3 Tips for a Perfect Investment Plan

When you want to evaluate your investment returns, what do you compare them with? Those of friends and neighbors? The latest market trend? To fairly assess how your investments perform, you look at your goals.

Now that summer is well along, stocks have pushed well beyond a five-year bull market run. You hear people talk at company picnics, club get-togethers or family events about how well their stocks do. The more successful the stories you hear, the more you feel like you’re falling behind even given occasional down days on Wall Street.

Instead of constantly comparing yourself with what everyone else is doing, keep in mind two important elements of your investment strategy – your goals, and an appropriate way to measure performance of your whole portfolio, not just the winners.

Let your goal guide you

What is it you are trying to get to, and how are you doing? Do returns (whether up, down or sideways) change the probability of reaching your goal? When you know your target, you can put recent market performance in proper context.

Your goal should not simply be a number. It should be a carefully chosen and wisely pursued mix of lifestyle decisions, spending preferences, savings capability and investment approaches. For example, the goals might read like this for a couple about to retire:

“We want to retire at 62. We plan to live in our current house, which is paid for, but need upkeep and maintenance. We expect that we can live on $60,000 per year of after-tax income, but we probably need more in the first decade of retirement. This amount comes from our savings, Social Security, a pension and distributions from our retirement plans.”

People who feel most prepared to make money decisions think in these terms, so that they have something to measure progress by. Outperforming the Dow Jones industrial average today doesn’t mean you are on track to meeting your life goals.

Compare to the right benchmark

After defining your goals, you can go a layer deeper to measure the effectiveness of your investments, first collectively and then individually.

Ignore headlines of the Dow or Standard & Poor’s 500 index at record highs. That’s nice for one piece of a diversified investment strategy, but leaves you short as a comparison point for a well-balanced approach. Compare your performance with a target risk index that fits your investor type (conservative, moderate or aggressive).

Or figure out how much you will need at a certain date to retire, then diversify your holdings to reach that goal. This approach works well for people who base their investment mix on how close they are to retirement. You can find performance reporting for different types of stock funds (such as small, large, value and growth) at Morningstar.com in the markets section.

After you know how your broad portfolio is performing compared to a relevant benchmark, you review which individual holdings are contributing the most to your overall performance, and which detract from it. Again, Morningstar provides category-specific information to evaluate each investment.

Don’t chase the market

When reviewing investments amid chatter of big gains, be careful to avoid the trap of chasing performance due to short-term thinking.

Following the recent leaders is rarely the way to go. In fact, over the past 15 years, according to the estimates of market researcher Craig Israelsen, investing in the previous year’s worst performing asset class generated more than investing in last year’s winner.

Market performance is not wholly unpredictable, but it is elusive. No bell rings to signify the top or the bottom. Even professional mutual fund managers don’t beat benchmarks every year. You shouldn’t hold yourself to that standard. Usually, you don’t need exceptional short-term returns to reach your goals. Chasing performance introduces more risk than necessary, actually reducing the probability of reaching your goals.

Invest with defined goals and evaluate your investments in the right context. You will have peace and confidence in managing your money, regardless of which direction the market goes.

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Written by Gary Brooks, a certified financial planner and the president of Brooks, Hughes & Jones, and a registered investment adviser in Tacoma, Wash. Find risk tolerance resources at his blog The Money Architects.

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