The Importance of an Investment Plan

When an entrepreneur starts a business, one of the first and most important steps is to create a business plan.   This plan is a statement of the business goals, the reasons these goals are attainable, and the method for reaching those goals.  Once the business plan is created, it then acts as a compass to guide key business decisions. If the business ever changes directions, then a new business plan should be created to document the reasons for the change – this way the business can never get too far off track without acknowledging that a change was consciously and strategically made.

I believe the same method should be used when setting up your investment portfolio.  After all, if you are serious about investing for your financial future, you should treat it as a business.  Whether you’re seeking income or capital gains, whether you’re an index fund investor or a dividend growth investor, and whether you have $500 or $5,000,000 – the importance of defining your plan remains the same.  Otherwise, you end up getting off track and you find that your investment portfolio is inconsistent with your life goals (which, I would suspect, is why you’re trying to invest your money for the future).

I’ll share my official BNL investment plan below.  Regardless of age, income, and savings, I encourage everyone to document their own investment plan with a similar level of detail for their own situation and set of goals.

Investment Goals

My short-term investment goal is to create a reliable and stable income-paying portfolio that will pay 100% of my family’s living expenses through dividend payments.  The entire purpose of my investments is so I can comfortably retire in about a year.  Long-term, I’d like the majority of that money coming from treasury bonds and “dividend growth stocks”  that may yield a lower dividend now, but will consistently raise dividends at a pace above the rate of inflation.  To supplement those lower yields (mostly 2.5%-3.5%), I’ll invest in higher-risk, higher-yielding investments that pay around 8%-15%.  Those higher yielding investments may include stocks such as REIT’s, private equity investments, hard-money lending, and P2P lending, but they won’t be limited to this list.

Since my highest priority is to have a reliable and consistent income for my family, I’ll have a fixed portfolio allocation that helps keep the overall portfolio net value as stable as possible throughout different economic climates.

A lower priority goal is to keep ~10% of my portfolio in alternative forms of income (e.g. P2P, private equity, etc) so that I can continue to experiment and learn about these types of investments.  There are two reasons for this:  First, it’s fun. I’ve always enjoyed learning about uncommon investments, and I simply can’t learn as much researching them unless I’m serious about putting money into them. Second, most of these alternative forms of income investing generally have higher yields.  This helps increase my average yield across my portfolio.

Investment Strategy

In order to provide stability in my portfolio, while also staying consistent with my Investment Goals listed above, I plan to use a 60/30/10 portfolio allocation.

  • 60% dividend growth stocks
  • 30% 20-year Treasury Bonds
  • 10% high-yielding alternative investments

The 60/30 mix of stocks and bonds serves 2 purposes.  First, it provides somewhere around a 3-3.5% initial average yield for my portfolio, which is close to what I need in order to meet my family’s annual expenses.  Second, it reduces the volatility of the portfolio as a whole. Generally, when the stocks rise, bonds drop.  When stocks fall, bonds rise.  It’s more complicated than that, but you can see a clear trend in these charts:

Short Term (1-yr)

Long Term (5-yr)

Since my goal requires that my annual dividends equal my annual expenses, I’m estimating that I will need to start my retirement with a 70/20/10 split in stocks and bonds, and I can slowly move to 60/30/10 as my dividend stocks increase their payout. My goal is to be 60/30/10 within 5 years.

60% Stock Mix

I firmly believe that investing in individual stocks is only for those people that are willing to do the work.  I recognize the concept of the “efficient market hypothesis,”, and I don’t completely disagree.  On the other hand, I also believe that it’s possible to find undervalued stocks that are managed well and have shown consistent historical growth.  Combining this with good evidence of strong historical dividend growth, I’ve set up these basic guidelines for my stock selection:

1. Increased annual dividends for at least 10 years.  For this list, I will use David Fish’s list of Dividend Champions.

2. Payout ratio should be reasonable for the industry, and no payout ratio should ever be over 100%.  It’s important to segment by industry since some industries commonly have a high payout ratio by nature, where as in other industries a high payout ratio could be a red flag that the company is raising dividends just to stay on the list of dividend growth stocks, rather than based on increasing profits.

3. Dividend growth should target 10% in 10 years.  This means that the yield on initial investment should rise at a rate such that historical dividend growth along with good fundamentals and rising profits would indicate it’s likely that the stock should be paying 10% on initial yield within 10 years.

