A Five-Step Process for Building and Maintaining Wealth

We at AAII have been thinking about the steps investors should take if they want to build and maintain wealth. Our discussions have been part of a broader project to help you build a personalized investing plan. While the project is too new to have an official name, we’ve started referring to it by its code name, “The AAII Way.”

At the heart of the process are the five key steps shown in the chart to the right. They are dependent, meaning one step must be done before moving onto the next, and a change at the top or bottom can lead to a comprehensive review. Picking an allocation strategy without knowing what you’re investing for can leave you holding a portfolio unsuited to achieve your goals. Similarly, it doesn’t make sense to select specific investments without first identifying what your investing preferences are.

Complete each step and you will have an investing plan to guide you through varying market conditions and significant changes over the course of your life. We’ll be going into more detail about each one in the weeks and months ahead, but to start off with, here is brief overview of each step.

Define Goals and Cash Flow Needs: Why are you investing? When will you need the cash? How much will you need to withdraw? Answering these three questions will guide all of your other wealth-management decisions. The answers determine your investing timeline and your tolerance for risk. The first question identifies your goals. The second question defines the length of time you plan to invest. The third question defines the amount of cash you will need to pull out of your portfolio.

Pick an Appropriate Allocation: Whereas defining goals and cash flow needs clarifies why you are investing, asset allocation is the framework for how you are going to achieve them. The asset classes you choose to invest in—and the proportionate amount of savings allocated to them—will significantly determine whether your goals are reached, and your needs are fulfilled. Asset allocation also governs all of your other investing decisions. It enables you to narrow your focus, identify when to make portfolio adjustments and to create a portfolio that’s tailored to your financial and psychological tolerances for risk.

Identify Investing Preferences: How involved do you want to be in the process of managing your portfolio? How much complexity are you willing to tolerate? Is minimizing costs and taxes key or are you willing to incur some higher (but not excessive) costs to pursue a more active strategy and/or have a professional make the investment decisions/provide guidance? Give those questions serious thought as the answers will vary by person. Some individual investors enjoy rolling up their sleeves and analyzing individual securities. Some find comfort in working with a financial planner or adviser. Others sleep well at night knowing their entire portfolio is invested in traditional index funds. It’s possible to be a blend of all three. Your personality, interest, time and comfort level determine what makes sense for you.

Select Investments: Your asset allocation strategy and investing preferences guide the decisions made here. Asset allocation determines whether you should be looking at equity, fixed-income or cash investment vehicles. (Since most of you reading this already have a portfolio, the decision about what to look at depends on the changes you will need to make to your portfolio to bring it in line with your investing plan.) Your investing preferences will determine the types of investments you are seeking out, whether they are individual funds, mutual funds, exchange-traded funds (ETFs) or a combination of all three. You may even instruct your adviser or planner to assist you if your preferences call for working with one.

Monitor: The final step is reviewing your portfolio and your investing plan for changes. The portfolio review involves monitoring your investments to ensure they are not violating your sell rules. (If one or more investment violates a sell rule, go back to the previous step and find a replacement.) Periodically check your allocation to ensure it hasn’t gone too far astray form your targets. If retired, ensure your required minimum distributions (RMDs) have been taken (RMDs are suspended for 2020) and that your portfolio is still on track to provide income for the remainder of your life. Finally, take note of any life or family changes. Retirement, marriage, the birth of a new child or grandchild or a significant change in health warrant revisiting your goals and cash flow needs to see if they are still valid. If a change needs to be made, go back to the first step and revise your investing plan accordingly.

Does this process work for you? Is there something you would suggest we change? Tell us in the comments section below.

In the weeks to come, we are going to expand on The AAII Way. There are many decisions underlying the framework shown here, and we’ll be unveiling simple worksheets to help you make them. Along the way, we’ll continue to ask for feedback to ensure that what we’re creating is something you and your fellow AAII members find useful.