If you step out of your front door and start walking, you'll inevitably end up somewhere after a few hours. Maybe in a beautiful park, or maybe just in a parking lot. If you want to be sure to make your walk a rewarding experience, you have to plan: How much time do you have for the walk, what footwear do you choose, and what do you want to see and experience?
It's the same with investing money. A goal and a corresponding plan can help to improve your chances of investment success. However, the stakes are much higher here, and your investing goal is farther off. Many of us find it difficult to estimate what life will be like in 10, 20 or 40 years - let alone the amount we need to save to achieve distant goals such as a comfortable retirement.
For some, that's a reason to put off their financial planning or simply invest haphazardly. But even a plan that has to change in the future can be a sensible plan.
Time is your friend in investing
When asked about the most powerful force in the universe, Albert Einstein is said to have once answered: "compound interest". As with many great quotes, its origin just might be a myth, but we stand by the sentiment. This is because over time, investors earn returns not only on the capital they invest, but also on the returns they have already earned.
The longer you put your money to work, the more noticeable this effect can be. The following table shows how much investors would have to invest each month in order to save half a million pounds at a constant return of 5% after costs:
Required monthly contribution
Source: Vanguard calculations.
This simplified example shows: With a relatively long investment horizon of 40 years, a monthly investment amount of £336 would be enough to reach the stated goal. With a time horizon half as long, an investor would already have to invest almost four times as much to achieve the same goal - so it becomes exponentially more difficult.
It is therefore worthwhile to start investing money today rather than tomorrow. But on what basis? If you're saving for retirement, for example, it’s hard to say what exactly will happen to the cost of living in the meantime. An inheritance or a career break can also affect your calculation.
Still, it pays to develop a plan, even if it's not perfect. Even if you need to adjust your strategy over time, early investments can bear fruit for longer. This also increases the likelihood that you’ll achieve your financial goals. So where do you start?
What makes a good plan?
Investment purpose, target amount and investment duration
The basic framework of any investment plan involves two questions: for what purpose are you investing money and how much time do you have to achieve that goal? For example, if you are saving for a home, you can set a goal of saving a certain percentage of the current price of a home in ten years.
Another part of the plan is the question of what one-time and regular amounts should flow into your portfolio. Investors should always keep reserves to cover three to six months' living expenses and only invest in the market beyond that. This ensures that you don’t have to sell parts of your portfolio unexpectedly in the event of a loss of income or another short-term need for cash.
Personal risk tolerance
When developing your plan, you should not only be aware of your investment objective, but also of your own comfort level. The greater the volatility or risk of an investment, the greater the opportunity for return; relatively "safe" investments offer a correspondingly smaller opportunity for return. Regardless of the desired returns and investment goals, however, you should only take risks that allow you to sleep soundly at night.
You can use these key points to develop an investment strategy - on your own or with the help of a financial adviser.
Adjusting plans is easier than planning from scratch
If your circumstances or investment goals change, your plan and strategy are far from obsolete. Rather, a solid plan makes it all the easier to deal with unexpected events and assess what they mean for your plans.
For example, if you receive an inheritance, you can use an existing plan to recalculate whether lower monthly investment amounts could lead to your goal - or continue to invest as before and increase your investment target. If you are planning a career break, you can allocate the savings amounts you miss out on to other months. If the market develops differently than expected over the long term, a clear plan often makes it possible to adjust parameters such as your savings rate and investment target until the goal becomes attainable again.
How clear goals help avoid mistakes
A well-thought-out plan can not only help you work toward realistic goals, but also help you avoid mistakes. Without clear goals and a corresponding strategy, some investors engage in a kind of "fund shopping": They evaluate individual funds and buy those that seem attractive to them - without thinking about what strategy they are pursuing. In doing so, investors often rely on characteristics such as historical performance. The result being investors may end up buying yesterday’s winners not the winners of the future.
In addition, there is the temptation to give in to feelings of euphoria and fear, buying investments in boom phases and selling them in crises. In doing so, investors often lag market developments. They may buy at a high price and sell when prices are past the worst.
The 20 best and worst trading days
Source: Vanguard calculations, based on data from Refinitiv using the FTSE All Share Index. Data between 1 January 1985 and 19 January 2022.
Better investment results can often be achieved by staying the course and sticking to your plan during turbulent market phases. And last but not least: Clear goals will give you a sense that you’re not leaving your future up to chance.
Investment risk information
The value of investments, and the income from them, may fall or rise and investors may get back less than they invested.
If you are not sure of the suitability or appropriateness of any investment, product or service you should consult an authorised financial adviser. Please note this may incur a charge.
This article is designed for use by, and is directed only at persons resident in the UK.
The information contained in this article is not to be regarded as an offer to buy or sell or the solicitation of any offer to buy or sell securities in any jurisdiction where such an offer or solicitation is against the law, or to anyone to whom it is unlawful to make such an offer or solicitation, or if the person making the offer or solicitation is not qualified to do so. The information in this article does not constitute legal, tax, or investment advice. You must not, therefore, rely on the content of this article when making any investment decisions.
Issued by Vanguard Asset Management Limited, which is authorised and regulated in the UK by the Financial Conduct Authority.
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