So you've decided to take the leap and get started learning how to invest.
First off, way to go!
It's a big step, but it's also something that will truly change your life for the better- so go ahead and give yourself a pat on the back.
The future “you” is going to be very grateful, I promise.
Related: Investing for Millennials: How Get Ahead and Retire a Millionaire
Learning the process of portfolio management is not hard
Keep it simple. That's our philosophy, and it should serve you well, too.
Sure, you could spend your days researching different stocks to buy and dive into the nuts and bolts of financial statements. You could burn the midnight oil making fancy valuation models in Excel after work each night. But who in their right minds would ever want to do that?! Yeah, pretty much no one.
Unless you have an innate interest in that stuff, there's not much benefit to making things that complicated. You definitely aren't guaranteed better returns. In fact, the opposite may be true. I think it's safe to say that most of us want to have a life outside of managing our portfolio, anyway. And now it's easier than ever for anyone (yes, anyone) to put together and manage their own portfolio.
Related: 10 Ways to Add $1,000 to your Bank Account this Month
Forget about buying individual stocks
Picking stocks and bonds takes a lot of time and heavy research skill, and isn't something that can be done easily (the right way, at least) by beginning investors.
The name of the game today is “Exchange Traded Funds”, or ETFs.
Think of an ETF as a “basket” that contains many different stocks, sometimes up to thousands. ETFs work by pooling your money together with other investors and then buying a bunch of different stocks with that bigger pool of money.
For instance, an S&P 500 index fund would purchase stock of all 500 companies in the S&P 500, something that just isn't feasible because of trading fees. But by owning one share of this fund, you actually own a tiny slice of all 500 companies in the index.
The really cool part about ETFs is that they make diversification easy. Since your risk is spread among hundreds of different stocks, if a few individual companies don’t do so hot, it won’t kill your portfolio. By owning just a few ETFs, you can build a perfectly suitable portfolio for yourself. Before ETFs, diversifying was a lot harder.
If you're itching to buy a few individual stocks that you're interested in, that's fine too. But I think it's important to keep the vast majority of your portfolio invested in index funds (ETFs). Since picking individual stocks is so risky I always ask myself, “If this company goes bankrupt and the stock drops to zero, is my portfolio still alright?” If the answer is no, I know I need to trim back the amount of money I put into that stock.
Understanding your attitude towards risk
Deciding how much of your money to put into stock ETFs and bond ETFs isn't an exact science, but it's also not entirely difficult, either. The first step is to get a feel for your own personal “risk profile”. Here are a few questions your typical financial advisor might ask:
1. How old are you?
As a general rule, the older you are, the less investment risk you should be taking. A 25 year old can afford to take more risk than a 65 year old who’s about to retire.
2. For the money that’s not in your retirement accounts, how long do you plan to invest the money?
The longer your “time horizon”, the more risk you can take with the money in hopes for a higher long term return. If you’re going to use the money for a down payment on a house in six months, you should be investing the money very conservatively (or maybe even leave it in cash).
3. If you were to see your portfolio drop by 15%, how would you most likely react?
a) Sell everything so you don’t lose any more money.
b) Hang on and not sell anything, as much as it hurts to watch your portfolio drop.
c) Make even more investments while prices are low, assuming you have cash on hand.
4. Which best describes your attitude and goals related to investing?
a) I want to make as much money as I possibly can.
b) I really don’t want to lose any money.
c) I’d like to protect my money, but I’d also like to make just a little bit of extra money.
When advisors ask you this question, they are usually trying to figure out what “style” of portfolio best fits you.
- For A, they would put you in what’s called a “Growth” portfolio, which is fairly aggressive.
- For B, they would lean towards a “Capital Preservation” portfolio filled with a lot of relatively safer investments.
- For C, you’d be put into a hybrid of the first two choices.
Your answers to these questions should give you better insight into how you feel about risk.
To make a lot of money from investing, you need to be comfortable with taking some risks. Some people are more comfortable with that idea than others, and that's okay. It's a personal decision, and everyone is a little bit different!
Next, you'll need to open a Traditional IRA in order to purchase ETFs and start setting up a retirement account.
Here is a step by step tutorial to help you get started investing (keep both tabs open as you'll need to switch back and forth between the two from here).
Now let's look at an easy way to determine your stock and bond allocation.
A simple formula for finding your asset allocation
This is not hard. Don’t overthink it!
To figure out how much you should put into stocks and into bonds, follow the four steps below.
This general rule has been used by many smart investors, and it should serve you well (barring any sort of highly unusual circumstances you find yourself in).
The best part about this method is that it keeps adjusting your asset allocation as you get older. Like we’ve mentioned before, the older you get, the less risk you should be taking in your portfolio. That's because you have less time to recover from any downswings. So, at 40 years old, most investors should have roughly a 70/30 split. And if you want to tweak it a bit to fit more in line with your feelings about risk, that's fine.
Is 70% a lot to have in stocks for a 40 year old? You bet it is. But you want to take advantage of the higher possible upside to investing in stocks while you are still relatively young.
The Process of Portfolio Management Should be Low Maintenance
Once you have your portfolio set up with the right mixture of stock and bond ETFs for you, the rest is quite easy. You don't need to anxiously watch over your accounts every day. In fact, just the opposite!
The best way to go about it, for both your time and your sanity, is to log in at most every few weeks. That's it. And if you only check on things once a quarter or so, that's still fine. When you do check on things, you most likely aren't going to be making any major changes. What you will be focusing on, though, is making sure that your asset allocation is still where it needs to be.
As time goes by and your stock funds appreciate in value, you will probably find that your allocation has drifted from where it started.
This is actually a good thing; it means your stock funds are making you money!
But in order to keep your risk levels in check, you'll need to rebalance. So if you started at a 70/30 stock vs. bond split and it's now sitting at 80/20, you should take some of your gains from the stock funds and put them into your bond funds to get back to 70/30.
You'll probably only need to do this a few times a year, at most.
You would have just paid $1000s for this information from an advisor
Yes. Seriously. Not even joking.
If you went to a financial advisor and had them help you with getting started, or even had them invest the money for you, you would have been charged fees that would have essentially crippled your portfolio right from the start.
And the truth is, a lot of advisors use a nearly identical process to the one I've outlined here. They aren't any big secrets that they have that are worth their fees. Of course, you'd never hear them say that.
For individual investors, learning the process of portfolio management has never been easier than it is today. With ETFs now common and accessible to anyone on the planet, there's no excuse for not investing your money.
Original article and pictures take www.vtxcapital.com site
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