The Most Important Part of Financial Planning: Why do I Need Goals?

Sample Investment Mixes Chart

Example of establishing a portfolio mix. Assume you are thirty years old and essentially thirty-five years away from retirement. You had fifty thousand dollars saved and you may save 10,000 dollars in an emergency fund leaving forty thousand dollars as an investment. Instead of buying one stock such as I began with the 40,000 dollars, you might consider buying three stocks such as 1/3 IBM, 1/3 Merck, 1/3 Caterpillar. Diversifying on three different stock sectors, in the event that technology group lost money for a period, perhaps the pharmaceuticals and the heavy equipment economic sectors may not be losing money at the same time.

This is even better illustrated when speaking of mutual funds. Assuming the same $40,000 one could buy three different mutual funds equally split among one international fund, growth stock fund and three, a sector fund such as technology. Mutual funds invest in a number of stocks within each group, the international may have four or five stocks in it, the growth stock fund may have four or five stocks and the technology group may have four or five stocks. Instead of having three companies on which you are placing your entire reliance, you may be relying on fifteen companies as an example. To the extent that one stock had a poor performance, the entire group may no be dragged down, whereas, if IBM, in our first example, had a poor performance, the entire investment may be dragged down.

Also the mutual fund groups may help to overcome economic conditions. Even in downturns of the economy, certain companies still perform adequately. But if the problem is, naturally, that the returns from such diversification, may not be as high as investing in three companies in our first example. The reason is that three companies, even if they are in the same sector, are not all going to have good performances at the same time. In our growth stock fund there may be three companies with good returns, one with mediocre return and one company with poor return. All of these will be averaged into our return and be less than the one stock such as the IBM return in our group. You can see that it is easy from a hindsight analysis to know what to do. The problem, of course, comes in speaking for the future. If you can afford a lot of risk and expect substantial returns, and have a long period of time in which to make up for any mistakes, a better strategy might be to pick the three stocks mentioned in our first example. If you have less time or have a difficult time sleeping if you are nervous about your stocks, the mutual fund with some 15 companies may be a better approach. All of this depends upon each individual and their goals, strategies and personal temperament. In addition to risks, all investors have an inherent predisposition to making some investment mistakes. Planning can help to avoid certain mistakes. A list of certain mistakes may be helpful so that you can match specific mistakes with your goals thereby creating an avoidance strategy.

1. Ignoring tax consequences. Sometimes an investor will buy a stock, it may run up three or four dollars, the investor may turn around and sell the stock thereby making a small return. The problem is, that by selling the stock, the investor creates a taxable consequence, whereas the purchase of the stock alone without selling even though it has gone up typically does not create a taxable consequence. An investor who is touting his "gain," needs to account for the fact that a third or more of the gain will be taken away by taxes.
2. All your money on one stock. Investing in one stock carries significant risks, in while sometimes significant gains can result, a investor must have the stomach for significant losses as well.
3. Significant price decline. Investors will sell a stock after which it has "taken a hit" based on poor quarterly earnings analysis or some other piece of bad news. Stocks today seem particularly susceptible to this type of oscillation. There are times/periods of significant price declines are better times to purchase stocks, particularly if the purchase you made in the beginning was based on sound financial information about the company. Patience is a virtue. Also understand that television and media news drives particular stock on the stock market at any given day. A feeding frenzy may impact a stock for no good reason. The work in purchasing a stock initially should carry you through to meet your goals. If the stock was purchased for long term and the price declines significantly based upon a piece of advice, you should continue to hold the stock and be patient.
4. Investors are tempted to purchase stocks after the significant price increase has reached the general public. Typically, one must be extremely careful in purchasing a stock after a significant price increase. However, this does not mean you ought not to do it across the board. There have been many instances where there have been significant price increases and one does not think the stock can "possibly go higher," but of course it does. And sometimes by two or three or four-fold. You may be able to prevent the loss of significant revenues by buying a stock at a price that is too high, thereby in contrast with the stock purchase price with the long-term goals already set in a person’s financial plan. Some instances, the stock price may mean nothing, even if it is inordinately high, if the research shows the stock price will be low in ten years. Many people without the goals would not analyze the stock price in this manner and refrain from purchasing the stock because the price seemed artificially high. An example of how your definitive financial planning goals can assist you in analyzing different investments.
5. Buying stocks from solicitations. People get regular phone calls from brokers who are in the business. Most phone calls start out something like, "Have you heard about this stock recently, its returns have been fantastic? You need to get in on this stock before the rest of the public hears about it." The purpose of such a solicitation is to inform one’s close friends of a stock with a commission that will be readily earned and establishes future stock on which commissions may be earned. As a general rule, it is not a good idea to respond to any telephone solicitation regarding stock purchases, without conducting a certain amount of research about the stock, the stock broker’s firm and the particular stock which the broker is touting. It may be that the stock is in fact a legitimate stock. Any indication that the stockbroker is conveying "inside or un-disseminated information" is misleading and quite possibly illegal. The stockbroker would not normally violate the law by passing along inside information, so it is safe to assume that the only "inside information" is for the all-willing investor.
6. Investing in the investment vehicles that you have never heard of. Along with stockbroker solicitation regarding particular "high-flying" stock, also come the solicitations from brokers selling cattle, futures, oil futures, stock options and other alternative investments. Unless your portfolio has, as its specific investment goals, some speculative stocks, your goals will provide guidance as to whether or not to buy these investments. Aside from the fact that one ought not to purchase any investments over the telephone, a quick look at your goals will be able to determine whether you have a speculative investment category and whether it needs purchases. Most likely, it does not, but it is possible that it could. If you have a "opening" for a speculative investment vehicle, then your own research may be the best indicator of whether the stock option, commodity, or index touted by the telephone solicitor is the best investment vehicle for you. A financial planner helping you in this manner, may also be a great source of independent advice as to this commodity.