11 Must have investment guidelines for anyone

During my last year of college, my wife and I spent countless hours discussing how we intended to manage our finances. We spent a fair amount of time discussing our goals and what we needed to do in order to financially reach those goals. Fortunately or unfortunately, depending on how you look at it, we made some foolish investments at the same time.

Our eyes and desire to quickly reach our goals overrode all of those nagging feelings that were telling us, “This is stupid.” As a result, we created several boundaries to help guide future investment activities. Before I jump into the specific types of limits that you need, I want to briefly describe the importance of guidelines or boundaries.

Boundaries: The kite example

Think back to being a kid again and flying kites with your family and friends. If you were ever like me, then you occasionally wanted to let go of the kite’s string once it had reached the end. I believed that the tethered string was holding the kite back and not allowing it to soar higher into the sky. As you may know, if you let go of the string, then the kite may fly higher for a moment, but it inevitably always falls fast and crashes into the ground.

The string actually acted as an anchor and allowed the kite to stay its course and continue to fly. By removing the anchor, the kite is easily tossed about by the wind. Life is the same. We need boundaries in order to stay anchored and move in the right direction. Extrapolated to an investment scenario, creating written guidelines as part of an investment plan gives you an anchor which allows you to make smarter financial decisions and avoid being a reed that is tossed about in the winds of the market.

11 Essential guidelines for your investments

1. What are your liquidity needs? Different investment account types have different legal restrictions. For example, early withdrawal from a 401(k) or Roth IRA is not only a taxable event, but it carries a penalty with it. Take the time to understand when you intend to make major purchases, such as a care, additional education, or a home, and understand whether or not you will be able to access your invested money in order to meet your needs.
2. What is your investment time horizon? This guideline is closely tied to #1. Determine the date or year when you will need to access invested money. For long-term goals, instill now the mindset that those investments are long-term assets and unaccessible until that time. Writing this down helps deter the temptation to deviate from your plans.
3. What are your acceptable and unacceptable asset classes? Make a list of asset classes that you are comfortable investing in and a list of asset classes that you will not use. For example, my wife and I have as acceptable classes: bonds and cash, stocks and mutual funds, REITs, gold funds, and business holdings. Our unacceptable classes are: derivatives, collectibles, foreign currency, options, futures, or any other asset class where we have no discernible specific advantage. You may not agree with us, but have a rational reason for why you make something acceptable or unacceptable.
4. When are you willing to invest in individual assets? Individual assets are defined as stocks. As you begin investing, one bad stock can have a serious impact on your entire portfolio. So wait a while. My wife and I decided that until we have $500,000 in our portfolio, we will not invest in individual assets. And even then, we will still follow guidelines #5 and #6.
5. What percentage of your total assets can be placed in one investment? This guideline can make or break you. Even though an asset class is acceptable does not mean that you can go hog-wild. Restrict how much you will invest in any one investment as necessary. For example, our guideline states, “At no time will the Team invest more than 5% of its investable assets in any single company, stock, or individual investment except broad market mutual funds, index funds, or ETFs.”
6. What is the maximum percentage of your total assets that you will place in Company Stock? As you begin to add individual assets to your portfolio, don’t let Company Stock overwhelm your portfolio. We have all heard the horror stories about individuals who placed on their bets on the Company Stock. If your company gives you stock as part of your compensation, then great. But make sure you have a balanced portfolio.
7. What is the maximum percentage of your total assets that you will place in new investments? Carefully move into new investments. This guideline helps avoid “hot stock” tips and other tall tales heard on the back nine. Our investment plan states, “The Team will invest not more than 5% of the total portfolio amount in any new or individual asset or investment. Index funds, mutual funds and ETFs do not fall under this category unless they have portfolios with less than 50 assets.”
8. What is the maximum percentage of your total assets that you will place in unlisted investments? Unlisted investments are assets not listed on recognized stock exchanges and therefore bare additional risk. In order to limit that risk, I recommend allocating no more than 3% of your total portfolio to such investments.
9. Will you use leverage? Leverage comes in the form of short-selling or buying on margin. I’ve made and lost money using both techniques, but they add substantial risk if not properly managed. If you aren’t sure why, read 4 Reasons not to use debt to make an investment.
10. If applicable, how often will you discuss the performance of your portfolio as spouses? Keep your spouse informed about your portfolio. Or if you aren’t the one handling the finances, ask to be kept up-to-date. Even if you are inexperienced, two heads are still better than one.
11. How often will you rebalance your portfolio? Over time, certain assets will grow or fall faster than others. So you need to adjust your investment allocation to re-align it with your target allocation. So determine how often you need to that. Personally, I believe every two years is sufficient.

A sleep well investment portfolio

I like sleeping. I don’t get much of it these days. So having a portfolio that lets me sleep and doesn’t keep me up all night wondering whether or not my stocks are plummeting is important to my peace of mind and lifestyle.

Answering the above questions and then writing it down may take some time and seem mundane, but it is crucial to your success. Knowing where you are going (your goals) is not sufficient if you don’t know how you will safely arrive there (your boundaries).

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