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It can be difficult for beginners to know where to start. The investment opportunities can seem endless, whether it’s cryptocurrency, NFTs (non-fungible tokens), real estate, stocks, bonds, or mutual funds.
Knowing how to build an investment portfolio can help you achieve your short- and long-term financial goals, such as: For example, having enough money to pay a down payment on a house in the short term, or being able to max out your IRA each year in the long term to retire comfortably.
Below, Select talks to Douglas Boneparth, President of Bone Fide Wealth and co-author of The Millennial Money Fix, about how people can start investing and successfully build their investment portfolio.
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Back to basics
Regardless of your financial priorities, investing is a great way to generate passive income — as long as you understand the risks and rewards involved — because it allows people to make money Compound interest. In other words, they can make money off both their capital balance and the interest they’ve already earned.
Think of it this way: If you invest $1,000 in year one and get a 10% annual return on your investments, you’ll end the year with $1,100. In the second year, assuming the same rate of return, you end the year at $1,210 (1,100 x 1.1). This example shows why it is important to start investing as early as possible. Because interest rates add up over time, the difference between waiting a few years and starting now can have a big impact on how much money you make long-term.
Let’s say you started with a balance of $5,000 and invested $5,000 each year. If you started investing at age 22, assuming a 7% return, you would have saved twice as much money by age 67 than if you started investing at age 32.
Before you start investing, Boneparth recommends having a solid financial foundation in the form of an emergency fund and an idea of what your short- and long-term financial goals are. Short-term goals could be as little as four years in the future, like a vacation or a down payment on a house, Boneparth says, adding that any money you choose to allocate to short-term goals shouldn’t be invested.
Saving for retirement
Most people start investing through their employer-sponsored 401(k). According to the According to Pew Research Center, 52% of Americans are involved in some type of investment in the stock market — mostly through 401(k)s, with only 14% invested directly in individual stocks.
Some employers offer a 401(k) match, typically between 2% and 4% of your salary, which is essentially free money. If you put 3% of your annual salary into retirement and your employer offers you an extra 3%, you’re really investing 6% of your salary. Because 401(k) contributions are typically automatically deducted from every paycheck, the money goes straight into your retirement account before you even have a chance to spend it. Also, these contributions are pre-tax, which helps lower your taxable income for the year.
401(k) accounts typically offer people the opportunity to invest in mutual funds or exchange-traded funds — having an exchange-traded fund and a mutual fund is like a basket of stocks and bonds from different companies. By having exposure to so many different stocks and bonds, these funds help investors diversify their portfolios – for example, if the value of some stocks falls, it can be offset by the appreciation of another group of stocks or bonds.
Fund managers buy and sell a fund’s underlying assets, while individuals pay an expense ratio, or operating fee, for the continued management of that fund. The annual expense ratio – the ratio of the fund’s operating expenses to the fund’s net assets – is presented as a percentage. For example, an expense ratio of 0.5% means individuals would have to pay $50 for a $10,000 investment.
One of the key differences between exchange-traded funds and mutual funds is that exchange-traded funds can be bought and sold on an exchange throughout the day, while mutual funds can only trade at the end of the day, Boneparth explains. In addition, you can choose to invest in a passively or actively managed fund.
Most exchange-traded funds are passively managed, Boneparth said, while actively managed funds typically have higher expense ratios because investors pay to have fund managers and researchers actively pick and choose stocks and bonds in hopes of outperforming the broader stock market. He recommends opting for passively managed index funds, which aim to match the market’s performance and tend to have lower fees than actively managed funds.
“What we definitely wish for them [people] What’s important to know is that most managers can’t really beat the market very well over long periods of time,” says Boneparth Gegenstück.”
About 80% of actively managed domestic equity funds failed to outperform their benchmark in 2021, according to S&P Dow Jones Indices’ annual SPIVA report.
Some retirement plans also offer fixed-date retirement funds, which are named after the year a person retires, and which automatically change the allocation of fund holdings over time, shifting more into conservative assets rather than riskier ones as people age invest assets. However, be aware that this may not always be ideal, especially if you have other investments, as your entire portfolio allocation may end up being riskier or more conservative than you’d like since target date funds work on autopilot.
What to put in your investment portfolio
When it comes to determining how to split your portfolio, consider yours Risk tolerance and the time horizon for your goals. Index funds and mutual funds are typically considered less risky investments than individual stocks. And bonds are considered less risky than individual stocks, index funds, and mutual funds.
Bonds are considered fixed income investments. Federal and local governments and corporations issue bonds to provide cash flow to fund projects. With bonds, investors know the interest or dividend payments they will receive before they invest. While stocks are a form of equity that expresses ownership of a company, bonds are not considered stocks.
While Boneparth can’t offer personal advice to all investors, he generally advises younger beginners to invest between 80% and 100% of their investments in stock funds and the other 0% to 20% in less risky assets like bonds. with your portfolio allocation becoming more conservative over time. As younger investors are further from retirement, they have more time for their portfolios to weather the ups and downs of the market.
Legendary investor Warren Buffet has advocated a “90/10” wealth allocation for his wife’s legacy when he dies, with 90% of the money in a low-fee stock index fund and 10% in short-term government bonds.
And if you want to invest in individual companies, just make sure you allocate only 5% to 10% of your portfolio to individual stocks. This strategy allows you to have some fun and invest in companies you believe in, but it also helps mitigate risk: if those companies’ stocks don’t perform well, your overall portfolio won’t suffer tremendously.
What type of account should you put your investments into?
It’s worth noting that Roth IRAs have an income cap, while traditional IRAs don’t. Both Roth IRAs and traditional IRAs have a contribution limit of $6,000 per year and offer the option to make an additional catch-up contribution of $1,000 if you are 50 or older. Like 401(k)s, IRAs offer a variety of different investment opportunities, whether mutual funds or individual stocks or bonds. Select ranked Charles Schwab, Fidelity Investments and Vanguard as the companies offering the best IRAs.
If you already have a retirement account, you can open a taxable brokerage account that allows you to freely buy and sell stocks. Select has ranked TD Ameritrade, Ally Invest, and Fidelity as some of the best no-commission brokerage accounts.
For investors who prefer a more hands-on approach, a robo-advisor could be a good option, as all you would need to do is fill out a questionnaire to assess your risk tolerance, financial goals, age, and other factors that might affect your investing habits . The robo-advisor then uses an algorithm to create a customized portfolio and automatically buys or sells assets in it to help you achieve your financial goals.
Note that many robo-advisors charge an account fee in addition to the expense ratios charged for investing in each individual fund. This account fee is presented as a percentage of the amount you invest. Pick Betterment and Wealthfront as the best robo-advisors.
Finally, if you’re more comfortable investing and want to buy or sell individual stocks and bonds, you should opt for a brokerage account — many of them offer $0 commission trading, meaning you don’t have to pay the brokerage fee to execute trade for you. Select ranked TD Ameritrade, Ally Invest and Fidelity as some of the best trading platforms with $0 commission.
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Editorial note: Any opinion, analysis, review, or recommendation expressed in this article is solely that of Select’s editors and has not been reviewed, approved, or otherwise endorsed by any third party.