Investing Principle 1: A Blueprint for Success

by Mark W. Riepe, CFA, Senior Vice President, Schwab Center for Financial Research
March 10, 2008

The second article in an 11-part series on Schwab's investing principles.

Having an investment plan that is realistic and actionable is crucial to meeting goals. That's Schwab's first investing principle, and the thinking behind it is simple: It's hard to get somewhere if you don't know where you're going.

You wouldn't build a house without a blueprint, so why should your investments be any different? Yet I've seen it time and again where someone wants to get started with investing and they think the place to begin is to open an account and immediately decide what kinds of stocks, bonds and mutual funds to buy and sell.

That's not a recipe for success.

For the vast majority of us investing is not purely a game. At some point in the future we intend to spend the money in our investment portfolio for some purpose—for example, to pay bills during retirement, to pay the college bills of our children, or perhaps both. Some of us may have other types of expenditures on our minds, or even future philanthropy.

With a goals-based approach in mind, investing becomes a means to an end, not an end unto itself. And the nature of your goals will determine the right type of investing for you to pursue.

What makes a good plan?
Having an investment plan is vital, but your plan needs to be a good one if it has any chance of helping you succeed. I think a good plan needs to pass three tests. It needs to be:

Complete
Realistic
Actionable

It's important to understand that a complete plan doesn't have to be complex. For most people, the plan doesn't need to be complicated. Instead, a complete plan needs to include just a few items:

Your important goals, how much money each goal will cost, and when that money is needed. Let's use retirement as an example since that's most people's No. 1 goal. When do you want to retire? How many years do you expect to live in retirement? How much money do you plan to spend each year in retirement? This is the type of thinking you need to spend some time on.
A review of your current situation. How much money have you already accumulated toward your goals, and how is it being invested?
Assumptions about saving and spending. For a goal that will take place in the distant future (for example, a young person thinking about retirement ) your plan needs an assumption about how much additional savings you'll be contributing toward that goal over time. If you're nearing retirement you'll need to decide how much you'll be withdrawing from your portfolio each year.
Risk tolerance. A complete plan will also include the level of risk that you're willing and able to tolerate with your investments.
Return expectations. Finally, a good investment plan contains some sort of expectation regarding the returns your investments will generate. These return expectations aren't year-by-year forecasts, of course. Instead they represent long-term averages that are expected to hold true over time.

Realistic and actionable
So let's say at this point you have a plan that covers all the bases. But merely having a plan doesn't cut it. Your plan needs to be realistic and actionable—something that you can actually make happen.

Unfortunately, realism seems to be in short supply at times. Let me give you two examples:

As I mentioned before, being able to retire is the No. 1 goal of most investors. In order to retire, a key figure that you need to determine is how much money you need to sustain yourself during your retirement years. Given the importance of that number, it's disappointing that the most popular method of determining it is to guess.
Another example comes from survey results¹ suggesting that 85% of individuals expect to spend less money each year in retirement than they were spending in their pre-retirement years. But when looking at the actual behavior of retirees, only 43% truly spend less.

So when you sit down to sketch out your investment plan be sure to ground that plan in facts.

You also want to make sure you draw up a plan that you can actually put into action. By that I mean, a plan that requires you to save 20% of your pre-tax income is going to be hard to put into action for most people. Rather than establishing a plan that requires Herculean feats on your end, make sure that all of the steps in the plan are ones where you can hold up your end of the bargain.

3 important steps	10 proven principles
Create a plan	1. Having an investment plan that is realistic and actionable is crucial to meeting goals. 2. Understand your plan, follow it and adjust it when things change in your life.
Put it into action	3. Saving and spending rates have the greatest impact on success. 4. Diversification is the second-most important factor in reaching goals. 5. Select the asset allocation that’s right for you and stick with it. 6. Choosing professionally managed investments can be a better way to invest. 7. Acting now generally beats waiting.
Stay on track	8. Periodic checkups keep a portfolio healthy. 9. Progress toward goals is more important than short-term performance. 10. Use the right benchmarks to evaluate performance.

Planning works
At this point I'm hopeful that the principle of creating a plan as a first step toward successful investing makes sense to you.

If you're still not convinced consider this: Professional investors consider creating an investment plan vital for performing their fiduciary duty to clients. In fact, 89% of employer-sponsored retirement plans have what is called an investment policy statement² (which is just a fancy name for one form of the type of plan we're talking about).

There's also empirical evidence that thinking about your long-term goals ahead of time actually works. For example, in one survey³ of Americans who had recently retired, 54% of those who had thought a lot about retirement before they actually retired reported that their retirement years were going better than their pre-retirement years. Only 18% reported that their retirement years weren't as good.

These results are in sharp contrast to those reported by recent retirees who spent virtually no time thinking and planning about retirement. Among this group only 11% felt their retirement years were superior to their pre-retirement years. And a whopping 57% felt their so-called golden years were actually worse.

In a different survey⁴ retirees were asked about their overall level of satisfaction with their retirement. Sixty-nine percent of those who had planned ahead reported being very satisfied. Of those who had done little planning, only 25% reported being very satisfied with their retirement.

Why does planning work?
I think there are three reasons why planning can be so effective:

Planning identifies what's important. Just thinking about your future is a good thing. Doing so clarifies your thinking and helps you figure out what's truly important for yourself as well as your family. Once you've decided what's important to you, you can ensure that your financial resources are directed toward those important goals.
Planning resolves conflicts. If you're anything like me, when you sit down to make a list of what's important, you rapidly get a long list. A key aspect of the planning process is to set priorities.
Planning prevents backsliding. To a certain extent, a plan is a set of rules you make today in order to govern future behavior. The reason this matters is that investing is an emotional activity. During the inevitable ups and downs of the market and the normal chaos of daily life, it's easy to lose sight of the long term and make decisions based on short-term, often unimportant, and even destructive considerations. A well-thought-out plan gives you that reference point, that compass to refer back to. It helps keep you focused on the right things.

Preparing a complete plan founded upon realistic assumptions about your situation is that vital first step on the road to becoming a successful investor.

Important Disclosures

1. Retirement Confidence Survey, Employee Benefit Research Institute, 2006.
2. Source: International Foundation of Employee Benefits Plans.
3. Annamaria Lusardi, "Saving for Retirement: The Importance of Planning," Research Dialogue, TIAA-CREF Institute, December 2000.
4. Harold W. Elder and Patricia M. Rudolph, "Does Retirement Planning Affect the Level of Retirement Satisfaction?" Financial Services Review, 1999.

The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision. Examples provided are for illustrative purposes only and not intended to represent results you should expect to achieve.

All expressions of opinion are subject to change without notice in reaction to shifting market conditions. Data contained herein from third party providers is obtained from what are considered reliable sources. However, its accuracy, completeness or reliability cannot be guaranteed.

Past performance is no guarantee of future results. Diversification strategies do not assure a profit and do not protect against losses in declining markets.

The Schwab Center for Financial Research is a division of Charles Schwab & Co., Inc.

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Schwab's Investing Principles

Intro: Becoming a Successful Investor

1. A Blueprint for Success

2. Stick With Your Plan

3. The Top Success Factor

4. Diversification Is Key

5. Get the Mix Right

6. Go With the Pros

Coming soon
7. Act Now, Don't Wait
8. Get Regular Checkups
9. Keep Your Eyes on the Prize
10. How to Measure Success

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What makes a good plan