Planning is a key element to success in any endeavor in life. Investing is no different, yet the majority of otherwise sensible individuals approach it like a game of chance. Although it will never be as precise as the physical sciences, investing can be approached in a systematic and logical fashion, which will come as close as possible to guaranteeing success. Investment success is not the same for everybody—not everyone’s needs and goals are the same. The following 20 questions are divided into three groups: Group I seeks to formulate your “investment policy” by looking primarily at what you have to achieve. Group II will lead you to an appropriate “investment strategy” by looking primarily at the tradeoff between risk and return. Group III will give some ideas for evaluating specific investments. These questions will help you lay out your individual investment road map.

 

GROUP I—INVESTMENT POLICY

 

1. Should I even embark on this journey of investing?

 

Yes. Reacquaint yourself with Matthew 25:14-30 to get a feel for God’s attitude on investing. When this parable was originally given, the context was the Kingdom of God, but the topic was money. However, balance this with Matthew 6:19-21.

 

2. Have I formulated an investment policy, or “road map,” to guide me on the journey?

 

If you can answer “yes” to this question, skip to Question #9 and review your current investment strategy. If you answer “no,” consider the following questions.

 

3. What must my investing accomplish for me?

 

There are “defined benefit” plans, where a specific end result is targeted, and “defined contribution” plans, where a specific investment is periodically set aside and the end result is not explicit. An individual policy should have elements of both approaches. College expenses and retirement are some typical answers, but the real value in this question comes from quantifying the answer—utilizing some informed estimates to put real numbers on your needs and goals.

 

4. How much time do I have to reach my goals? This is known as the “time horizon,” and the answer to this question goes hand-in-hand with the answer to Question #3. Together they determine the vehicles used, the route taken, the speed traveled—and by implication, the risk incurred—on your journey to your goals. Time is the investor’s greatest ally (the investor’s worst enemy will be revealed a little later), so start as early as you can! Make a realistic and informed estimate of the time frame you are working in.

 

5. What effect will taxes have on my investing?

 

Uncle Sam likes to share in your success. Both federal and state taxes should be factored into your investment decisions, and it’s astonishing what a difference that can make! For example, a 6% investment will take just about 12 years to double. But in a 35% tax bracket, that same 6% investment requires 18 years to double! Fortunately, the government has given us a few options (tax-free bonds) and opportunities (IRAs, 401(k)s, etc.). Depending on your tax situation, choices between taxable, tax-deferred, and even taxfree investments can be made.

 

6. What effect will inflation have on my investing?

 

Here is the investor’s worst enemy! Inflation has come to be accepted as a fact of life but is a more insidious foe than Uncle Sam’s annual cut of your profits because its effects are not explicit. With taxes, you see them go out each year and what remains is yours to keep—sort of like normal wear and tear on your home. Inflation, on the other hand, is more subtle— like termites eating away at your foundation. Our 6% investment example—which takes 12 years to double the number of dollars— would require 36 years to double your buying power! And that’s with a relatively modest 4% inflation rate and no taxes. If that 6% return was taxable income each year at a 35% rate, even after 50 years you haven’t increased your buying power at all! If you believe, as I do, that no growth in your buying power over time is hardly different than a loss, then even so-called “safe” investments, like Treasury Bills, turn out not to be very safe in light of taxes and inflation.

 

7. Will my investment fund be required to make periodic or emergency disbursements?

 

An emergency is by definition unpredictable, but some sort of probability can be assigned (a healthy 30-year-old is less likely to require funds for a medical emergency than is the not-so healthy 75-year-old). An example of periodic disbursements would be the 16 quarterly tuition payments from your college expenses fund. In the investment business, we call this “liquidity.” The level of liquidity required will vary as the years pass, but the answer to this question will help in making investment choices.

 

8. Are there any other specific considerations that I need to factor into my planning?

 

Examples of such constraints might be social concerns (such as avoiding nuclear utility investments), or ethical concerns (such as avoiding investments that support abortion), or even legal constraints (your investable funds might be in the form of a trust that has specific, legally-enforceable directives or prohibitions). An excellent reference on this whole section is Investment Policy: How To Win The Loser’s Game, by Charles D. Ellis (Homewood, IL: Dow Jones-Irwin, 1985).

