Financial Planning -- 10 Personal Steps in the Right Direction

Overview - Ten steps to sensible and efficient investment planning

The Skilled Investor provides this ten-step process to help investors optimize their financial and investment affairs and reduce the unnecessary waste of their money and their time. We hope you benefit from this series of personal financial planning articles

Step 1 - Develop your personal investment and financial planning skills

You are completely responsible for your financial and investment success or failure. Delegating investment decisions to advisers largely on faith and hope without adequate personal knowledge, attention, and control can be very risky to your personal and family welfare. The only practical solution is for you to increase your personal investment knowledge and skills.

Step 2 - Set your personal savings, earned income, and other financial goals

The single most significant financial lever that individuals control directly is their management of personal expenditures. The second is their lifetime effort to obtain sufficient income. Most people simply do not save enough of their current income to fund their future needs.

Step 3 - Assess your personal investment return and risk tolerance preferences

Differences in risk tolerances mean that more risk-averse investors are personally more satisfied with a lower risk portfolio despite its lower expected returns. Less risk-averse investors are more satisfied with portfolios characterized by higher risk and higher expected returns. Investors with different levels of risk tolerance are more satisfied by the expectations associated with investment strategies that are better aligned with their risk preferences.

Step 4 - Diversify fully within financial investment asset classes

Diversification is genuinely an investment “free lunch,” and it is a key contributor to improved investment risk management. Diversification has become an axiom of personal investing, because the specific risks of businesses and other investment entities can be reduced or eliminated from a portfolio without reducing expected returns.

Step 5 - Allocate financial investments across the primary investment asset classes

Appropriately setting your personal asset allocation in line with your personal risk tolerance is a critical decision for every investor. Because the average risk-averse investor holds the average portfolio asset allocation, this becomes the starting point in determining how a specific individual’s portfolio might diverge from that average allocation.

Step 6 - Select financial investments rationally

Given the extremely large number and variety of available securities, investors need a rational basis to select among them. Without rational selection criteria and a good understanding of which factors are more or less likely to increase risk-adjusted returns, investors will make decisions based on false assumptions.

Step 7 - Reduce investment expenses and control investment taxation

Even with optimal investment strategies, there is still substantial room to improve upon net investment performance through continued and vigilant focus on controlling investment costs and tax realization. The fees extracted by the financial securities industry increased substantially during the last two decades of the 20th century on both a total and a percentage of returns basis. At the same time industry deregulation, market innovation, and increased competition provided many new and useful mechanisms for investors to manage their assets in a much more cost- and tax-efficient manner.

Step 8 - Insure against financial risks economically

While value, affordability, risk exposure, and risk tolerance should affect insurance purchase decisions, insurance is often sold and purchased emotionally. Yet, insurance premium payments reduce personal funds that might otherwise be available for additional investments. Many people could spend all their net savings on insurance premiums and have nothing left to invest and to build an investment portfolio. The issue is where to set a rational rather than emotional balance between expected risk and return.

Step 9 - Monitor and adjust your financial plan time-efficiently

Time in life is the most precious and perishable asset that a person has. It should be spent enjoyably and efficiently. Scientific investment strategies that rely on relatively efficient financial markets allow people to minimize their time commitment to investment management. Yet, on average, they are still expected to obtain optimal risk-adjusted portfolio returns that are near the market’s return

Step 10 - Choose objective and competent investment advisers

Pick investment advisers solely to obtain objective and high quality advice. Specific investment advice is potentially of high quality, if it is carefully customized to your particular needs and is given by an adviser who is independent, knowledgeable, and competent. If you agree with the advice being given, then buy the recommended securities through the most inexpensive channel possible.