How to Invest - Building Your Portfolio
A recent survey by TD Ameritrade asked 15-24 year olds about their finances and revealed that almost half believed that using a savings account was the best way to plan for retirement, and less than 20% believed that the stock market was the ideal option for growing their money. 76% of respondents admitted to knowing little to nothing about investing at all. A similar survey by Bankrate reported that Millennials were twice as likely as any other age group to cite lack of education about the stock market as the reason they weren’t investing.
The truth is that everyone should invest, but many young people are missing the opportunity. Too often, this is because they believe they either don’t have enough money or knowledge to invest. But you don't need to be a Wall Street trader to invest intelligently. The point of investing for most of us is to save consistently and grow our money over the long term. It is a matter of following some simple, proven financial principles that any investor can use to achieve their future goals. Let's start with the 3 that can be used to begin building the foundation of your investment portfolio.
Principle 1 - Asset Allocation
Asset allocation is the way your money is divided up across different asset classes. Most investments can be separated into the 3 major classes of stocks, bonds, or cash. Stocks have higher risk but can offer long term growth, whereas bonds typically produce a fixed income with less risk, but generally offer little in appreciation. Cash gives you your stability but provides no growth at all and earns very little to nothing, making it useful only for your most immediate needs or emergency savings. Figuring out your asset allocation will depend on your personal financial goals, risk tolerance, and time horizon. Thankfully, there are many online tools or advisors who can help you answer those questions and blend the assets in such a way to achieve the right balance of risk and return for you. This optimal allocation is backed by something called Modern Portfolio Theory, an academic concept that is time tested and proven to help create the appropriate mix for each investor.
Principle 2 - Diversification
Diversification can further enhance your ability to mitigate risk in each class. The idea is that by investing in a variety of different assets within each class, the overall risk of your portfolio is reduced because your exposure to any one specific asset is limited. For example, when investing in stocks, it's a good idea to include both U.S and foreign companies, large and small companies, and different sectors and industries, (ex: technology and health care). Different areas provide different levels of return and risk, which contributes to the balance of your portfolio when combined in the right way. This graph from Morningstar shows how diversification does just that by reducing risk and increasing return.
Principle 3 - Passive Investing
Once you have determined your asset allocation and diversified in each asset class, you then select investments. Passive investment selection is a method of achieving market performance through the use of lower cost indexes. Index investments allow you to own a broad representation of the entire market, asset class, sub asset class, or sector. As an example, instead of buying one stock that is a large company in the U.S., you can invest in an index representing an entire basket of large U.S. stocks. Because of this, indexes tend to keep the same holdings and follow the market as a whole, avoiding the risks that can be associated with moving in and out of the market. Since passive investing involves less trading, it also benefits you by keeping your costs down and your money working longer.
Practical Investment Thinking
As a practical side note, it can be helpful to think of investing in terms of separate time periods. Money you may need to access in the short-term (3 years or less) should be in cash instruments like savings accounts, money markets, or CD's (certificate of deposit). Savings for the mid-term (3-10 years) should have more in bonds and maybe a small amount of stock investments. While long term savings (10 years or more) should have the biggest portion of stocks to provide growth and give you the time needed to ride through any market swings.
If you follow the above 3 principles and apply a little sensibility, you should have a pretty good foundation for your own portfolio. The second part of this series will outline the principles associated with how to apply smart financial behaviors around managing your investments. If you are having struggles with investing, want to share your own experiences, or are looking for professional advice, send us an email at firstname.lastname@example.org!
This information is for educational purposes only and is not an offer to buy or sell, nor a solicitation of any offer to buy or sell the securities mentioned herein, or considered to be the rendering of personalized investment advice. Past performance is no guarantee of future results. Therefore, no reader should assume that future performance of any specific investment or strategy (including the investments and/or strategies discussed), will be profitable or equal to past performance levels. Conscious Capital Management, LLC assumes no responsibility for loss or damages resulting from the use of this information. A professional advisor should always be consulted before implementing any of the options presented.