If you want to change your financial life, set out a clear investment plan.
In The Principles of War: Invest Like a General I showed how aligned the principles developed for warfare are with the behaviour of the successful investor. The most important of these is far too often taken for granted. Your life is not at stake when investing, but your quality of life is, both in the difference good long-term returns can make, and in peace of mind when setbacks occur.
Objective
"I want to make lots of money."
Well, that's great, but can we do better than that? There are four key tests to apply to your objective. Is it:
- clearly defined;
- well understood;
- measurable; and
- attainable.
1. Clearly defined
"I want to make lots of money" may seem overly greedy in these banker-slapping times but it's surely clear enough? However the tougher you are in planning the better your outcome.
This objective has no timescale, no end target and no idea of acceptable risk. The objective must take into account the resources in cash, time and skill that you have.
"A man's got to know his own limitations" spoke the philosopher-cop Harry Callaghan. Do you have the temperament, knowledge and time to be a stock picker? If you are not sure, it's best to find an ace fund manager to do this for you. That is unless personal satisfaction is added to the objective, which it certainly is for me, in which case start or continue to trade on a modest scale.
Most of us have the luxury of time, so choose a long timescale. This will be retirement age for many, allowing you to run your portfolio in tandem with your pension. You can then work backwards from the pot you want that will be enough to top up your monthly pension. Using a reasonable real rate of return (more than 3% - 5% above inflation shows ambition) you can calculate how much you need to start with or how much to invest a month.
2. Well understood
It would be fair to say that although the 2003 Iraq War had a clear objective -- the installation of a democratic government and the securing of Iraq's petroleum infrastructure -- the first part was not well understood. The invaders severely underestimated how difficult the transition would be.
If you think you can make over 10% a year more than inflation you are either the new Buffett or you will have to accept a much higher risk, typically by buying smaller cap growth shares at higher P/E ratios. You must embrace the downside -- higher volatility and possibly a lower return in the end than had you taken a less ambitious path.
You must take a realistic look at how much time is involved if you aim to best the market. Accept that inflation will erode the buying power of your gains.
Let's assume you're looking to build a pension pot. If you will be buying an annuity, rates may be even worse than they are now. Is your pension inflation-proofed? Are there any caveats e.g. a maximum rise of 2.5% against price rises? Are you prepared to downsize your home, to release equity or simply to cut running costs?
How long do you expect to live? Average life expectancy is increasing by around 0.2 years per elapsed year. A woman of 65 can right now expect to live to 85. If that increases to 90 for you at retirement will you have enough put away?
3. Measurable
Unlike war, the market will tell you every minute how well you are doing, or rather, how well everybody else thinks you are doing. Don't check too often though, it makes you twitchy.
4. Attainable
If you've only got £1,000 starting capital and £100 per month to invest, you are not likely to make an inflation-adjusted retirement fund of £500,000 in thirty years. That would require a heroic 15% per annum return, even with inflation at 2%. Like leaping the Grand Canyon on a motorbike you will either meet with great success or a great drop.
If you do want to target a higher return with risky assets, a sensible proviso would be to plan to inject more cash should your pot fall say 10% below its target to date.
Here's an example...
An attainable objective might look something like...
- Achieve a portfolio value in twenty years of £100,000 (in today's money) at low risk, to supplement my pension. I will invest in managed funds.
- My starting capital is £3,500 and I will contribute £250 per month, increasing with inflation. My target annualised return is 4% after inflation.
That level of regular investment can be put in an ISA to forever shield your capital gains and avoid a lot of bother with Self Assessment forms.
Why not post your objective in the comment box below and tell us if it has changed after reading this article?
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