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AAII InvestoGraphic Investing Basics PRISM Wealth-Building Process

A Process for Creating Your Own Investing Plan

Our goal is to give you a framework to think through the various aspects of investing—from your goals to monitoring and reviewing your portfolio and investment profile. Introducing AAII’s new project.

by Charles Rotblut | June 2020

Charles Rotblut leads a class in AAII's new Essential Investing Video Course. Go to https://www.aaii.com/ves for more information and to subscribe.


AAII founder James Cloonan had two simple rules for achieving investment success. Rule #1 was “develop a consistent, well-defined approach to investing.” Rule #2 was “stick to rule #1.”

Telling you to follow a rules-based approach is one thing. Equipping you with the tools to do so is another. We at AAII are embarking on a project to do the latter. We’re going to help you and your fellow AAII members create a comprehensive plan that can be your investing guide. The project is code-named “The AAII Way.” It’s such a new project, we’re still settling on the official name.

There’s a reason why we’re introducing the project while it’s still in its early stages: We want your feedback. Our goal is to give you a framework to think through the various aspects of investing—from your goals to monitoring and reviewing your portfolio and investment profile. As we unveil worksheets in our weekly Investor Update email, in the AAII Journal and at www.aaii.com/AAIIWay, we’re going to ask you and your fellow AAII members to try them out. We want to know if you find them helpful and what feedback you have. Depending on what we hear back, we may even revise and release them for additional feedback.

AAII’s Proposed Five-Step Process

The chart to the right shows the five key steps of The AAII Way. 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.

With this in mind, here are the primary steps that should guide your investing plan.

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 new 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 from 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.

Give Us Feedback

Does this process work for you? Is there something you would suggest we change? Email us at journal@aaii.com or post your thoughts at www.aaii.com/AAIIWay.

In the weeks to come, we are going to expand on what we’ve code-named 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.

Discussion

Dan L. Smith from VA posted over 6 years ago:

I agree with the philosophy. After looking at various methods - bucket, percentages, etc., I think I like the Level 3 philosophy best. Not necessarily the allocations suggested, but the general "bucket" type philosophy. Keep 3-5 years of spending in safe investments, and the rest should generally be in the Market.


Stephen Bowles from Missouri posted over 6 years ago:

The level 3 approach is what I like and use. Of course the safe investments are defined and are working. The portion that is invested in the market is what I hope The AAII Way will help define with respect to my Investing Timeline and Tolerance for Risk.


CHARLES R from IL posted over 6 years ago:

Thanks for the feedback. Stephen, discussing allocations and strategies for deciding which investments should be in your portfolio are both in our AAII Way outline. -Charles


JOHN L from NJ posted over 6 years ago:

Step 1 and step 2 should be iterative (add an arrow from step 2 to to step 1). It is good to start with goals but there is a trade off between how much can be realistically saved and invested and how much volatility can be tolerated in order to get the returns necessary to meet retirement funding needs. If you can save 40% of your salary and have 35 years to retirement you don't need stocks. Money market and bonds might be enough. But if you can only save 12% and have 35 years you need a large allocation to stocks to have a reasonable chance of success.


DAVE G from WA posted over 6 years ago:

It's important to know the "tax character" of the assets that are creating your cash flow in retirement in order to understand how much you will need to withdraw to cover both your living expenses and taxes. In other words, deferring taxes while you are working has to be done with the knowledge that taxes may be a significant portion of your budget later on in retirement. Paying taxes on working income on the front end can often mean less for savings and after-tax income later in retirement. Tax rates are part of the unknown that needs to be monitored just like investments chosen and there returns.


EDWIN K from VA posted over 6 years ago:

Tell me about it I'm 15 years into retirement and paying more taxes than ever before. The Roth is a great IRA wish I had used it instead of the Regular.


Anthony T from NC posted over 6 years ago:

Have neen investing 40+ years and retired for 15 Haven't a for mal investing plan but do some of the basis: budget, L3 cash bucket, etc but have evolved in time of crisis to a day trader - too anxious about destroying years of capital build. Understand the process and need help with the decision rule alternatives in the process steps, so that I understand the range of alternatives and the choices available to effectively implement the steps Thanks -


F F from OH posted over 6 years ago:

This would have been a good place to also discuss the role of technical analysis in creating and maintaining an investment portfolio. I learned long ago that by just minimizing the impact of major drawdowns in history (e.g. major bears), one can substantially improve one's long term returns, with minimal risk. TA is a unique technique, properly used, for accomplishing that. It's also very useful for determine when to invest, as opposed to what. This is differfent from common market timing, often discussed and derided. Unfortunately, AAII does not seem to be inclined to include that concept and approach.


J M from NJ posted over 6 years ago:

A critical step in "The AAII Way" process appears to be missing. After identifying goals and cash flow needs but before considering asset allocation, one needs to determine how much savings they need to accumulate to achieve their goals and satisfy their cash flow needs. For example, at what age will a person retire, how long might they live in retirement, how much needs to be saved in order to fund retirement cash flow needs for how many years? How much needs to be saved each year and what rate of return on savings is needed to meet ones goals?


DANIEL B from MN posted over 6 years ago:

I typically use a blend of level 3 investing along with Shadow stocks. I don't have any particular problem with this method, but my wife is a little less enthusiastic. She cringes at the volatile swings in the all stock & ETF portfolio. So while I can stomach the sometimes wild ride, she literally will stop looking at the portfolio during "interesting times" That works for her but the point it brings up is your spouse or other interested parties must also be on board with your particular investing strategy. In real life many people have somebody else that has to either stay out of the portfolio altogether or understand the investing philosophy and the expected ups and downs in the market and how it will affect the portfolio. In light of that I think one of the steps should be "Buy in by spouse or other interested parties" if they exist. My wife is pretty good about it overall, but when the market is crashing and I am buying bargian stocks, I do have a little "splainin" to do. Both have to be able to live with the investing philosophy or at least trust the other to do it or its not going to weather a downdraft. I really like the Mike Tyson quote: "Everybody has a plan until they get punched in the mouth.


JUAN M from VA posted over 6 years ago:

I have been investing since 1985 and now retired for 9 years. I have been a member of AAII for some 30+ years and I credit them with providing the knowledge to have been able to retire early at 60 and essentially live off my investments. I will be taking SS at 70 this coming year which will provide some fixed income together with my wife's SS which she has been receiving for 2 years. I have updated my Investment plan following your article in June 2020 and the purpose of my comments is to highlight that it is worthwhile to review and to update one's plans periodically. I normally do it once a year but had not followed up for past 2 years, (skipped one year). This corona crisis and the impact on economy/ finances is quite a challenge. No change in plans except for monitoring and insuring that I am maximizing return without too much risk and optimizing tax payments. RMD to 72 is good. Great work on the AAII Way.


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