Wealth Building 202 – Investment Strategy Building Blocks

Now we will begin to build some foundational knowledge that will help you to understand (or better understand) how investing works. At this point I am assuming that you have your budget under control and that you are saving for emergency spending, short term expenses, and long term goals. If not, you can still continue reading and store this information for the (hopefully near) future when you will be able to use it. Even if you’re not ready to invest yet, it’s never too early to start learning about it!

All the technical financial stuff aside, in my opinion the key building blocks for developing a successful in investing strategy are: Goals, Time Horizon, and Risk Tolerance. I discuss each of these in detail below:

Goals

Having high net worth sounds good, but when you think about it, for most people it’s really not very motivating to deprive themselves of immediate gratification for a number on a balance sheet. What makes it really motivating is to have goals that you are investing for. These are the things that, as you pass up that extra vacation, you can say “this is for (___________)." The more specific you can be the better. For example, I had a client come to me one time who had a significant sum of money saved up and wanted to retire young. As I looked at his portfolio I asked him what he wanted his standard of living to be. At the end of the discussion it turned out that, given his desired standard of living, he needed to continue working for a bit more before he could retire. So, as you can see it really helps to put a very fine point on exactly what you are investing for.

Time Horizon

This is a significant piece of information required to determine what an appropriate investment strategy would be. For example, I manage a portfolio for someone who had a 10 year time horizon very differently from someone who had, say, a 30 year time horizon. What might be very appropriate for one might be extremely inappropriate for another simply based on the time that they can leave their money in the investment.

Risk

The financial community is obsessive about the concept of risk and it can get very technical, but for the purposes of our discussion I will speak in very general terms here. The saying goes that the more risk you take on the more potential you have for reward. I would hasten to add that “potential” is the operative term here. The potential reward of winning the lottery given the amount of investment beats pretty much any investment out there, BUT the comparative risk is also astronomical to the point of absurdity. When discussing potential investments with my clients they would often focus on investments with very high returns. However, after further discussion what I sometimes found was that their tolerance for risk would not allow them to be at peace with the investment(s) that they were looking at. We ultimately decided on something a little more conservative. I would say that the rule of thumb with respect to risk is to put it to the “Will I be able to sleep at night?” test. That said, there are many ways of reducing risk and while still working towards superior returns. I will cover those in a later segment.

The key is to have these things well defined in your mind. This will serve you well in creating an investment strategy that you can work with and that works for you.

Assignment: Thing about these three building blocks. Make a list of your financial goals, determine what your time horizon is for each of those objectives, and think about what your risk tolerance is. Perhaps a good way to think about your risk tolerance is to make a scale from 1 to 10 with 1 being that you would never want to see any less in your portfolio than at least what you put in and 10 being that you think a good retirement plan is to buy a lottery ticket ever day. Most reasonable people fall somewhere between 3 and 8!