4. The initial yield must meet my personal expense needs.  For example, let’s say I need an average of 3.5% yield to meet my income needs.  But if I have 30% of my portfolio in bonds returning 3%, and 10% of my portfolio in higher yielding investments that yield and average of 10%, then my stock picks require me to be at a minimum yield of 2.7%.  So if I find a company that looks great but only yields 2% currently, I would not purchase it unless I can also find a stock that I find to be a good value that can average back up to 2.7%.  I realize this may be counter-productive at times, but there’s a mental benefit to retiring with 100% of expenses being paid by dividends, so that no shares ever have to be sold to pay the bills.

These are baseline requirements.  Once these requirements are met, I’ll do a full stock valuation based on P/E ratio, EPS, EPS growth, and some other factors specific for the industry.  How I do that valuation goes beyond the scope of this investment plan, and I’m also constantly tweaking my valuation method based on my continued studying of this area.

30% Bond Mix

For bonds, I’ll just invest in ETF’s that represent the 20-year US Treasury Bond.

10% High Yield Investment Mix

The primary purpose of this portion of my portfolio is to increase the average overall yield.  For example, if the other 90% of my portfolio (in stocks and bonds) yields 3% on average, but I’m able to get 12% out of my high-yielding income investments, that takes my average up to 3.9%.  Even if I only yield 10%, that’s still takes my average up to 3.7% yield.

The secondary goal of this portion of my portfolio is to keep active in learning about new investment opportunities.  I’ve had a lot of fun learning about P2P lending, private mortgage lending, real estate investing, and other opportunities.  There are still many more methods I want to learn about when I have more time in retirement (for example, I’ve recently been learning more about high-yielding energy trusts that have piqued my interest).

Other Considerations

There are other variables to consider for my 5-10 year investment plan that will represent my first 5-10 years in retirement.  Although I can’t predict the future, I should at least consider some of the more likely possibilities:

Other Income

Currently, I make somewhere around $3000/year online (the vast majority is not this blog).  Not exactly get-rich money, but I expect this income could very well go up after I quit my day job. I have a lot of projects I’ve considered in the past, but haven’t had the time to work on.  In retirement, I expect my free time to increase dramatically.  I also expect my energy levels to increase so that I’m more likely to go pursue these projects.  If that happens and I see a reduction in the amount of money I need from my investment portfolio, I have three options (in order of priority):

1. Spend more – Yep, you heard that right.  At first, I’ll likely take the majority of any additional income I don’t need and start paying off my mortgage faster.  This is a guaranteed 3.2% return, since that’s the interest rate I pay.  I’d also like to let my hair down a little, so we’ll also consider other luxury purchases in the future. Some ideas we’ve talked about are extended vacations, a pop-up trailer, and a new bike – I’m sure my wife has a longer list.   :)

2. Save more – Ideally, I’d like to get to the point that I’m saving about 20% of my investment income into more investments.  This will keep my investments growing at a faster pace than inflation, and increase my margin of safety.  If all goes well, I can eventually retire from my active portfolio management if I choose to do so.  Actually, I doubt I’ll ever do that…

3. Make less – Since I’d like to minimize any income taxes I’m forced to pay, I’ll probably never try to make more than 20% of my expenses in a given year.  To do this, I’ll move away from dividend stocks to balance my taxable income with my expenses, and instead direct more of my portfolio allotment into non-dividend paying stocks that are valued well.

Dividend Drops

If the first few years of my retirement face a large downturn in the economy, forcing stocks to drop and reduce dividend payouts, I could see a shortfall in my income compared to expenses. Hopefully this won’t happen since any dividend stock I buy will have made it through the 2008 financial chaos without dropping dividends, and most will have also made it through the 2000/2001 economy as well.  Since this scenario would be during an economic downturn, it also means it’s the most important time to hold stocks and even invest in new ones if I can, since they are most likely riding a general market downturn rather than actually faltering as a company.  For that reason, I never want to cash out of a stock to pay the bills.   If this were to happen, my plan is to make enough money to cover the shortfall, either by getting a short-term job, doing some freelance work (online or off), or amping up my current online profits just enough to cover my shortfall.

One Final Note

The most astute readers will notice that my current investments are not consistent with my investment plan.  This is true, and actually it’s worse than it looks since this site only lists my income paying investments.  I actually own several other stocks that aren’t shown there, since they don’t pay dividends.  I’ve been slowly making moves to reconcile this difference between my portfolio and my investment plan, but I’m also sitting on some 10-year old stocks with a lot of capital gains.  I’ll continue to move to the 60/30/10 allocation over the next 1-2 years while attempting to minimize my taxes by balancing capital gains with capital losses.  Luckily, Europe is making this a lot easier these days.

