Putting together a perfect investment portfolio may seem like an impossible task, especially if you're just getting started as an investor. But when you get past all the jargon, clutter, and complicated investment vehicles, the basics of any successful investing plan boil down to just three simple goals, each of which matches key considerations in your financial life.
The 3 basics of financial planning
Financial planning is all about making money do what you need it to do. So in order to get to the fundamentals that your investing plan must address, all you have to do is establish your money needs at the most basic level possible.
Of course, no one plan works for everyone. If you're rich beyond all dreams of avarice, then you don't really need your money to work at all -- you just have to keep from losing it. But most of us can build these reasonable expectations for our money:
- You want the money you invest to grow over time.
- At some point -- either now or in the future -- you'll want your investments to create a stream of income for you to spend.
- Ideally, you want your investments to protect you from as many known risks as possible. For whatever risks remain, you want to seek out other ways to protect yourself.
There it is, in simplest terms. So how do you turn those goals into ideas for your investment portfolio?
Investing for growth
Unless you can save all the money you'll ever need, you have to find ways for your money to grow. Over the long run, stocks have done the best job of producing that growth.
Granted, other investments have done well over time. Gold, for instance, has risen more than five-fold in slightly over a decade, putting the stock market to shame and giving shareholders in SPDR Gold Trust (NYSE: GLD ) impressive profits. Oil has risen from lows in the teens in the late 1990s to more than $100 per barrel today.
But great businesses do more than just rise in value: they produce value. Coach (NYSE: COH ) , for instance, takes a simple utilitarian handbag and imbues it with the intangible value of its brand, which is known and well-regarded around the world. priceline.com (Nasdaq: PCLN ) revolutionized the travel industry by taking what had been a seller-dictated market and giving buyers something they'd never had before: bargaining power. Those companies and others like them have given investors big growth, and they did it by innovating and giving their customers exactly what they wanted. As long as they keep doing so, they should continue to grow.
Investing for income
Growing your money is great, but eventually, you'll also need to draw income from your portfolio. Balancing your growth and income needs will determine which investments you should own.
If you don't need any more growth by the time you retire, then fixed-income investments like bonds and bank CDs can produce modest income. But with rates low, dividend-paying stocks actually pay more income than many bonds right now. Even among the top tier of the market, Johnson & Johnson (NYSE: JNJ ) , Procter & Gamble (NYSE: PG ) , and AT&T (NYSE: T ) all have significant yields that reward you simply for owning shares.
Investing for protection
Financial risks are everywhere, and many financial products try to address those risks. To counter the effects of inflation, price-indexed investments like the ETF iShares Barclays TIPS Bond (NYSE: TIP ) have part of their value linked to changes in consumer prices. Annuities counter the risk that you'll outlive your money by offering guaranteed streams of income no matter how long you live.
Other needs, though, require thinking beyond your portfolio. Life and disability insurance products help protect your family against unexpected calamities, while property coverage covers your most valuable assets from damage or loss. Buying that insurance is an expense rather than an investment, but it's an essential way to give you peace of mind.
Take a closer look
Of course, once you get started with investing, it's easy to let things get a whole lot more complicated than this. But even as you expand your knowledge, keep these three simple principles in the back of your mind. In the end, as long as your investments accomplish these three goals, then you should do just fine.
To get more of the basics of financial planning, be sure to take a look at our 13 Steps to Investing Foolishly. It'll get you on track to a great financial plan in no time.
Tune in every Monday and Wednesday for Dan's columns on retirement, investing, and personal finance.