Financial Planning Before Investing in Stocks (8 Steps)

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Financial Planning Before Investing in Stocks (8 Steps)

Financial planning before investing in stocks

You see everyone around you discussing which stock to buy now, how much they made in Tesla last week, or how much their portfolio has grown this year, and now, you’re all hyped up about investing in the financial markets. 

But wait, before you go all-in, here’s the truth- not everyone makes money in the stock market. In fact, most people lose their money. 

So, what is the difference between those who make money and those who lose? And more importantly, what can you do to not lose money yourself? 

Well, a large part of your investment strategy’s success depends on your financial planning. Financial planning is where you ascertain your financial situation, set financial goals for your life, and make a plan to reach there in a particular time window, keeping in mind the risk you can take.

But why is financial planning so important? Why can’t you just follow some YouTuber or guru’s investment strategy that is already working for them? Well, let’s discuss that.

Why is Financial Planning Important

When you first begin to think about investing in the online financial markets, it’s tempting to simply give in to a one-size-fits-all investment strategy that some guru on the internet claims to be the winner.

While they may have made some decent money with that strategy on their own, chances are that strategy is not going to work for you.

And even if someone else’s strategy has worked for you once in the past, there are no guarantees that it’ll work again in the future. 

One of the biggest reasons why these one-size-fits-all investment strategies don’t work for a lot of people and most people end up losing money is that these strategies are not designed for your unique risk tolerance, your financial situation, and your unique financial goals.

This is when financial planning comes in. It helps you ascertain your financial situation, gauge your risk tolerance, set financial goals, and then create an investment strategy around that. 

Financial Planning Before Investing in 8 Steps

Two very common misconceptions about financial planning are: First, It is only for the very rich and wealthy, and second, it is some strenuous process that will require you help of a financial planner. 

Both of them are myths. The truth is, you can easily do financial planning yourself, and it is more important for people with limited money to do financial planning than the rich or wealthy.

So, let’s see how to do financial planning before investing in stocks in 8 simple steps.

Step 1: Set Financial Goals

The first step is fairly easy. You need to set financial goals so that you know where you’re going and then plan your way to reach there. 

Let me ask you this, would you take a long road trip without knowing the routes or having some sort of road map? Would a construction company start building a house without a blueprint? Would a teacher teach a course without a curriculum? No? So why start investing without having a goal in mind? 

You might have heard the saying, “If you don’t have a plan, you have a plan to fail.” and that is very true when it comes to investing. 

Start by asking yourself what is your biggest 5 years financial goal. Whether it’s earning a particular amount or saving it, write it down, and let’s move to the next step.

Step 2: Calculate Your Risk Tolerance

This is the most important step that you must take before investing in anything, ever. Risk tolerance is simply your ability to take a risk in order to achieve your financial goals.

Calculating risk tolerance is what will give you the ability to invest in assets that match the amount of risk you can take. If you calculate your risk tolerance prior to creating your investment strategy, you won’t panic all the time and wonder which direction the market will go. 

There are two components to risk tolerance. One is your willingness to take a risk and two is your ability to take a risk. 

So, how do calculate your risk tolerance? Well, this is where things get fun & interesting. You need to spell out your investment goals, your time horizon, your need for liquidity for each goal, and your tax situation, among some other metrics. 

Now you need a calculator, or just simply your smartphone, to calculate some of the main ratios, including your emergency fund, current liquidity, basic housing, and others you can see in the image below. 

To help you figure this out, we’re giving away our risk management toolkit for free if you register your seat and attend the upcoming masterclass by going to

Your risk tolerance and portfolio structure also depend on life cycles. For example, between ages 20-45, you’re more growth-oriented and willing to take more risk, but after 45, your approach becomes more conservative and less risk-taking.

Step 3: Budgeting 

Budgeting is planning in advance about your income and expenses for the month. It is generally done to evaluate your spending and saving behavior. 

The budgeting process includes establishing goals, checking your income, checking your expenses, and finding out if your net cash flow is positive or negative. 

