As a female financial advisor, one of the most common things I hear about investing is that it feels overwhelming. While it is impossible to ever guarantee investment success, there are some basic guidelines that can help you make wise financial choices and support a life you love. Although investing carries risk because no one can predict the future, when you don't invest you take the risk that you will not meet your long-term financial goals.
My personal finance mantra is "simply your finances, simplify your life." In the spirit of enabling you to focus on what brings you the most joy in life, here are four simple steps you can use to begin to craft an investment plan for your unique circumstances.
Step #1: Identify how much money you can set aside for longer than five years
First, divide your total pool of money into two buckets. Bucket number one is for your emergency fund and any other money you think you might need to spend in the next five years. (A rough rule of thumb is to aim for at least six months of living expenses in an emergency fund). The second bucket is for the money you are saving for your longer-term needs, such as your children's college education and your retirement. The money in first bucket should be held in checking, savings and/or money market accounts. The money in the second bucket is what is available to "invest." I recommend a minimum five-year time horizon with this bucket because -- as I've written about before -- the odds of positive investment returns increase with the length of time in the market. Investing is like a roller coaster with natural ups and downs. To win at investing you need to be able to stay the course until the end of the ride and not jump off when it gets a little scary.
Step #2: Decide how much to put in stocks vs. bonds
This is the first step in a key process called "asset allocation." Historically, stocks (aka "equity") have tended to provide higher returns, albeit with more volatility. By contrast, bonds (aka "fixed income") tend to provide lower yet more stable returns. A helpful guideline made popular by Vanguard's iconic founder, John Bogle, is this: 100 minus your age = the maximum percentage of stocks to put in your portfolio. Note: Importantly, as with all rules of thumb, this is just a starting point.
Step #3: Determine how much to invest overseas
These days, since developing and emerging international markets are growing at a faster pace, the U.S.' share of the total global economy is gradually shrinking. By putting a portion of your assets overseas, you not only benefit from diversification, but you can also get exposure to faster growing emerging markets. At MoneyZen Wealth Management, I target around 30 percent of equities for international exposure. However, as you can see in this Wall Street Journal discussion, there is a wide range of opinions on this topic!
Step #4: Decide if you want to be an "active" or "passive" (evidenced-based) investor
Active investors seek to "beat the market" by picking stocks of specific companies and frequently trading them. Unfortunately, the evidence shows that vast majority of active investors fail to beat the market over the long run. By contrast, passive investors who rely on what I like to call an "evidenced-based" approach, seek to capture the market return using low cost, index type funds. In short, evidenced-based investors believe that markets are efficient and asset allocation (the mix between stocks, bonds, cash, etc.) is a much stronger driver of long run returns than "security selection" (trying to find the next hot stock). Three great books on this topic are The Investment Answer, Think, Act, and Invest Like Warren Buffett, and Investing Made Simple.
After making your decisions on these steps, commit your investment plan to writing so you can easily chart your progress. You'll want to periodically review the results (at a minimum, once a year) to make sure you haven't drifted too far from your targeted course. If you are looking to add some MoneyZen to your financial life, these simple steps are a great place to start.