What you invest in is less important than your investment plan and how you use it to reach your life goals.
Investing is more personal than most people realize. It’s not about beating the market or even about picking stocks.
The problem is that people think of ‘investing’ as a verb, something you do.
The truth is, the word ‘investing’ is actually a noun.
Investing is a plan, a thing that helps you meet your financial goals. Understanding it that way means you can forget about all the bad advice you hear on TV or online about what stocks to buy and why you should lose sleep over when the next recession will start.
Accept investing as your personal plan to meet your goals and you reduce it to a few very simple and manageable steps.
Setting Realistic Investment Goals You Can Meet
So if investing is simply a plan to meet your goals, the first step should be to figure out your goals. This goes way beyond guessing a quick number for how much you’ll need to retire.
One of the biggest roadblocks to keeping an investment plan is that retirement goals just don’t seem real for many people. Retirement is at least 20 or 30 years into the future and little more than a concept.
Do you really know what you’ll be doing in retirement? Do you really know why you want to retire other than you don’t want to go to work every day?
Without the answer to these questions and others about your financial goals, how could you possibly be motivated to save money and invest? Why not enjoy your money now if your financial goals are nothing more than public opinion that you need something saved for retirement?
The only way to make your investment plan work is by making your financial goals real.
Let’s look at the major financial goals, how to calculate your investing goals and how to make them real.
Should You Pay for Your Kids’ Education?
Through my 20s, I never understood why people were so concerned about having money to pay for their kids’ college education. I took out student loans and worked part-time to pay for college, why shouldn’t my kids pay their own way?
That all changed when my son was born.
I know how important higher education is to a person’s job opportunities and overall quality of life. You qualify for more jobs, office jobs outside the hot sun or the factory-line, and graduates make about $24,000 a year more.
I hope my son will be able to get a scholarship or find ways to pay his own way but I’m not going to let anything keep him from having those opportunities.
That means putting money away for his college fund.
The College Board estimates the total cost of attendance including tuition, fees and room & board for an in-state public college at $24,610 for the 2017 academic year. That equals just under $100,000 for a four-year degree.
Whether you plan on saving enough to cover the entire cost of attendance or just a portion, saving for college is something you need to build into your long-term investing plan. We’ll look at how to add in these costs to your investment plan later in the article.
Life goals for Investment Planning
Investing and saving isn’t just about retirement. It’s about having money for all your life goals. Having money to pay for living expenses in retirement is just one of those goals but shouldn’t be the only thing you work your entire life to accomplish.
For your financial goals to be real, they have to be things you can look forward to and something that’s going to motivate you to save.
One of the most common retirement goals is travel, whether it’s to see family or to that dream destination you never had enough money to visit.
My mom and I worked mornings on a paper route when I was ten to pay for a trip to Australia. It had always been her dream and the movie Crocodile Dundee had just come out so, of course, I was psyched as well. We started saving…and then Nintendo came out with a video game console that changed the world. We never made it to Australia.
Besides travel, what else have you always wanted to do? What’s on your bucket list?
What hobbies do you enjoy? We tend to think of hobbies as things we do that don’t cost too much money but there might be a few you’ve always wanted to try that cost a little cash to get started, i.e. lessons for learning to fly or play guitar or classes for writing a book.
This exercise in planning your investment goals isn’t just so you can get an idea of how much it will cost. Thinking through your goals in terms of what you want to do helps make them real. You’ll be able to visualize yourself on that dream vacation or behind the stick for flying lessons.
That visualization is a mental picture of your goals you’ll be able to take out anytime you start to stray from your budget and savings goals.
Adding in Basic Retirement Needs to Your Investment Plan
Adding in your basic retirement needs to your investment plan is easier than you may think. You can look through your current living expenses to get an idea of how much you’ll need in retirement.
You don’t need to be exact because you’ll be fine-tuning your investment plan every five or ten years and being off by a few thousand dollars won’t change the picture much.
Remember, there are a few expenses you have now that you won’t need to pay in retirement.
- Your spending on clothes and transportation (i.e. gas and car maintenance) will likely decrease because you won’t be going to work every day.
- You’ll no longer need to save for retirement and may not need to save for educational expenses either.
- If you plan on downsizing your home or moving to be closer to family, that will change your housing expenses.
Start with your current budget and take off any expenses you don’t think you’ll have in retirement. Most financial planners suggest that you can take 20% off your current expenses because retirees tend to spend less as they age.
I would say just go with your current expenses minus the spending you won’t have any more plus the extra spending you calculated from your life goals and education costs. This way, you’re more likely to save too much for retirement rather than not enough.
Using Retirement Calculators to Find Your Magic Number
Once you have an estimate for how much you need to retire and pay for life goals, you can use a retirement calculator to find the return you need on your investing plan.
The retirement calculators on the web are easy to use and you can adjust the numbers to find a plan that meets your goals with a reasonable rate of return and regular deposits that don’t break your budget.
- Investment goal is the amount of money you need at retirement.
- Years to accumulate is your planned retirement age minus your current age.
- Amount of initial investment is how much you’ve already got saved for retirement.
- Rate of return on investment is how much you need to earn annually to meet your goal. Use this as your guess number where you plug in all the other numbers first and then find the return needed to meet your goal.
- Periodic contribution is how much you can invest per year so multiply your monthly savings by twelve.
- Contribution frequency will be ‘per year’ and compound interest should be set to annually.
Remember when using these financial calculators that you’re not just trying to find the annual return you need on your investments, you’re trying to find a realistic return. You might be able to meet your retirement goal with low contributions if you assume a 10% or higher return but that just isn’t going to happen over the long-term.
It’s better to assume a return between 4% to 7% and adjust the amount you need to contribute or your target amount. This will mean you can invest in a diversified portfolio of stocks, bonds and real estate without having to chase high returns on the hope of reaching your goal.
