Important: This article is for general guidance purposes only and should not be considered investment advice. If you are unsure about the suitability of an investment, please seek out advice. When you invest, your capital is at risk. Tax treatment will depend on your individual circumstances and could potentially change in the future.
Creating a financial plan for the next five years can help you think with clarity about what you want for your future. It allows you to think about how you’re going meet your financial goals and potentially helps you make smarter investment decisions – like using a tax-efficient stocks & shares ISA.
Every investor is different, of course. Factors such as your appetite for risk and your ideal retirement age will inevitably change the details of your plan. By following these six steps, however, we hope you’ll be able to create something of a roadmap that sets you up for what you need.
1. Get a handle on your budget
To start, lay out your income and expenses to see what you really have available to invest. You may have a lump sum already, or you may want to deposit regular payments into an investment account monthly. Whatever the case, knowing how much you can invest will help with the rest of the steps.
As an extra bonus, by looking at your outgoings, you may spot expenses or subscriptions that you can cut to boost your monthly savings or investment pot.
2. Fine tune your goals
Next, list your short and long-term financial goals. This will not only help you to focus on what you want to achieve, but it will also help determine your investment portfolio (see step four).
If your goals are focused on building your overall wealth, for example, then that will result in a different type of portfolio than if you’re simply saving for a rainy day.
Long-term goals include things like being able to have a comfortable retirement, paying for your children to go to university or buying a holiday home. Shorter-term goals, on the other hand, could focus on big expenses over the next five years, such as a deposit for a house, a new car or that once-in-a-lifetime trip.
3. Consider your risk tolerance and time horizon
Typically, the shorter the time horizon (or closer to retirement), the less risky investors become.
To start investing in a way that’s right for you, you need to consider your goals, risk tolerance and time horizon.
Risk tolerance – as the name suggests – refers to how comfortable you are with risk. Would you be ok with losing £500 one year after investing £10,000 if it meant there was the possibility of making much greater returns in the future? If this doesn’t alarm you, then you may have a high risk tolerance. If, on the other hand, you can’t stand the thought of losing money, your appetite for risk is likely lower.
Generally, riskier investments should have higher potential returns – or upside. Stocks are usually viewed as riskier than bonds.
The stock of Company A, for example, may return 12% in one year, but then fall by the same amount a year later. Meanwhile, bonds issued by the company, which pay a fixed amount of interest, would return 4% each year – steadier performance but with a lower upside.
Time horizon refers to the timeframe over which you plan to stay invested. It’s often determined by when you need to meet your financial goal. Are you saving to send your children to university in 10 years’ time? Or to take a dream trip in the future?
Typically, the shorter the time horizon the less risky investors become. Those that have a longer time horizon can afford to take on more risk since they don’t need the funds right away. If they lose money, they have time to allow markets to recover and make it back.
4. Place your assets
Next up, you need to consider what to actually do with your money, also known as your portfolio asset allocation. This is essentially where you decide how much money you put in different assets as you build your investment portfolio.
Commonly, people like to create a portfolio comprised of:
Note: ETFs – or exchange-traded funds – are a collection of hundreds or thousands of stocks or bonds in a single fund that trades on major stock exchanges.
It doesn’t have to end there, some other investments considered by retail investors include:
Real-estate investment trusts (REITs), which provide exposure to the real estate market but trade like stocks or ETFs on an exchange
Precious metals or precious metal ETFs
Once you’ve got your head around the types of assets you are interested in, you need to consider what percentage of your portfolio will be directed to each asset.
To give you a guide, here are some common allocations for a long-term investing strategy. These are all examples by online trading and education platform Corporate Finance Institute:
A 100% stocks allocation is typically for the risky investor with a long time horizon, whose main goal is high return potential.
A 20% bonds, 70% stocks and 10% cash allocation is typically for the moderate-risk investor with a long time horizon, who wants good return potential with a bit more stability than 100% stocks.
A 40% bonds, 50% stocks and 10% cash is typically for the investor that’s more focused on price stability and/or is getting closer to retirement.
A 60% bonds, 30% stocks and 10% cash allocation is typically for the investor who is more risk-averse or who is nearing retirement.
The long-term returns, as well as the asset allocation, can help forecast how long it will take to reach your short-term and long-term goals.
5. Open an investing account and implement your strategy
"Whichever way you go, it’s worth exploring whether you can open a stocks and shares ISA, which is a tax-free wrapper for your investing account."
Now that you’ve defined your goals and fine-tuned your portfolio construction, you can open an account and begin to implement your plan.
Take the total amount you have available to invest and then multiply the allocation percentage by that number. For example, if you have £50,000 and decide to put 50% into stocks and 50% into bonds, then £25,000 will be allocated to these two categories.
If you don’t want to actively pick stocks, you can opt for diversified stock or bond index funds, which all you to invest in hundreds (or even thousands) of stocks or bonds.
If you do want to be more active in what you buy, consider learning more about how to invest in stocks before purchasing individual securities.
And whichever way you go, it’s worth exploring whether you can open a stocks and shares ISA, which is a tax-free wrapper for your investing account. (Note: Tax treatment will depend on your individual circumstances and could potentially change in the future.)
6. Remember to rebalance
As with all life plans, situations change, so when portfolios drift away from your ideal allocation, you’ll need to rebalance things.
Market movements may mean your chosen mix of assets changes.
Let’s say you’ve allocated 50% of your portfolio to stocks and 50% to bonds. Then, during the year, stocks wildly outperform bonds. In this circumstance, your portfolio will be skewed – a much greater percentage will now be invested in stocks because this portion has grown at a greater rate. Under this scenario, you may want to take steps to bring the allocation back in line with what you originally intended.
"Investment strategies and goals may change over time"
Similarly, your risk tolerance and goals may also change over time as you grow older. Because of this, you should check in on your portfolio and consider rebalancing it at least once per year.
Capital at risk.