together a financial plan. In many cases it is a robot helping you — which at first we thought was crazy — but it turns out that robots are very good and disciplined advisors. If you still want a human involved, however, you have that option, too:
- Wealthfront — automated guidance for IRAs
- Blooom — automated guidance for 401(k) or 403(b)
- Wealthsimple — automated plus human guidance for IRAs
Every investing plan will need some tweaking as you go along. You might even need to make substantial changes if something major and unexpected should happen with your finances or in your personal life. The best thing you can do, outside of extenuating circumstances, is create a plan and STICK TO IT. Good luck and happy investing!