What makes the rich rich? Examining the spending habits of various income groups in the United States clearly shows: savings. The real difference between the rich and the poor is that the rich spend more of their income on savings (pensions and insurance) and education.
Source: WSJ, Department of Labor,
When creating wealth, preserving it, and passing it on to the next generation is the formula for financial success, it’s surprising that less than 20% of Americans have a written plan for investing and even retirement. .
The paradox of human behavior is that we are perfectly rational and able to plan for a major event in our life, but this is usually forgotten when it comes to investing. In fact, you will find that only a third of investors have a written plan guiding their investment strategy and retirement plans.
Why is a plan needed?
The world of investing is a harsh jungle, a world of troubled waters where the smartest and most organized survive and succeed while the rest are swallowed up. A written plan bypasses our normal response to something as emotional as money. This prevents us from resorting to our instinctive feelings and emotions. Instead of following the herd mentality that can trick you into making reckless investment decisions, a plan will force you to stick to a rational strategy that is grounded in fundamental investing principles. Some of the difficult emotions that you will need to overcome while investing include:
1) fear of failure
2) The tendency to continue with a certain approach just because you started it
3) Personal issues such as relationship problems at home
It is also important to highlight the main reasons why investors fall prey to the market and lose their precious funds:
1) Omitted facts and figures lead investors to invest in a structurally unhealthy company or financial instrument
2) Overconfidence makes some investors believe that they are invincible and can always beat the market.
3) Everyone wants to be seen as a champion, the successful general capable of leading an army to victory. This can lead you to make investment decisions that are not based on rational thinking but rather on the desire to impress your friends, colleagues or family members.
By having a written investment plan and following what it says, you will have significantly increased your chances of winning and increasing the size of your nest egg or investment portfolio. Here are simple steps to create a plan and avoid the herd mentality and instinctual impulses that make us fools when we invest:
1. Set specific and realistic goals
For example, instead of saying you want to have enough money to retire comfortably, think about how much money you will need. Your specific goal may be to save $ 500,000 by the age of 65.
2. Calculate how much you need to save each month
If you need to save $ 500,000 at age 65, how much will you need to save each month? Decide if this is a realistic amount to set aside each month. Otherwise, you may need to adjust your goals.
3. Choose your investment strategy
If you are saving for long-term goals, you might choose more aggressive and riskier investments. If your goals are short term, you can choose conservative, low risk investments. Or you might want to take a more balanced approach.
4. Develop an investment policy statement
Create an investment policy statement to guide your investment decisions. If you have an advisor, your investment policy statement will outline the rules you want your advisor to follow for your portfolio. Your investment policy statement should:
Specify your investment goals and objectives,
Describe the strategies that will help you achieve your goals,
Describe your return expectations and your time horizon,
Include detailed information about the level of risk you are willing to take,
Include guidelines on the types of investments that make up your portfolio and how accessible your money is, and
Specify how your portfolio will be monitored, and when or why it needs to be rebalanced.
A smart investor with a written plan and strategy has already won half the battle without making a single financial decision. By implementing the plan and sticking to the established rules of operation, the savvy investor will avoid the pitfalls caused by human emotions and behavior and end up winning big.