If you’re cash flow positive, then the goal is to maximize the amount of cash in hand so that you can have more money to work for you while you rest.

If, by any chance, your net cash flow is negative, then that is an alarming sign because either you’re spending too much or your income is too little to bear your expenses. In both cases, you can’t start investing or start building your investment strategy yet.

Step 4: Write Down Your Investment Policy Statement 

Next up is creating a written investment policy statement with the help of risk tolerance derived in the second step. 

Your investment policy statement is like your investing Bible that will guide you while making any investment related decision.

Here are some simple steps you need to follow while drafting your investment policy statement: First, you need to document your financial goals derived in the first step as detailed as possible. Then, you need to document your risk tolerance in detail. 

Next, document your current investments, if you have any. And finally, write down your target asset allocation based on your risk tolerance and financial goals. 

Having these actually written down and documented might sound a little unnecessary because you already have them in your head, right? 

Wrong! What you have in mind is a scattered idea of what you might do. Having them written down in one policy investment not only gives you clarity but also serves as a guide that will help you with your investment choices. 

It will also prevent you from panicking every time the market goes up and down because you can already see the big picture in your investment policy statement. 

Step 5: Select Assets That Match Your Investment Policy Statement

Now that you have a written investment policy statement in your hands, it’s time to select assets that best match that investment policy statement.

Depending on your financial goals and risk tolerance, you can create a diversified portfolio including different assets and securities such as stocks, cryptocurrencies, futures, ETFs, fixed income, options, real estate, and even forex. 

The goal in this step is to figure out the right asset mix for you. Don’t just look into the broad categories listed above. In every category, you can go deeper and see which categories within the category are suitable for you.

For example, in the case of stocks, there are nine different types of stocks that you can choose from. If you don’t know what are those nine types of stocks, then here is a video on our YouTube channel that you can check out. 

The percentage you allocate to each investing asset in your portfolio depends on your risk tolerance, financial goals, the economic cycle and your life phase. 

Also Read: How to Prepare for a Stock Market Crash

Step 6: Examine External Environment 

Now that you have an idea about what type of assets you want to invest in, it is time to examine the external environment and the economic and geopolitical events that may impact your asset class.

It’s the step where our signature Invest Diva Diamond Analysis (IDDA) comes in, and that analyses every asset from five different points: Fundamentals, Technicals, Market Sentiment, Capital, and overall how it fits with your portfolio.

Fundamental analysis is concerned with the fundamentals of the company or asset. Technical analysis is basically the study of the price chart of the asset to predict its short-term move. Market sentiment is the overall trend or sentiment of the general market, generally bullish, bearish or neutral.

Capital basically comes from your personal investment policy statement. So Examining the external environment is invest diva diamond analysis’s point one.

Step 7: Develop an Investment Strategy

Finally, step 7 is concerned with developing an investment strategy by incorporating all the previous steps. But this time, you’ll be determining what price you should buy, what price you should sell, and how long you should hold your investments. These are defined in IDDA’s technical and sentimental points. 

Now, you’ve probably come across trading gurus who sell buy and sell signals. The problem with that and why you can’t follow them, even if those gurus are actually legit, is because their signals are one-size-fits-all.

We have already discussed why one-size-fits-all strategies do not work in the financial markets because they do not consider one’s unique financial goals and risk tolerance. 

You are unique and your preferences, ability to take a risk, life stage, etc. are different from other people. That’s why you can’t rely on someone’s buy and sell signals to be successful. You’ll need to create your own strategy that is unique to you.

Step 8: Monitor

Once you start investing, the only thing you need to do afterward is to monitor your portfolio and its performance from time to time.

And here’s what we don’t mean by monitoring- Sticking to your screen all day and following the market’s ups and downs. 

Sticking to your screen will not only cause unnecessary stress but will bring the worst emotions out of you, which will lead you to lose sight of your investment strategy and increase the chances of making a stupid decision and losing your money. 

Ideally, you should only manage your portfolio once a week, and even once a month is fine if your view is very long-term.  

If your view is short-term, then having a look at your portfolio daily is fine but try to avoid making changes every now and then.