Investing in the stock market can take a toll on ones emotions. After all, it is commonly said that the stock market is led by 90% emotion and 10% reason. While education is a great way to help decrease this emotional pull it does not always provide a matrix through which you can make investment decisions. This is where an investment plan comes into play. An investment plan puts meat on the bones of your investing goals and simplifies your investment decisions. I found that early in my investing life I was simply throwing darts hoping to hit something good and be able to rack up some solid wins. Looking back, I realize that was aimless investing; it gave me no real way to manage my returns. A number of years ago I was introduced to the idea of having an investment plan and have not looked back since. I’ll not get into the details of how specific an investment plan should be, but it is basically a written plan dictating what types of investments you are looking for (sectors, industries, profit margins and the like) along with a quantifiable number you are comfortable losing.
An Investment Plan Makes Decisions Easy
If you’re like me, when you buy a stock or ETF you intend on holding it for some time. When I research a stock, I intend to hold it for a while, but I never intend to hold it forever. An investment plan helps you know when the time is right to sell a stock. Before I had an investment plan I sold when I felt like it or when I thought the stock had run its course. That approach leaves much to chance; in the end, no decision made in a vacuum is perfect. Having a written investment plan helps make the decision to sell a stock easier for you. When I buy a stock now I decide how much I am comfortable losing on it and set a stop loss order at that amount. The typical amount is in the 10-20% range and I set the stop loss order at that. If the stock goes up (as I hoped it would) I then readjust the stop loss order to continue to trail by the chosen percentage. This takes the emotion out of selling and am now guided by the numbers rather than fear of losing my shirt.
You Don’t Always Need to be Near Your Computer
If you’re involved in online investing, you either need to be near a computer or have a smartphone in order to place a trade. Just imagine if you’re on vacation and one of your stocks takes a nose dive and loses 30% over the span of a few days. If you did not have a stop loss order in place then you’ve taken a bath with everyone else. However, if you did have a stop loss order in place you’ll likely have gotten out much sooner, limiting your loss to an amount you’re comfortable with. Using stop loss orders in conjunction with your investment plan is a sound way to manage your portfolio and hopefully limit losses over time. This also will help you stay away from the “click and hope” mentality that is often found in retail investing.
You’ll Avoid Mistakes That Will Cost You Money
We’ve all heard the term “Buy Low, Sell Hi”. The problem is that many times it’s the opposite that happens. We get fearful of what’s going on and jump ship to avoid further losses. The problem is that many times the stock comes back and if you bailed out then you’ll miss out on some decent returns. This also works the other way, and did for me recently. I recently was holding an Apple call contract that gave me the right to buy 100 shares at $650. I made a very nice profit on it, but because I did not follow my investment plan I lost out on another $1,000 that I could’ve made in my retirement portfolio. I did not follow my investment plan and let fear be my guide. This ended up in me getting out of the option and missing out on the increased return. While the profit I made was quite sizable, I could have made more if I would’ve followed my investment plan.
An Investment Plan Will Help Your Entire Portfolio
In my years of speaking with investors, I have always been surprised by the number of people who don’t look at their portfolio as a whole. I realize that a 401k is separate from other outside investment accounts you might have, but the simple fact is that the parts make up the whole. By not looking at it that way, you risk being either over diversified or being overly concentrated in just a few sectors, stocks, etc. This is where an investment plan will help you. It enables you to look at your investment portfolio as a whole in order to make sure you’re properly diversified without focusing too much on one area that might end up causing you problems in the future.
Do you have an investment plan in place or is this the first you’ve heard of it? How much are you comfortable losing on an investment?
Photo courtesy of: Robert Linder