Financial planning includes investment planning, but investing is not financial planning. A couple of weeks ago, I wrote about what a financial planner does. It still surprises me how many people I speak to who think of a financial planner as being synonymous with an investment portfolio manager. This is not the case. A financial planner who provides comprehensive wealth management services provides both financial planning and investment portfolio management, but investing is just part of the service. A financial plan needs to be in place to direct and guide the portfolio.
“If you fail to plan, you are planning to fail.”
You Need a Financial Plan Before Investing
I’m someone who believes that most people need a financial plan before investing. Don’t get me wrong, starting to invest as early as possible is very important. That just means that you should work on creating a financial plan for yourself (whether on your own or with the help of a professional) as soon as possible so that you can get started investing.
There are some people who may not necessarily need a financial plan in place before making investment decisions (think those who are extremely wealthy). However, having a well thought out financial plan prior to investing would be extremely beneficial to many.
Why do I think that you need a financial plan before investing?
The intent of a financial plan is to help you determine where you are and figure out the steps that you need to take to reach your goals. As I mentioned, investment planning is a part of financial planning. However, financial planning is so much more than just investing.
Everyone has different goals and each goal has a different timeframe and different amount of money necessary to fund it. This means that different investment strategies and different investment accounts are appropriate for different goals.
Having a well thought out financial plan in place prior to making major investment decisions provides a set of rules and guidelines to fall back on when making those choices.
Your financial plan should guide your investments, not the other way around.
Your financial plan tells you why you are investing and lays out the goals that your portfolio is meant to fund. It should help you understand how much cash flow you have to invest and when you will need the money, which will help you understand how to and where to invest it.
A Financial Plan Tells You If You Should Be Investing
You may not even be in a position where you should be investing much right now, depending on your personal situation. However, it could be hard to figure this out without first completing a comprehensive financial plan. Many people need to focus on building out other parts of their financial foundation rather than focusing on investing.
This includes having a properly funded emergency fund in place, having the proper insurance policies and coverages, getting the company match, and eliminating high interest rate debt. Without a solid foundation in place, your financial house is much more likely to crumble, especially if something bad were to happen.
There’s a recommended sequence to financial planning and investing for a reason.
A Financial Plan Tells You Where to Invest
There are so many pieces of a financial plan that go into developing an investment strategy. It’s hard to determine how you should direct your investments without these vital pieces of information all laid out in a plan tailored specifically to reaching your goals.
- Risk tolerance
- Desired retirement age
- Desired retirement spending
- Other goals to invest for (including those prior to retirement)
- Retirement savings rate
- Current tax rate
- Projected future tax rate
- Current financial assets
Knowing all of this information helps you determine what rate of return you need, what types of assets to invest in, and what types of accounts to invest those assets in. Different goals require different considerations.
Retiring, retiring early, paying for healthcare expenses, buying a second home, and saving money on taxes are all financial goals that require different consideration in the context of your overall financial life. You would not want to invest the same exact way for each of these goals.
Some people might not see the value in financial planning and/or might not understand why it’s important. Investing without a financial plan in place can be fun, but it lacks direction and doesn’t take long-term consequences into consideration.
If you want to take a cross country road trip, then it’s going to be hard to figure out how you’re going to get to where you want to go without knowing where you are and without having a map, GPS, or phone that can tell you how to get there. A financial plan is a tool that solves both of these problems and helps you to get to where you want to go.
A Financial Plan Can Protect You from Yourself
Many people jump head first into investing without having an overall financial plan or even an investment strategy in place. I think that it’s awesome that people are excited about investing and growing their wealth, but I’m often afraid that this excitement comes from a different place – greed.
Getting started investing as early as possible is great and will likely pay off over the long run. However, beginning to invest because you want to get rich quick could end up badly. These motives can often lead to chasing returns, investing based on a hot tip from someone who is not a professional, and not having proper procedures in place, all of which could lead to subpar decision making or worse.
Consider that “two-thirds of US equity funds unperformed benchmarks over the last 12 months”, according to the S&P Indices Versus Active scorecard. The most well educated investors in the market with the most sophisticated systems and research routinely underperform their benchmarks. Data shows that we may occasionally hit big in investing, but it’s not likely that we will be able to continue doing so over time.
Having a financial plan in place means that you don’t have to spend a lot of time making decisions when investment opportunities come up. Does “X” investment make sense within my overall financial plan? Does it help me reach my goals? Maybe more importantly, am I okay with the impact on my goals if I make this investment and it goes to 0? Your plan should be able to answer these questions for you.
A financial plan can help to ease FOMO on certain investments because you know that you have a plan in place and those investments don’t fit in the plan
Long-term investing is not, and should not look like, gambling when done correctly.