22 Responses to The Importance of an Investment Plan

  1. Patrick says:

    Have you thought about the currently low interest rates and their effect on bond prices? Obviously, if someone were using a 4% SWR calculation, and they were going to draw down principal, this would make a big deal, as eventual rising interest rates would cut down the valuation. But, if you’re really only using the coupons, which wouldn’t change, would it matter? And at the end, even if the valuation is lower, you’d have enough capital to buy new bonds with higher yields, but resulting in the same coupon payments, right?

    hmmm…I’d never thought of bonds this way. I’d always just stayed in the “bonds go down when interest rates go up” camp which led me away from them currently.

    • If you buy individual bonds, then you’re right that the value of the bonds technically goes down when interest rates rise. After all, who would buy a bond from you that pays 3%, when the US government is now issuing new ones at 5% for the same par value? They wouldn’t, unless you were willing to sell it to them at a discount. If you only need the rate that it’s paying, however, then you can hold it to maturation and the “value” of the note doesn’t matter – unless you view opportunity costs…

      Since I’m using ETF’s, it’s a little different. If rates rise, I’ll see my overall value go down, but my immediate rates that the ETF pays out will go up since it tracks the 20-year rate. With a fixed allocation portfolio, I’ll then need to sell some of my stock allocation in order to re-balance with my reduced bond allocation to get the 60/30/10 split again. At that point, I’ll be buying the bonds at a lower price. Of course, that’s the optimistic way to look at it…

      Understanding bonds, par values, coupon rates, and how they all work as they approach maturation is pretty interesting, and something that should be understood if you’re going to get into investing in individual bonds.

  2. Fiveoh says:

    I’m following a DGI strategy as well. Makes the most sense to me. Which stocks are you looking at adding to your portfolio currently?

    • Most of the stocks I want to own are in the link at the top of the page titled “My Dividends Holdings.” With exception of SYY and CVX, which I bought last week but forgot to add to the spreadsheet until you reminded me now. :)

      That table also has quite a few stocks I no longer want to own, I’m just waiting for the right time to sell them while reducing capital gains taxes.

  3. Poor Student says:

    My plan is to have the income from my portfolio pay 110% of my expenses in at most 15 years. This would leave the 10% to keep investing or take a fun trip or buy something nice.

    I am doing this with 100% dividend paying stocks or index ETF’s. I have a long time frame to live out these investments so I believe the time will justify my strategy which some would consider aggressive.

  4. BNL, this is a great post. I have yet to really spell things out this way, and this is a great reminder – if I don’t course correct, I’ll eventually end up being 90/10 – 90% stocks, 10% cash. When you are calculating your 60/30/10 split, I assume this is only for your investments. Have you considered figuring out your allocation when you add in cash/emergency fund?

    • I don’t actually have an emergency fund. Since my overall net worth is nearly 30 years of living expenses, and the vast majority is in liquid investments of stocks and bond ETF’s, I can get the cash quickly if an emergency were to come up.

      With that said, I still encourage anyone starting out with their savings to have an emergency fund of 6-12 months minimum.

  5. bdub says:

    I am curious about your absolute confidence that you can pick stocks that will serve you better than a low-cost mutual fund yet you are defaulting to an ETF for your bond portfolio. Shouldn’t your logic/confidence about stocks also parlay into your bond fund? Don’t you believe you can beat the bond market with hand-selected options?

    Note: I am one of those people who firmly believe an individual investor cannot beat the market and therefore your investment strategy should be based only on your timeframe, tax efficiencies, and investment expenses of selected funds.

    • If you believe in a purely efficient market such that the price of a stock at any instance perfectly reflects the intrinsic value of the company based on all previous, current, and future information (and it appears you do) then a low cost mutual fund, index fund, or ETF is the right choice.

      However, if you don’t agree with a truly efficient market (and my belief is it’s somewhat efficient, but not completely), then you would agree that there are are a range of stocks ranging from great->good->average->bad->terrible. Index funds do a great job of tracking the average.

      I’m not implying that I can pick and choose only “great” stocks, but I’m confident that with basic fundamental analysis you can avoid the “terrible” stocks and most of the “bad” stocks as well. By just doing this, you can move your personal average above the market average that the index funds track. As Warren Buffet says, the key to beating the market is not finding the winners, it’s avoiding the losers. Maybe I’m being arrogant that I can do this, but this seems like a pretty logical strategy.

