Last updated on December 26th, 2023 at 01:23 am
Investing is a great way to grow your money over time. Many people get caught up in hype trains. They want to replicate the Warren Buffet stock portfolio, get into robo-investing, or learn 4 types of portfolio management all at once. However, before you can start exploring all those cool things, it’s important to understand the basics of investment portfolios. This is where a baseline understanding of investment portfolio strategy comes in. Before we get deep into the sauce, let’s establish some key terms and what they mean…
- An investment portfolio strategy is a plan for how you will invest your money. It should include your investment goals, your risk tolerance, and your time horizon.
- Your investment goals are what you hope to achieve with your investments. For example, you might want to save for retirement, buy a house, or send your kids to college.
- Your risk tolerance is how much risk you are comfortable taking with your investments. Some people are comfortable with a lot of risk, while others prefer to play it safe.
- Your time horizon is how long you plan to invest. If you are investing for the long term, you can take on more risk. But if you are investing for the short term, you will want to be more conservative.
Once you have considered your investment goals, risk tolerance, and time horizon, you can start to build your investment portfolio. There are many different types of investments, so it’s important to choose ones that fit your needs. Let’s check out a couple of popular options.
Some common investment types include stocks, bonds, mutual funds, and ETFs.
- Stocks are shares of ownership in a company.
- Bonds are loans that you make to a company or government.
- Mutual funds and ETFs are baskets of stocks or bonds that are managed by a professional.
What’s best to start with?
I like to put the majority of my investment money (that I budget for every week) into total market ETFs. Rather than tracking the performance of an individual company, like Microsoft or Apple, they track the total stock market. This means that they are comprised of stocks of multiple companies across different sectors, and thus represent the market as a whole. For example, one of my favorites, VTI, contains 3,839 stocks as of this time of writing!
So, when you buy 1 share of VTI, you’re effectively buying a percentage of all the companies included in that stock. Below are some of the stock’s top holdings currently:
So, for example, let’s say Google stock tanks in value on Monday, and Tesla stock soars in value. Tesla’s gains will offset Google’s losses, meaning the value of my ETF stock basically stays the same. Now, if I had just bought straight Tesla stock outright, I may have made a ton more money on my same initial investment. However, if I had bought Google outright, I would have lost a ton more. I like the Goldilocks formula. I want it to be just right. I don’t chase crazy gains and I don’t risk crazy losses. The US stock market, as a whole, has a track record of performing positively over time. If you have patience and ride out the dips, you stand to profit handsomely in the long run. Since I’m a buy-and-hold investor, I see ETFs as almost always being one of the best options.
What about mutual funds?
A lot of people get confused about the differences between mutual funds and ETFs. Mutual funds are a lot like ETFs, except people and firms actively manage them. These firms do a great amount of research to pick the best investments. They then compile these “best investments” together in a singular package, called a mutual fund. Depending on your investment strategy, mutual funds can have their own benefits, However, because they’re actively managed, they have high expense ratios. Basically, these ratios are the annual operating costs you pay for the firm to actively manage the fund. This money is used to hire and retain investment advisors, cover legal costs, office supplies, etc. Much of this is required to satisfy the requirements of the SEC. ETF expense ratios, most of the time, are lower than mutual funds because they are managed passively.
So… you take that management fee and add it to the trading expense ratio (which is the transaction cost of buying/selling a security for the mutual fund), and you get the total management expense ratio (MER). You have to read the fund company’s prospectus to get an idea of these numbers, as different companies word the fees in different ways. Let’s say you have a MER of 3.125%. That means you lose $31.25 for every $,1000 investment. When you factor in compounding value, you quickly see how MER can cut into your profits.
The thing I find funniest about mutual funds is the fact that humans can’t predict the stock market. No matter how hard they try. The best investment manager is a day away from a total wipeout. There are simply too many factors at play for anyone to accurately predict what will perform best. In fact, studies have shown that almost 80% of active fund managers fail to beat the market with their customized portfolio picks.
That means an ETF like VOO, which seeks to mimic the performance of the S&P 500 Index passively, would have beaten out 80% of mutual fund managers in profits in 2021! Sadly, in 2021, those mutual fund shareholders paid a premium (in terms of MER) to have an actively managed fund… and they still got beat by the security that didn’t charge a big MER fee. I’m not the guy who’s gonna take 20/80 odds that a firm can manage my money better than a passive fund. And I’m definitely not gonna pay extra for those 20/80 odds!
Diversify. Diversify. Diversify.
When you are building your investment portfolio, it’s important to diversify your investments. This means investing in a variety of different types of investments. Diversification can mean you have stocks in different sectors, like healthcare, technology, infrastructure, etc. It can also mean you have different types of investments, like real estate, crypto, stocks, and bonds. Any type of diversification will help to reduce your risk if one type of investment performs poorly. The old adage “don’t put all your eggs in one basket” rings true in regard to investing. If you are young, you can handle the risk of a uniform stock portfolio better, as you can (ideally) recoup the loss if it tanks. Still, it’s rarely wise to take this approach. Diversification is almost always the better option.
Rebalance. Rebalance. Rebalance.
It’s also important to rebalance your investment portfolio on a regular basis. Portfolio rebalancing is the practice of realigning your investments to their original target allocation or a revised one. This involves periodically buying or selling assets within your portfolio to maintain the desired balance of different asset classes, such as stocks, bonds, and cash equivalents. The primary goal is to manage risk and ensure that your portfolio remains in line with your risk tolerance and time horizon.
Also, it’s important that you capture gains through the process of rebalancing. When a particular asset class outperforms, rebalancing allows you to sell some of those assets at a profit. You can then take that profit and use it to acquire assets in a different asset class. For example, if I buy a bunch of stock in NVIDIA (NVDA), and the value skyrockets like this, then, depending on the amount I bought, it may be wise to sell some shares and take those profits to invest in some shares of a BlackRock ETF like the iShares Core S&P 500 ETF (IVV).
Taking my money out of the more volatile option, NVDA, and putting it in a safer option like IVV rebalances my account. After I make that switch, the majority of my investment account value isn’t any longer tied up in the well-being of a single tech company, meaning my financial future is safer. It’s worth noting that, these days, many experienced investment professionals include crypto, commodities, and real estate as asset classes as well. Buying into these different investment vehicles means you’re using those gains to ensure that your portfolio benefits from diversification!
Investing can be a great way to grow your money over time. But it’s important to do your research and develop a plan before you start investing. An investment portfolio strategy can help you to achieve your financial goals. Hopefully, this article has given you a baseline about the basics of investment portfolios. If you feel like it was too much info all at once, don’t worry! The best way to learn is to do. Set aside a bit of money and begin investing bit by bit. I highly recommend ETFs as a place to start, as they are generally safer and more diversified.
If you have any questions, don’t hesitate to reach out!
