Plan, process, product and not the other way around.
Investing is one of the best ways to secure our financial future, but doing it correctly is not always easy. The key to long-term success lies in good financial planning, which involves understanding our life and financial goals, defining investment horizons, and, from there, making the right investment decisions.
Financial planning is not only about choosing what to invest in, but also about establishing a comprehensive and coherent plan that fits our personal goals: supplementing our retirement, buying a home, saving for our children’s master’s degree or college, or simply achieving financial independence.
We often make the mistake of thinking about which product to invest in (stock, bond, mutual fund, etc.) before clearly defining our objectives.
To better understand this mistake, it would be like planning a trip by first choosing the means of transportation without knowing whether we are going to a nearby city or to another continent. It is the same mistake we make when we go to the pharmacist looking for a drug without knowing yet what disease we want to treat. If we treat COVID-19 as if it were a common cold, we will not be cured.
That is why instead of thinking first about what financial product to put my money in (deposit, stock, bond, mutual fund, ETF, etc.) it is very important to ask ourselves what are my objectives, my plans.
Once I determine my planning, I can think about the appropriate process, as illustrated by the pyramids below:
- which process is best suited to fulfill that plan, i.e., whether to put myself in the hands of a manager, an advisor or do it myself (“Do It Yourself” or DIY) to determine an optimal asset allocation for those objectives.
- and finally, I can think about the “product” more broadly to determine which assets to invest in, considering key aspects such as costs or taxation.
Good habits or rules
However, for many people, thinking about financial planning can seem complicated at first. In my daily experience, I observe that many investors are not yet ready to clearly define their objectives.
An alternative may be to start by acquiring good investment habits or following minimal rules.
For example, when I set out to run a marathon, I couldn’t just start with long distances. I first had to acquire basic habits, such as exercising regularly and maintaining a healthy diet. These initial habits were fundamental to build a solid base to later be able to make a more ambitious training plan and run several marathons and triathlons. Now that I no longer feel like participating in such demanding events, a good part of those habits are still present (at least that’s what I tell myself every day).
Similarly, in investing, starting with good habits helps us take the first steps and develop a disciplined and consistent mindset to manage our finances effectively over the long term.
Here are some of the most important habits every investor should adopt.
1. Don’t invest the money you need in the short term.
It is crucial that the capital destined for investment be that which you do not need in the short term. Investing should be viewed as a long-term endeavor. To make sure you don’t touch those funds, establish a family budget and pay yourself first, saving systematically before spending. What you spend on consumption is what you don’t need to save, not the other way around.
2. Don’t waste and live below your means
One of the most well-known principles in personal finance is to live below your means. This does not mean depriving yourself, but maximizing the efficiency of every euro saved. Always seek to get the maximum possible return for your money, minimizing unnecessary expenses. Squeeze the most out of the money saved, making the most of it.
3. Create an emergency fund
Never start investing without having an emergency fund. This financial cushion is vital to cover unforeseen events without having to sell investments at the wrong time or under unfavorable conditions. A key rule of thumb is to have at least three to six months of expenses covered before venturing into riskier investments. You may decide to have a little extra for peace of mind. If so, put that excess in a short-term deposit, an interest-bearing account or even better in money market funds. Once you have the emergency fund, prioritize your long-term goals (see habit number 7).
4. Diversify your investments
A well-known saying is “don’t put all your eggs in one basket”. In the investment world, this means not concentrating all your capital in one asset or asset class. Diversify into various asset classes (money market, bonds, stocks, etc.) and, in addition, spread your investment globally. A good rule of thumb is not to concentrate more than 5% of your capital in a single stock or bond.
5. Don’t invest in what you don’t understand, but educate yourself.
This is a common mistake that many novice investors make. If you don’t fully understand an investment product, it’s best to refrain or keep researching. Knowledge is power, and in investing, being well-informed can make the difference between winning and losing. This rule works both ways: it is important not only to refrain from investing initially in what you do not understand, but also to acquire knowledge in various fields that will allow us to grow as individuals (and expand our job opportunities), as well as improve, even if only minimally, our skills as investors. We should not blindly believe everything we are told; it is essential to maintain a curious and critical attitude towards our personal finances.
6. Invest first in a simple way
When you first get started in the world of investing, it’s easy to feel overwhelmed by the number of financial products available and the complexities that seem to be behind every decision. That’s why one of the best strategies to get started is to keep investing simple. You don’t need to be an expert in financial markets or constantly looking for the next big opportunity to get good results.
Indexing is one of the simplest and most effective ways to start investing. It involves replicating the performance of one or better several market indices, such as the S&P 500 or the MSCI World, rather than trying to pick individual stocks or specific assets. This strategy, known as index management (also known as passive management), has several key benefits for investors looking for a simple and cost-effective way to build their wealth with very high diversification and low costs. By combining equity indices, such as those mentioned above, with bond indices, with a global view (“buying the world”), we can achieve an appropriate exposure to our objectives or risk profile and obtain above-average results for investors who still do not understand the advantages of this simple and efficient way of investing.
7. Prioritize the long term
The long term is your ally when it comes to investing. The magic of compound interest works in your favor when you hold an investment for a long time. Once you have an emergency fund, focus on long-term goals, as they are the hardest to achieve. Also, by investing for the long term, you will be able to get better returns.
In the long term, the volatility of the financial markets becomes less important and “luck” (actually statistics) is on your side.
8. Master your emotions
Emotions can be an investor’s greatest enemy. Learn to control them and assess the level of risk you can bear. A good investment plan is designed so that you are not dependent on your impulses or the mood of the market.
Systematize your investments with automatic contributions aligned with your investment plans.
9. Periodically evaluate and adjust your rules and think about your financial planning.
If you adopt these good habits or rules, you will be much better prepared to develop sound and effective financial planning.
Once you have these habits well internalized, start thinking seriously about your goals and turn them into investment plans.
Once you have done this, it is essential to review your investment plan on a regular basis (once a year may be more than enough). Evaluate whether you are achieving your objectives and whether your “minimum rules” are still effective. This constant re-evaluation allows you to adjust course if necessary and ensure that you remain on track.
Good habits and minimal financial planning will prevent your emotions from getting the better of you in difficult times, and you have a very high chance of achieving your financial goals that will help you achieve your life goals and, therefore, your happiness.
At inbestMe we give a lot of importance to the good habits mentioned here and that are internalized in everything we do. Investing by objectives is very important in our platform, and we propose different portfolios that you can combine designed for immediate savings, for short and medium term investment and for long term investment or even retirement.
