Well-designed investment plans are simple, not complicated. Each investment complements the others and contributes positively to the portfolio’s performance. In simple terms, when an asset is added, it should either reduce the risk or improve the after-tax return.
Unfortunately many investors make decisions ad hoc, based on recommendations from the media and suggestions from others, without regard to the impact on the entire portfolio. Over time this leaves them with a mismatched collection of redundant and overlapping positions that underperform the broad financial markets, contain unnecessary risk, are difficult to understand and expensive to maintain. Investors pay a steep price each year they hold these portfolios.
Constructing a sensible and efficient investment plan consistent with an individual’s specific goals and circumstances takes careful thought and effort. Here are some fundamental questions to help you determine if you have the right plan.
Does the portfolio match your financial goals and ability to handle risk? What goals and expenses do you want to fund and when do you want to fund them? Are you saving to buy a home, pay for a child’s education or fund your retirement? Have you quantified these goals and the amount you will need to save or invest to reach them comfortably?
Your emotional and financial ability to accept short-term losses in exchange for expected, but uncertain longer-term gains must be determined before you invest. A sensible mix of different assets should reflect the risk level you can tolerate.
Does the portfolio compensate you adequately for the risk you are taking? When you invest you accept 100 percent of the risk. Are your investments sufficiently diversified so that unnecessary risk is stripped from the portfolio? Are you being compensated for the risks you are taking in the form of higher expected returns?