You may have to use the investment calculator twice, first to estimate your savings for educational costs and then to estimate retirement savings. Educational costs will likely come years before retirement so that’s going to change the return you need and the amount you need to invest regularly to meet your goal.
Meeting your long-term investing goals isn't just about your return though, it's also about saving. Use these financial calculators to pay off your debt faster.
Where to Invest for Your Long-term Plan
Where to put your investment plan money doesn’t mean which stocks to buy or even which online brokerage to choose. An even more important decision is the type of account you use to invest.
We’ve already seen how you can save thousands a year in taxes by taking advantage of special retirement accounts such as a 401k, IRA, Roth IRA and a 529 plan.
How do you decide which to use or how much to put in each if you have multiple accounts?
The answer surprises most clients I talk to but you should have at least one account of each type. That may seem like overkill and a lot to manage but remember, each type of investment account offers different advantages and limitations.
Company-sponsored 401k plans are great for getting free money from your company match. You get an instant tax deduction plus many companies will match your contribution up to a percentage of your salary. The downside is that most of these plans only offer a short list of investment funds with relatively high fees.
Individual retirement accounts (IRAs) give you complete control over your retirement money and an instant deduction on taxes. You’ll be able to invest in low-cost exchange traded funds (ETFs) that give you broad market diversification. The downside is that annual contribution limits are low and you may not be able to save enough for your goals with just this account.
Roth IRAs don’t give you the instant tax deduction but you pay no taxes on withdrawals in retirement. You pay income taxes on the money you deposit in a Roth IRA but NEVER pay taxes on the earnings. It’s a great way to manage your taxes in retirement with tax-free income so you can take less taxable income.
529 Plans offer a triple-tax benefit for education savings. You’ll pay federal income taxes on contributions to the account but many states offer deductions on state income taxes. The money in the account grows tax-free and you pay no taxes on withdrawals as long as they are used for educational expenses.
The downside to 529 plans is that they must be used to pay for educational expenses. That’s why I recommend balancing costs for educational goals between a 529 and an IRA. You can also use money from your IRA account for educational expenses but you’ll have to pay income taxes on the withdrawal.
Consider putting half of the savings for your educational goal in a 529 plan and the other half in your IRA account. That will give you tax-free money to pay for educational costs and you won’t have to worry about having more money locked in a 529 and not being able to use it if costs are lower than expected.
How do you prioritize money to these different retirement accounts for your investing plan?
- Always max out your company match on a 401k plan. That’s your first priority for savings because it’s free money plus the tax deduction.
- After your company match maximum is met, max out your contribution limit on an IRA and a Roth IRA. There is one combined limit for both of these accounts so you’ll have to split it between each. You can do 50/50 or put more in your IRA and a little less in the Roth to take advantage of the instant tax deduction.
- If you still have money to save, put some of it in a 529 account and the rest in your 401k account.
How to Invest for Your Long-Term Plan
How to invest your money is much less important than you may think. Now that you know what kind of a return you need on your investments, you can look at the asset classes (stocks, bonds and real estate) to determine how much you need in each to meet your goal.
You do this by finding the percentage of your total investments in each asset class that will equal your annual return needed.
For example, say you need a 6% return on your investments. We’ll assume, from historical data, that stocks provide a return of about 7.5% annually while real estate returns 6.75% and bonds offer a 4.5% return.
To get a 7% return, you would need to invest 10% of your money in bonds, 25% in real estate and 65% in stocks. You can find these percentages by multiplying a percentage times the expected return in each asset class and then adding them up.
i.e. (10%*4.5%)+(25%*6.75%)+(65%*7.5%) = 7.01%
Why not just invest everything in stocks and get that 7.5% expected return? Spreading your investments across the three asset classes is one of the most important concepts in investing, called diversification. By investing across the three asset classes, you won’t have to worry about a stock market crash or real estate bust wiping out your retirement savings.
Investing across stocks, bonds and real estate offers solid returns with far less risk than investing in just one asset class.
You can invest in all three asset classes in the same retirement account, just divide up your money according to your percentages and then invest in funds that hold investments in the assets. I prefer broad exchange traded funds (ETFs) because they give you instant diversification within an asset class and are cheaper than mutual funds.
Closing Summary and Action Steps
Life goals change and so do your finances as you get older. The one thing that won’t change is this simple process for investment planning. Plan on revisiting your goals and investment strategy every five or ten years to make sure you are on track to save enough.
- Remember, investing isn’t necessarily something you do but more a plan around your goals.
- Make your goals real by thinking through them, imagining what life will be like and the things you’ll enjoy.
- Don’t forget to include educational costs, travel and your bucket list expenses to normal retirement expenses.
- Use a little trial-and-error with an investment calculator to find how much you need to invest regularly and a realistic return to meet your financial goal.
- Spread your investment into the four account types including 401k, IRA, Roth IRA and a 529 plan.
- Create a diversified portfolio that includes stocks, bonds and real estate to meet your investing goal with as little risk as possible.
Use this simple investing plan process and you’ll be closer than ever to meeting your financial goals. You’ll be motivated to keep saving because your goals will be something real, something you can dream about and look forward to even when your budget gets tight. Your retirement plan doesn’t have to be perfect or 100% accurate. The important point is that you stick with it and know that you’ll get the retirement you deserve.
About the Author
Joseph Hogue is a financial expert and investment analyst. After serving in the Marine Corps, he started his career investing in real estate before becoming an investment analyst for some of the largest private investors. He's appeared on Bloomberg and on CNBC as an investment expert and has published ten books in personal finance. Now he helps investors reach their financial goals and invest in the stock market with some of the same advice he used when working for the rich.