How to Build Your Investment Plan from Scratch?

The 20 that leads to 80!

The 80:20 rule states that for most areas in life, 20% of what you do leads to 80% of the results.

My whole blogging journey was started in pursuit of this simple question –

How do we identify the 20% that really matters when it comes to investing?

While the pursuit for the answer still continues and will keep evolving, here is my thought process at the current juncture.

Any good investment plan predominantly is about getting two things right…

  1. Your Asset Allocation
    • Deciding the mix between Equity, Debt & Gold
    • Rebalancing
    • Adjusting Asset Allocation in a Bear market and Bubble market
    • Building Equity, Debt and Gold portfolio with the right products
  2. Your Own Behavior
    • In a bear market
    • In a bubble market
    • When your funds underperform

Over the course of next few weeks, I will try and deconstruct the thought process that goes behind these two critical decisions.

Get yourself a good cup of chai and let us begin…


Your Asset Allocation

Now before you switch off hearing the word, asset allocation, hang on.

Asset Allocation simply is a fancy way of asking…

What is the mix of equity, debt and gold that you want in your portfolio?

There is a lot of academic research which demonstrates that approximately 80%-90% of long-term investment returns can be traced back to your asset allocation.

So in other words, this single decision will become the most important determinant of your long term investment returns.

Unfortunately, the ‘asset allocation decision’ despite its disproportional importance, somehow doesn’t get the deserved attention.

Majority of the efforts are usually spent on futile pursuits such as trying to predict the markets and identifying the best fund of the past!

Now that we realize its importance, let us spend some time on the most important question

How do you decide your Asset Allocation?

The decision to arrive at your Asset Allocation can be unpacked into three vantage points:

  1. Why?
  2. Risk
    1. Time Frame
    2. Ability to take risk
      • Stability of Income
      • Need for liquidity – do you have an emergency fund?
      • Backup options if you fall short of money
    3. Tolerance for risk
      • Normal Expected Decline
      • Maximum Expected Decline
      • 6 month range of return outcomes
      • Past Behavior & Experience
  3. Return Expectation
    • What is the risk that needs to be taken to target the required returns needed to reach your goal?


Vantage Point 1: Why?

Irrespective of the asset allocation plan you choose, there will be several intermittent phases, where your ability to stick to your plan will be severely tested.

There will be the inevitable bear market phases where you will want to sell out of equities and those bubble market phases where you will want to add far higher equity allocation. There will also be the constant temptation to sell out of your chosen strategies at the first signs of underperformance. You might jump on to the recent performing funds only to painfully realize after 3-5 years that these funds too have started underperforming.

Welcome to the harsh world of mean reversion and cyclicality.

So the simple question for us is:

How do we make this inevitable intermittent struggle worthwhile?

Before we try and answer that, check out this inspiring video clip of the Colombian weightlifter Oscar Figueroa.

This video while no doubt is super motivating, here is a weird perspective.

Let us assume you were an alien who landed on earth and you get to see this. You immediately wonder, why in the world is this person trying so hard to lift that piece of weight only to put it down immediately.

Is there any utility derived out of it? Don’t these guys have a machine to do this simple task?

Why would someone spend so many years struggling to get this right?

While the alien has a point, this also opens to us an interesting perspective.

Maybe if we understand how Oscar Figueroa was able to stick to his plan despite all the intermittent struggles and failures, we can probably try and apply it to investing as well!

While to be honest, I have no access to Figueroa directly, here is what I think might be happening.

Human motivation is not always about utility or money. It is sometimes about the story we tell ourselves – the meaning and purpose we attach to the struggle towards the goal.

The ‘MEANING’ or the ‘WHY’, Oscar Figueroa attached to weightlifting and winning Olympics, makes the entire pursuit and struggle worthwhile for him. If we don’t share the same meaning or purpose as Figueroa, there is no way you and I will be able to go through such a long struggle. The WHY is a very personal thing.

In other words once you have a strong WHY in place, it is a lot easier to endure short term pain and struggles.

You can see many such similar stories play out…

For example, India’s Arunima Sinha, became the world’s first female amputee to climb Mount Everest in 2013. Imagine the struggles that she would have had to go through…

Climbing Everest: Mountaineers Arunima Sinha and Raha Moharrak discuss  physical and social challenges they overcame

Now you have a drift of where we are going.

Coming back to our world of investing, what if we attach a WHY to our investment plans?

This is the genesis of what is called GOAL BASED INVESTING.

The idea is simple – you decide your financial goals first (the WHY) and attach a plan to it. The goals can be anything from financial freedom, your own venture, awesome home, kids college cost etc

To be honest with you, I was never a big fan of attaching a goal or end outcome to my investments. My logic was a 40% fall will remain a 40% fall irrespective of whether I am saving it up for my retirement or simply saving. To me, the returns were the only end outcome that mattered.

However recently just to experiment, I began to associate my financial freedom goal with my investments.

Truth be told, it has completely changed the way I look at my portfolio.

There is suddenly a subtle shift of focus from returns to whether I can try and increase my savings for this goal. I end up doing a lot of permutation and combination on what else can be done to supplement the savings and become financially free a lot earlier.

This reminds me of how Indian parents force their kids to buy a house and all of a sudden, given the new pressure of EMI, there is a lot more discipline and focus on saving and finishing off the loan. I have seen a lot of my friends completely change their lifestyle, career choices and become a lot more disciplined once they take a home loan. While I never understood what was going on, now I kind of get it.

Late Realization – Our ancestors are probably the most underrated behavioral scientists!

Apart from helping me save more, attaching a ‘why’ has also helped me during the recent fall. The focus on the end goal and the consistent reminder of the long time frame I still have, is a useful distraction from the otherwise painful daily declines and scary headlines in the middle of a bear market.

Mentally bucketing into different goals also helps prioritize where to invest the new money especially when receiving one time amounts such as salary bonus etc.

So while I was not a believer of Goal based investing, personally after having tried a quasi-version of it, I think it definitely makes a lot of sense.


Summing it up

That leaves us with a simple takeaway:

Before you build any investment plan, Always start with the question: WHY ARE YOU INVESTING?

In other words,

Decide on your goals first and then attach a plan to it.

This post has gone slightly longer than I expected.

So as of now, decide on three to four of your most important money goals and in the next week we will explore the other determinants of your plan – Risk and Returns.

Meanwhile, make sure you subscribe to the blog so that you don’t miss out on the future posts and you get to read them directly in your mail.

Till then, happy investing as always 🙂

If you have any feedback you can also mail me at rarun86@gmail.com.

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Disclaimer: All blog posts are my personal views and do not reflect the views of my organization. I do not provide any investment advisory service via this blog. No content on this blog should be construed to be investment advice. You should consult a qualified financial advisor prior to making any actual investment or trading decisions. All information is a point of view, and is for educational and informational use only. The author accepts no liability for any interpretation of articles or comments on this blog being used for actual investments.

3 thoughts on “How to Build Your Investment Plan from Scratch?

  1. Hi Arun
    Great article. I also always thought that goal based investing is not much meaningful. You gave new insights.

    For financial freedom, how much amount do you think one should have, considering our Indian lifestyle and expenses, before one thinks of leaving his job? Can you give a number.

    Like

    1. Thanks and glad you found it useful. In my view, roughly 25-30 times of annual expense should be a good range for financial freedom.

      Like

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