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Investing in the stock market is a great way for the average investor to passively build their wealth. At the end of 2021, Fidelity, one of the largest managers of workplace plans, reported that the number of 401k millionaires jumped 32 percent that year. During this same time, the number of IRA millionaires increased 30 percent as well.
However, to the average person, knowing how to make money with the stock market can seem like a mystery. Which assets should be purchased and what investment strategies work the best? Furthermore, how do you put it all together into a single plan that actually produces tangible results?
An investor's primary focus should be to create a stock market investment plan that strikes a balance between their financial goals and needs. It should also include other important factors such as diversification, risk tolerance, and tax mitigation.
In this post, we'll walk through each of these considerations and the impact they can have on the overall plan. We'll also provide some actionable steps that a person can use to start putting their stock market investment plan to work today.
How To Create A Stock Market Investment Plan
There's no one-size-fits-all investment strategy. Since every person needs money for different reasons, their investment plan must be tailored in a way that will produce the results they're looking for while following methods that they’re comfortable using.
Here are nine important factors that every investor should consider while creating their personalized stock market investment plan. Note that they all overlap one another in some way, and so a change to one can mean changes to several others.
1. What Are Your Goals?
Goals are the reason we do the things we do. Most people probably wouldn't work if they didn't have the goal to get paid or exercise if they didn't have the goals to be healthy and look better.
In terms of investing, there can be many reasons why a person wants to grow their net worth:
- To retire by a certain age
- To get out of debt or build up an emergency fund
- To afford college for their children
- To have the capital to start a business
- To leave behind a financial legacy
Notice I say goals (i.e., plural) because it’s perfectly okay for someone to have multiple, parallel goals. For instance, many families balance the goals of saving for retirement alongside building up their children’s college fund.
What's important is that these goals are determined upfront. Once they're known, they can set the direction for the next steps.
2. How Much Do You Have To Save?
Investment planning would be easy if everyone earned and spent the same amount of money. Unfortunately, that's in no way the case.
A person's budget will play a huge role in the success of their investment plan. Logically, someone who has $1,000 per month available to save will most likely reach their financial goals sooner than someone who only has $100 per month available to save. (Of course, this will also be impacted by the way their money is invested among other variables.)
A good exercise for every investor is to take a hard look at their budget and truly understand how much can be saved. At the same, they should also look for places where “fat” can be cut out of their budget if needed.
3. How Do You Feel About Risk?
Like it or not, there is always some degree of risk involved with investing. However, not every stock market investment needs to be a shot at the moon.
There are plenty of financial products that are designed to mitigate risk. However, there is also a limitation as to how much these financial products can grow versus single stocks.
Investors with big goals need to be aware of this relationship and choose their securities appropriately. Producing the desired outcome is crucial, but not at the possibility or fear of losing a significant amount of money.
4. What Assets Will You Invest In?
Speaking of stock market investments, there are several types that a person can purchase:
- Common stocks – Regular shares of various companies. Money is made when the investor sells those shares for more than what they paid for them (called a capital gain).
- Dividend stocks – Shares of companies that also pay dividends. Dividends are typically quarterly distributions that come from the company's profits. Just like common stock, the shares themselves can also be sold for a profit if the stock goes up in value.
- Mutual funds – Bundles of stocks and other assets (bonds, real estate, options, etc.) that are pooled together. Earnings are made either when the mutual fund share goes up in value or distributes capital gains and dividends to the shareholders.
- ETFs (exchange-traded funds) – Similar in design to mutual funds, but traded like equities.
There are of course many others. However, the majority of investors would do well to stick to one or more of these types of core investment products.
5. How Will You Diversify?
One of the best-known ways to reduce the risk of any portfolio is to achieve diversification. This is when an investor holds several different types of stocks or financial products from various market sectors. The idea is that while some securities may lose money, others will make a profit, and this will lead to a more stable net return.
Some financial experts recommend that a portfolio should have a minimum of 20 to 30 individual stocks to be truly diversified. Investors who opt for mutual funds and ETFs will automatically achieve diversification through the nature of the asset. However, this can be taken a step even further.
Stocks, mutual funds, and ETFs often will target specific types of companies (large to small cap) or industries. Investors who want to be well-diversified will often divide their portfolios among these various types. This is a common practice called asset allocation.
