is basically a process of matching your financial goals
and objectives with your financial resources. It focuses on identifying effective investment strategies according to an investor’s risk appetite and financial goals. There is a wide variety of investment options- including shares, bonds, mutual funds, bank deposits, real estate and futures and options
etc. Through investment planning
, you can identify the most appropriate portfolio mix to achieve your financial goals in the most efficient way.
Investment planning helps you:
- Achieve financial goals.
- Generate income and/or capital gains.
- Enhance your future wealth.
- Strengthen your investment portfolio.
- Derive maximum returns from investments.
- Strike a balance between risk and returns.
- Save on taxes.
Following five steps are involved in the investment planning process:-
Step-1:- Setting Investment Goals: The very first step in the investment planning process is setting your future financial goals. You need to set these goals according to your present financial conditions and future expectations. To define these goals you need to answer the following questions:
- How much money do you have available to invest?
- What are your sources of investment money? Do you have a lump sum, or will you be investing regularly and systematically?
- What will be the duration of your investment?
- How many returns do you need the investments to generate?
- What is your current income tax bracket?
- What is your age?
- For what purpose will you use the dividends generated from the investments? Whether you will reinvest it or withdraw it?
- What is your current income?
- What do you expect your income to be in the near future and in distant future?
- What are your current expenses?
- Do you need current income?
- When will you need the money?
Step-2:- Understanding Risk Profile: Understanding risk is a key part of the investment planning process
. In addition, you also need to determine your own risk tolerance. No investment plan is likely to be successful if it doesn’t fit your temperament and your individual financial situation.
Step-3:- Designing an investment portfolio: In the next step you need to design the investment portfolio taking into consideration your investment goals and personality. It can be a combination of various investment categories, whether they are fixed income investments, such as bonds, CDs, or variable income investments, such as equity shares, mutual funds etc.
The process of determining how much of your assets to put into each of various categories of investments is known as asset allocation. No one asset allocation strategy is appropriate for everyone. For long-term investors who want high growth and don’t need current income, an aggressive plan-one that focuses primarily on potential growth-might be established. For example, an aggressive investment plan might include 60 percent in equity stocks 25 percent fixed income instruments and 5 percent cash alternatives.
On the other hand, for investors who put a higher priority on current income and stability than growth, a more conservative plan might be established; for example, it might consist of 20 percent equity 55 percent bond funds and 25 percent cash alternatives.
Step-4:- Managing and monitoring the portfolio: Once your investment plan is set in motion, your portfolio needs ongoing management. You should review your plan regularly to make sure it’s on track. As market circumstances or the investment psychology change, your portfolio may need some adjusting. That review can occur, monthly, quarterly, semi-annually, or annually, depending on the types of investments you own and your need and desire to monitor your investments.
Step-5:- Rebalancing or redesigning the portfolio, if needed: During your periodic reviews of your portfolio, you may find you need to make changes if it is not performing as expected. For example, you may need to rebalance or redesign your portfolio. Rebalancing means adjusting the amount invested in various categories to return to the original asset allocation.
- Define Your Goals: Investment planning begins with the determination of your financial goals. Knowing the results you want will help you more easily choose the right avenues and strategies to reach them. Defining your goals, such as earning money for a big purchase or growing your retirement fund, is an important part of investment planning that allows you to look at the big picture when creating and reassessing your investment plan.
- Know your risk appetite: Every investment option represents a unique risk-return trade-off. Risky investments generally offer higher returns, making them profitable for investors willing to take on the additional risk. So, it becomes really important to take into account an investor’s risk appetite, which dependents on his current income level, savings, lifestyle, and responsibilities.
- Capital growth versus regular income: Investors aiming at long-term goals focus on capital growth. A long-term investment will allow you to overcome your bad times without changing your plans. Stocks, mutual funds, and real estate represent investment options for capital growth.
On the other hand, if you’re investing to meet a short-term goal or to give you a regular flow of funds to complement your present salary, you should opt for fixed- income investments such as bonds, certificates of deposit (CDs) etc. These investments generate a regular flow of income in the form of dividends and interest. However, while making a selection, it is important to consider the tax implications and associated risks.
- Determine your investment profile: There are mainly four types of investment profiles on the basis of risk appetite:
- Conservative (Low-Risk Tolerance): Such portfolios comprise mainly (about 70%) of fixed income assets, such as bonds, CDs etc.
- Balanced (Average Risk Tolerance): This refers to portfolios with an equal emphasis on growth and income assets.
- Growth (High-Risk Tolerance): Such portfolios comprise mainly (up to 80%) of growth investments, such as stocks, foreign currencies etc.
- High Growth or Aggressive (Very High-Risk Tolerance): This refers to portfolios with more than 90% of the funds in growth investments.
Investment planning should strictly be done keeping in mind the investment profile of the investor to derive the maximum benefits from the same.
- Review your investment plan regularly: This helps in churning your portfolio regularly according to your current financial situation and change in risk preference.
- Diversify your portfolio: Try to diversify your investment portfolio. Instead of putting your all money in one asset class split it into various asset classes. If possible invest in different sectors. So that, if an entire sector underperforms, you can still count on others. So, it’s always good to have a diversified strategy.
Investment planning, if done wisely and regularly, even a small amount can produce considerable rewards over long-term and can help you to efficiently meet your financial goals.