Taking control of your investments is a smart thing to do. Saving and investing for your future is important, maybe one of the most important things that you’ll do and leaving it up to people that don’t have the incentive to act in your best interest is maybe one of the dumbest things you can do in your life. This is your financial future and you should take control of it. With that said, many will learn some basic or even complex nuances of investing, learn how to pick stocks and ETF’s or even pick the mutual funds in your 401K. And generally I think everyone has the same basic approach of taking acceptable risk and trying to earn a high return. But I find that what people invest in is typically based on personality toward risk. Risk taking people invest in riskier assets while risk averse people will tend to stray away from riskier investments and stick their money in mostly fixed income. What few personal investors do is actually plan out what they need by creating a long-term financial plan, the plan that should be the basis for all your investment decisions.
First off, if you have the smarts and intelligence to invest for yourself, I am confident that with just a bit of effort, and some Microsoft excel acumen you have what it takes to make an intelligent long-term financial plan.
The first and potentially most complicated thing you need to do is calculate your required return. As with any investment strategy, the goal is to make sufficient return with minimum required risk. Then potentially trade some risk for some upside. But these aren't decisions that you can intelligently make if you don't have an idea of what your required return is.
Calculating your required return:
Interpreting your required return:
First things first, note that even extremely long term models are not tools to tell you what you should do in the future. You can't make future decisions today. You can only make today's decisions today. Planning is still an essential thing to do because it gives you vital information for the decisions you make today but things will not go to plan, and you should repeat this model annually.
Second, understand that the figure you got is the target return for today, but your goal isn't to get that. It's to minimize the probability that you don't. To that end, understand your time horizon. If you're required return is 4% and you're only 35 years old, buying a AA 30 year corporate bond that yields 4% is probably riskier than investing entirely in an SP500 ETF. The probability that you return on average less than 4% in equity markets over a 30 year period is lower than the chances that a AA bond defaults over 30 years.
Create the mix that minimizes your failure probability and then play the risk reward game:
However, you measure risk is fine. But do some form of math to give you a sense of your chances of success given different portfolio options. Than adjust. If you love to invest, make some realistic expectations for your "alpha" portfolio and see how much allocating to your portfolio to alpha impacts your probability of failure.
If you're a risk taker, don't be scared to lower that probability a little bit for some upside, you are who you are. If you're risk averse, understand your probability of failure number. Don't invest in a manner that your certain to fail, but just by a bit. Always plan to succeed.