How to start investing

Common Problem

You want to start investing but you have hundreds of options to choose from. They’re between mutual funds, exchange-traded funds (ETFs), and stocks, there are so many to choose from. This leads up to people quitting or procrastinating.

Solution

You can build your portfolio like many professionals do, by just starting with asset allocation. It’s a simple concept, asset allocation is the way you spread your investing dollars across asset classes. Some examples of asset classes are stocks, investments, bonds, etc.. 

For some people, building their investment mix can be exciting and rewarding. It is not the only way to invest. For many investors, it may be easier to turn to a target date fund which is an asset allocation fund/managed account to handle the asset allocation. If you’re saving up for retirement, you should consider selecting a target date fund with a retirement date closest to your planned retirement age. Having an asset allocation fund, you pick a mix of stocks, bonds and short-term investments. Or you can choose a managed account provider who will ask questions to help you determine the mix of investments that fit you, then provide advice on reaching your goals.

Stocks provide growth

Stocks provided higher returns than less tense asset classes, and with higher potential returns may be necessary for your goal. In the short term, the stock market is very unpredictable. In the long term, it has trends. The stock market has many pros and cons, and the risk of losing money is much higher than with other asset classes.

If you have a long time ahead of you to invest, you are in the perfect position to take advantage of the long-term growth of the stock market. By having time, you may be able to benefit from potential appreciation in your investments as the years pass.

Short-term investments help you save money

For long-term goals, short-term investments are most likely a small portion of an overall investment mix. They generally pay a small rate of return but can offer stability.

Creating your investment mix

Creating your investment mix all starts with you. The basic things to think about are your financial situation, how long you plan to invest, and your tolerance of risk. Risk tolerance is a personal measure. History shows that the more stocks you have in your investment mix, the more your account value may fall or rise. Risk tolerance makes you consider how you’re willing to put up with the stock up-and-downs in exchange for the potential long-term growth.

It’s hard to imagine how you would feel if the value of your account fell for a period of time. Some people stress and lose sleep over temporary stock market volatility. This can lead to selling investments at a very low point and losing money. This is why it is very important to choose a level of stock market risk you can live with.

To find out your personal risk tolerance, it is helpful to work with a financial professional and complete an investor profile questionnaire. There are also free online tools that can help you find out your risk tolerance.

If your goal is to retire in 20 years, your ability to take risk in a retirement account would be higher than the account you use to pay bills. Your retirement account has plenty of time to recover from setbacks, while in your bill-paying account a loss could prevent you from paying rent next month.

It’s important to consider your risk capacity, risk tolerance, and investment horizon. They don’t always match up. Your ability to endure losses could exceed your financial situation and vice-versa. 

For a chance to get higher returns from the long term, investors have had to put up with bigger fluctuations in value over the short term. 

It may be necessary to take risk, but the risk shouldn’t be more than you can take financially or emotionally. You also don’t have to be all in stocks to benefit from the way the stock market moves. Adding shorter-term investments to a stock investment mix can make your mix more stable. 

Adding stocks and bonds to a portfolio of short-term cash investments that are stable could boost the probability of achieving larger long-term returns.

Your time frame, goals, feelings on risk, are key factors in deciding how you should distribute your investments.

Your time frame

Most investing is goal based. An example is saving for retirement, buying an apartment, or education. This makes it easy to see how long you need to be invested in order to achieve your goals.

You simply don’t know what’s gonna be your outcome. Even if you are very confident, it is a bad idea to invest all of your savings in stocks if you need your money back in a year. No one can predict the market: your investments can rise in value or end up losing your savings because it was a bad year in the market.

Being able to stick with a plan through all of the ups and downs in the market is key because staying invested over a long period of time better than wasting time when you’re not in the market.

Asset allocation

After you’ve decided on your investment mix, it is time to fill in some investments. The main consideration is making sure you are diversified within asset classes.

Diversification reduces the overall risk in your portfolio, and could increase your return for that level of risk. For example, if you invested money in one company’s stock, that is very risky because that company can be in a crisis, which takes the stock down.

Investing in many companies reduces risk. Similarly, spreading your investing money among different bond issuers and maturities can provide diversification.

A key concept is also correlation. Investments that are perfectly correlated are going to rise and fall at exactly the same time. When all of your investments were rising and falling at the same time, you’d experience fluctuation. When your investments are going up and down at different times, the investments that are doing good can out-do the impact of the poor investments.

Do this as an ongoing act

You would want to revisit asset allocation periodically, or if your financial situation changes. It’s very important to revisit your investment mix because once you’ve set your asset allocation and investments, it will probably change as some investments do well and exceed the proportion of your portfolio while other investments may shrink. Getting your asset allocation back together is called rebalancing. You should re balance whenever you feel  uncomfortable about your portfolio.