 

GROUP II— INVESTMENT STRATEGY

 

9. Have I formulated an investment strategy to implement my investment policy?

 

If you can answer “yes” to this question, skip ahead to Question #15 and get some ideas for how to evaluate specific investments by logically applying and extending your policy and strategy. If you answer “no,” then ask yourself the following questions.

 

10. What are the historical returns from different classes of investments? No formulation of strategy is possible without reasonable knowledge of what has gone before. In investing, awareness of how different types of investments have performed in the past is critical to formulating a strategy. For example, if your investment goals lead you to a need for 15% average annual return, it’s a good bet you won’t accomplish that with United States Treasury Bills. T-Bills have returned close to 15% in one or maybe two years in the last century, but most of the time have generated something between 3% and 8%. An excellent, albeit somewhat technical, reference on historical returns is Stocks, Bonds, Bills and Inflation: Historical Returns, by Roger G. Ibbotson and Rex A. Sinquefield (Homewood, IL: Dow Jones-Irwin, 1989 and updates).

 

11. What are the historical risks incurred by different classes of investments?

 

The flip side of Question #10, this one serves to inform you about the “cost” of the historical returns. Neglecting this aspect can be dangerous. Ibbotson and Sinquefield can help in this area, as well. 

 

12. How should I allocate my investable funds among the available investment classes? 

 

This is the key strategy question. “Asset allocation”—the distribution of your funds among investment types—is the primary determinant of your long-term return. Use your policy as the guide and determine the types and amounts of various investment classes that should make up your “portfolio.” No single investment, and probably no single investment class, will meet all of your policy criteria. But several investment classes taken together should “balance” each other so that your portfolio does fit your policy. Don’t forget inflation and taxes as you work through this one!

 

13. Should I adjust my policy and/or strategy to conform to my (or some expert’s) current view of the economy and/or markets?

 

As regards investment policy, the answer is a resounding “No!” Your policy is a statement of what you need to achieve, how much time you have to do it, and what limitations you have to deal with along the way. Policy should change only when one or more of those changes significantly. As regards investment strategy, the answer isn’t so plain. Many will argue that you should set your allocation once and leave it alone until such time as your policy changes. I believe moderate adjustments to strategy in light of economic and market cycles can be beneficial. But that leads nicely to Question 14.

 

14. Should I consider employing professional advisors?

 

Choices include financial consultants at brokerage firms, fee-based financial planners, product-based financial planners, investment advisors that specialize in individuals, and CPAs or attorneys. Seriously consider professional advice, but be aware of the caveats mentioned in Questions #17-19. Do your homework about any so-called advisor’s background and reputation. You should almost always say “no” to any investment where the benefit depends in large measure on the tax angle.

 

GROUP III— SPECIFIC INVESTMENTS

 

15. Does this specific investment comply with my investment policy?

 

Not every investment in your portfolio must comply with every element of your policy, but there are some policy parameters that transcend the portfolio concept. The time horizon is one of these. For example, a limited partnership that doesn’t generate cash flow until the tenth year won’t fit a policy that has a ten-year time horizon.

 

16. What role in my strategy would this specific investment play?

 

Consider what part in your strategy this investment would play. Understand how it fits in. Is it a growth vehicle? A tax minimizer? A return stabilizer? Cash-flow generator? Don’t invest just because the “story” is good.

 

17. Do I know what I’m getting into? 

 

Do enough investigation and research to understand the basic structure of the investment, the potential return, and the potential risk. Find out what the worst case scenarios are in possible losses, taxes, and liquidity. The amount of time and effort spent here should be proportional to the weight this investment carries in your total portfolio.

 

18. What are the reputation, background, and history of the firm behind the salesman? 

 

Because investing is relatively intangible, involving hopes and expectations, reputation and background take on heightened importance. Long history, extensive background, and solid reputation are what you’re looking for.

 

19. What is motivating the salesman to get my money into this investment?

 

Ideally, the salesman wants to sell you this investment because it fits your policy and strategy so well. In reality, there are a number of competing interests, not the least of which is the salesman’s income. Your best interests are served by seeking good value, and the point of this question is to get you to think about these issues.

 

20. What does a trusted advisor think about this investment? 

 

Too many times I’ve convinced myself that Questions #1-19 were answered satisfactorily and yet a trusted advisor was recommending against the investment. I was certain that the advisor just wasn’t “progressive” or “forward-looking.” But in the majority of cases, the advice was correct—the investment didn’t work out well. So, get an opinion from a knowledgeable third party whose judgment you respect.