6. What's Your Experience Level?
Picking out stocks can be fun. But knowing how to combine them together and what role they'll play within the portfolio can be quite a bit trickier. Investors need to be honest with themselves and the extent of their ability to choose the right securities.
For beginners, this is another area where mutual funds and ETFs can shine. Investors can buy a handful of these products and be well-diversified without knowing intimate knowledge of the assets they hold.
For people who are truly new to investing, an even easier approach is just to buy a stock market index fund (such as one that tracks the S&P 500). By holding shares of an index fund, the owner essentially is buying stock from all 500 of the top companies in the U.S. Not only is this an incredibly simplistic strategy, but there is also a mountain of data to suggest that index funds do better than most active funds over the long term.
7. What's The Timing Of Your Goals?
The timing associated with an investor's goals can make a huge impact on how they assemble their investment plan.
- Someone who wishes to buy a house in the next 2 to 3 years won’t want to take on too much risk because they’ll need their capital back. This person might choose conservative mutual funds or ETFs with modest returns to help ensure they retain their principal.
- By contrast, someone else who is saving for retirement will have 20 to 30 years to ride out the stock market cycles. Therefore, they'd be okay to invest in high return, high-risk products or even carefully selected individual stocks.
Additionally, an investor will also have to consider how their budget will influence their goals. Someone with shorter-term goals and a low-risk tolerance would need to be willing to contribute more than someone with long-term goals and higher risk tolerance.
8. What Taxes Will Be Owed?
Any time an investor makes money with the stock market, the IRS will be waiting with their hand out to collect what's owed to them. However, a good investment plan will plan for this and use the IRS's rules to reduce their tax bill as much as possible.
One easy way to do this is to hold assets for longer than one year. Any earnings would be what's called long-term capital gains and be taxed according to a more favorable rate. By contrast, the earnings from assets held for less than one year are called short-term capital gains and taxed less favorably as ordinary income.
A fool-proof strategy to avoid taxes for decades is to use retirement plans such as a 401k or IRA. With these plans, all contributions and earnings are tax-deferred until the owner retires one day and starts making withdrawals (after age 59-1/2). Investors can also use Roth-style accounts where contributions are taxed, but earnings will grow tax-free as long as they're also not withdrawn until age 59-1/2.
9. What Are The Investment Fees?
Like taxes, fees can quickly erode the returns produced by your investment plan. That's why care should be used to pick brokerages and funds that will minimize fees as much as possible.
For stocks and ETFs, the industry used to charge a commission of around $10 per trade per security. However, it’s easy to find reputable brokers like Robinhood or M1 Finance that have eliminated these commissions. However, with ETFs, investors still need to be mindful of the expense ratio.
Mutual funds also carry expense ratios and they can tend to be somewhat higher than ETFs. However, investors who stick with mainstream financial companies like Vanguard or Fidelity can find some of the lowest-cost mutual fund offerings available.
Example Stock Market Investment Plan
With so many moving parts and dynamics, coming up with a stock market investment plan can feel very complicated, especially for beginners. However, investors who take a systematic approach both from a qualitative as well as a quantitative perspective can do very well.
Let's put this all together with an example about retirement planning.
Let's say you've got a goal to retire with $1 million. You'd like to retire by age 55 and you're 25 years old now. That means we've got 30 years to work towards accomplishing this.
What Will I Use To Get There?
Perhaps you're a beginner or even an intermediate investor already. You're comfortable with risk, but there's also no reason to go over the top speculating on individual stocks. Therefore, a mixture of low-cost mutual funds or ETFs that invest in mid to large-cap companies should do the trick.
Since this money will be for retirement, you'll use your 401k or IRA. This will allow you to save money on taxes with every contribution.
How Much Should I Save?
To figure out how much you should be saving every month, you'll want to use a compound interest calculator. Here's a good, free one from the SEC.
Knowing in advance that large-cap style funds tend to yield an average of 10 percent per year, we can then subtract an average interest rate of 3 percent for a 7 percent net return. Putting this into the calculator gives a monthly savings target of $820.
Does This Match Your Budget?
With this calculation, do you believe you will be able to realistically save this much money every month? If not, then perhaps you'll have to readjust the model and take a different approach (such as working for 35 years instead of 30 years).
