The understanding of your financial situation and long-term objectives (leading to the preparation of a long-term investment plan) constitutes the cornerstone of your financial future. This first step will define all your other investment decisions.
As mentioned by Paul Crafter in its “Investment Guide”, “Writing down your objectives, goals and strategies declares you are serious, helps you remember the details and stay focused.” Just owning random investments is not the same as meeting clear goals with discipline. Only a well-planned strategy based on your situation and objectives will help you navigate economic good and bad times in the long run.
You should define reasonable long-term return expectations (which may correspond to a long-term history after deducting a conservation margin regarding the level of valuation. Let us start with a reasonable 5% nominal return and a 3% real return). Due to the very high recent growth of earnings, a reversion to the mean is likely and potential low real returns in the future may occur. As an orientation, you can determine how many years it will take an investment to double, by dividing 72 by the annual rate of return. For example, an investment that returns 3% doubles every 24 years (24 = 72/3).
You can always develop a plan B in case your portfolio fails to deliver the returns anticipated. However, the best approach is to start with conservative expectations in order to be on the safe side and follow the strategy with discipline.
While you cannot set the return you will get, you can at least select an appropriate risk level for your investments, which will drive your asset allocation. Your personal situation will particularly contribute to define your asset allocation, i.e. the components of your wealth (real estate, stocks, bonds and cash) and the share of your future wealth that you wish to invest in stocks. If you are young, you can tilt more towards risky investments and focus on equity. Since cash loses its real value, real estate often already constitutes an important part of your wealth and bonds do not offer a satisfactory return today, even older people shall aim for a reasonable equity allocation as inflation protection. For the sake of diversification, these stocks should represent the global market as best as possible, with different industries and currencies.
You should try to invest early in life in order to avoid a long-lasting bear market or investing at a high price just before retirement. Whatever your age, you should intend to have a share of your wealth in equity by having invested small amounts on a regular basis.
Another way of deciding on your asset allocation is to start with the market portfolio allocation and adjust it toward higher or lower expected risk and return mixes, depending on your objectives, time horizon and level of comfort with risk (your risk capacity is your financial strength and your risk tolerance is your psychological acceptance in case of market stresses).
Once you have shed light to your financial situation and objectives, you can start to define your investment plan and stick to it!
Guide Finances 