      As for bonds, I think you can probably beat the market there too. However, I’ll freely admit that I don’t fully understand the valuation of bonds yet (it’s something on my list to learn), so it’s safer to just go for the average. The purpose of US treasury bonds in my portfolio is only to hedge against a major loss in the market, so average is good enough for me right now. Perhaps when I understand them better, I’ll see an opportunity to buy individual bonds, but I don’t have that understanding yet.

  6. Tyler says:

    What happened to the Brave New Portfolio?

    • I phased out of the Brave New Portfolio when I finally took the time to sit down and define my investment goals (as defined in the article). In short, I realized that my priority is to pay 100% of my expenses from dividends, and not have to worry about short term volatility of the market (since I won’t be selling shares and worrying about paper losses). With the BNP, I would have had to sell shares every so often to pay for my expenses, and that adds the stress of deciding which ones to sell, and constantly looking back at whether you should have sold something else instead.

      I still think the Brave New Portfolio is a good one, and if I could have paid 100% of my expenses from dividends with that portfolio allocation then I would have stuck with it. Unfortunately, gold and cash don’t pay out any income…

  7. John says:

    I love your Investment Portfolio Plan, though occasionally i like to take 5% of Total Portfolio, amoritize it, and with the monthly amount buy something extremely low on a dip, wait a week and sell high to net 10% profits about 1 a month, just for the thrill of the Short Market.

  8. Andrea Jones says:

    Amazing content to say the least. The most important financial-planning document you will prepare, besides your list of personal and family goals, is your investment plan. In finance terms. An investment plan is important because it creates a framework for every investment activity in which you will participate. It states what you will invest in, how you will invest, why you will invest, what percentage of your money you will invest, and so on. In short, your investment plan significantly affects your investment returns. Write this plan well and then follow it carefully.
    Andrea Jones

  9. Joe says:

    I really think you should work 2-3 years more. Let your div income be 120% of your expenses. Or stay with 100%, but have $100k just complete emergency. There are going to be bumps in the road. Maybe a kid needs an appendix out. What if rates go up? that TLO is going to get crushed, stocks could be down making rebalancing difficult. Also , why not invest in SDY? What you are trying to do picking stocks to yield at least 2.7% might be risky.

    • The thought of working in an office for 2-3 more years makes my skin crawl, so there’s slim chance of me doing that. Your idea to have a larger div stream or a huge emergency fund like that is prudent if you’re risk averse, but for me I’d rather quit now, take my chances, and work as I want to or need to down the road.

      Besides, a 100K emergency fund is way too big. I’ll still have insurance with a high deductible, and that deductible will be much less than $100K.

      As for SDY, I don’t like it because the dividends are all over the place. I want consistent payouts that rises slowly at a rate higher than inflation. The dividend growth stocks in my portfolio do this, SDY does not.

  10. KYD says:

    Lovely post. Essentially, Investment Planning involves identifying our financial goals throughout our life, and prioritizing them. For example, if you want to invest for funding your vacation next year, don’t choose an investment vehicle that has a three-year lock-in. Investment Planning is important because it helps you to derive the maximum benefit from your investments. Your success as an investor depends upon your ability to choose the right investment options. This, in turn, depends on your requirements, needs and goals. The choice of the best investment options for you will depend on your personal circumstances as well as general market conditions. Often, a good investment for a long-term retirement plan may not be a good investment for higher education expenses.

  11. Jennifer says:

    Investments should be a part of your financial future, but unfortunately doesn’t happen on their own. Investment planning involves figuring out how to do the most with what you’ve got. Any money you put into investments is money that you can’t spend today, so proper investment planning means striking a balance between what you want to do with your money today and how financially comfortable you want to be in the future. Undoubtedly your content is a well researched one..
    Jennifer Goldblum

  12. Before, I wonder why should I have to have an investment plan before putting anything to actual, but now, while reading your article, realizations pop up on my mind that I must really do it. I know it will be not easy, but effort will pay back after. I was really impressed by this article. Thanks a lot!

  13. […] Do you have an investment plan? […]

  14. Ruthe Bronson says:

    I was really impressed by this article, I beleive that investment strategy is really one of the important factor when you are planning for an investment. It is a systematic plan to allocate investable assets among investment choices such as bonds, certificates of deposit, commodities, real estate, stocks (shares). I did some research about some investment strategy and i came across This site that i think would help me to understand and know more about different strategies.

  15. Hi,

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    Investing in a property is a big decision which requires, time, patience and of course right guidance.

    The biggest thing that matters is that what type of property you are interested in exactly interested in.

    The best option would be to look for a good and reputed real estate company or an agent who can help you in getting the right property on your budget and the type of locality you are interested in.

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    Lyle L. Ketner

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