On the other hand, if you're more than able to manage this, then you've got lots of room for improvement. Perhaps you could:
- Save even more aggressively and reach your target sooner
- Choose less risky investments
- Use the excess cash to fund a different financial goal
This is the beauty of coming up with an investment plan. Once it's laid out, you can optimize the variables until it achieves exactly what you want them to do.
Getting Started With Your Stock Market Investment Plan
There's a lot that a person can do to prepare a good investment plan. In addition to balancing each of the variables we mentioned above, there are several other qualitative factors to consider. Here are some of the most important ones to keep in mind.
There's a crucial difference between being an investor and a trader. A trader’s goal is to produce as many short-term profits as possible by capitalizing on market fluctuations and temporary price changes. There are certainly many money-making opportunities involved with trading, but the majority of them amount to little more than speculation and open the investor to a whole lot of unnecessary risk.
By contrast, an investor designs their plan with a long-term mindset. This is the preferred way we encourage you to invest because it:
- Builds true, sustainable wealth
- Is much more passive than short-term investing
- Is far less risky than short-term investing
Long-term investors have the luxury of ignoring short-term market fluctuations. They know that the market as a whole goes up over time, and so they invest in ways that align with this trend.
Make SMART Goals
Having a vision of what you want your financial goals is the first step to creating a financial plan. However, when a goal is too lofty or vague, it can seem more like a wish than something which can actually be achieved.
This is why investors should opt for SMART goals instead. SMART stands for:
For instance, rather than saying “I want to retire someday”, a SMART goal would be “I will retire by age 55 by saving $820 per month over the next 30 years”. Notice how the latter seems more defined and tangible than the first?
When an investor uses a SMART goal, it forces them to figure out all of the details. That may be more work, but it also makes the target more attainable.
It’s amazing how far just a little bit of financial education can take a person. Even if you’re a beginner, something as simple as reading a blog about how to invest in stocks will make you that much more prepared.
Of course, you don’t have to raise the level of becoming a certified financial planner. The focus should be on learning as many of the fundamentals about making an investment plan as possible. Spend some time during your commute or workout listening to Podcasts or YouTube videos that provide trustworthy financial advice.
Determine Your Tolerance For Risk
We know that if we want a chance of a higher reward, we have to be willing to accept higher risk. But reward potential shouldn’t be the primary focus.
A smart investor starts with setting their risk level and then looking for the best investment options from there. Every investor needs to be completely honest with themselves about how they feel about certain financial products. There’s no benefit to holding investments that are making you lose sleep at night.
The problem with holding assets beyond your risk tolerance is that you’ll be more likely to sell them if something goes wrong. Millions of people do this all the time when the stock market crashes and they sell in a panic. For that reason, it's better to stay in your lane with investment choices that will help you to stick to your plan.
Start As Early As Possible
No one makes money sitting on the sidelines. For an investment plan to start generating some earnings, decisions have to be made and put into action as quickly as possible.
The problem with waiting too long is the loss of compound returns. Because investments grow by compounding, every year that’s missed could result in hundreds of thousands or even millions of dollars later on down the line. This is why it's so crucial to create a plan and get it on its feet sooner rather than later.
Seek Out Help
No one ever said you had to make your investment plan all alone. And trust me – no matter how educated you become as an investor, there’s always something new you can learn from the right teacher.
This is why Minority Mindset created Market Insiders. Market Insiders is a live weekly coaching program where members can speak to real industry experts. This allows them to pick the coaches' brains for the best tips and insight as well as learn the strategies you need to be a confident investor.
Are You Ready To Make Your Stock Market Investment Plan?
Investing in the stock market is a great passive way to build long-term, sustainable wealth. However, there's more to it than just picking the right securities. Creating a solid investment plan should strike a balance among all of the variables that goes into it
Because there's no one-size-fits-all investment strategy, every plan should be tailored to the individual. This will include a variety of factors such as their budget, investment preferences, and strategy. It will also include being mindful of such expenses that can detract from your plan like taxes and fees.
To create your stock market investment plan, the best approach is to think long-term and in terms of SMART goals. Becoming educated and really understanding your risk tolerance is also important. It's also one-hundred percent acceptable to reach out for help and seek guidance from experts that can show you what to do.
Perhaps the most important step you can take is to just create a plan and get started. Your investment plan doesn't have to be perfect because it can always be further optimized as you gain more experience. The sooner you put one into action, the closer it will bring you to your financial goals.