Back to Basics in Investing
The more people have achieved in their professional lives, the more uncomfortable they are about committing real money when they are in unfamiliar territory.
But everyone must start somewhere. The first steps are to define your financial goals and take inventory of your assets and your net worth. (Do not include emergency funds or money earmarked for tuition.)
- What is your after-tax income?
- What are your debts and expenses?
- When do you plan to retire? (What is your investment horizon?)
- Are you investing toward a down payment on a house or building a nest egg?
- What is your risk tolerance?
Having established your overall financial picture, you can decide how you want to invest and with whom. You can also start thinking about what to buy. Building and cultivating a portfolio is a lifelong discipline. If you are young or early in your career, you will want to start small to become financially literate and to develop confidence as an investor.
Planning your portfolio
Creating a portfolio is similar to planting a garden. You can choose among individual stocks, index funds or robo-advisers, which are computer algorithms programmed to match your assets with your goals and risk tolerance.
How long should the first inning of your game plan be? Think in terms of at least three years, preferably five or longer. You need enough time to ride out volatility, which will inevitably strike. How many stocks or positions should you hold? Many advisers recommend about 10-30, but the principle is to keep enough to maintain a diverse portfolio without loading too many eggs in one basket.
Assembling a portfolio comprising individual stocks takes serious time and research. But if you do decide to focus on individual stocks, it makes sense to begin with large caps and well-known companies with extensive track records of increasing sales and profits. Most are household names. When you research them, look for those without excessive debt that are priced at reasonable valuations. They are the blue-chip companies, named after the color of the highest-value poker denomination.
Blue chips often tend to increase their dividends faster than the rate of inflation, so glance at their dividend payment history. Or if you are interested in long-term capital appreciation, check out growth stocks’ earnings per share. How do they compare with similar companies?
How often should you add new money? If possible, consider regular infusions, perhaps even monthly. You can also auto-invest periodically, as well as look into plowing back (reinvesting) earnings and dividends. Meanwhile you will be benefiting from compounding, which is sometimes called the eighth wonder of the world! Last, you should rebalance your portfolio at least once a year to ensure your holdings do not become top heavy with either stocks, bonds or even a particular company or industry.
Opening a brokerage account
Brokerages firms have evolved in recent years. Almost all have now eliminated commissions altogether. Distinguishing factors are costs, research and educational tools, investment selections, and the existence of some physical branches. Some permit trading on foreign exchanges. Some also allow demo versions with “paper trading” as a starter exercise.
Professional money managers typically charge about 1% of account assets per year, although they may require high investment minimums. Some also expect customers to hold a certain amount in cash with them, on which they pay minimal interest. Robo-advisers, on the other hand, have become a popular low-cost option. They often charge around 0.25% of an account balance.
No matter which vehicle you use, a few critical principles apply to both novice and experienced investors.
- Ignore market ups and down and stay invested for the long haul. Don’t panic and bail.
- Diversify your portfolio.
- Don’t check your balances too often — you may get nervous and overtrade.
- Remember that a company’s performance does not translate directly to its stock price. Investors’ reactions are what matters. Are they pleased or disappointed? News is often already baked in.
Consider bringing a professional adviser on board. You may enjoy learning how to navigate the markets, but a financial pro can help you reach your goals.