So far, in the getting started series, we’ve covered how to start investing and the basics of how to buy stocks online. The series has been about keeping it simple because that’s as much as most investors need.
The series isn’t for the vast institutional money manager or the stock market trader. It’s for everyone else that needs to know how to win by playing the amateur’s game in investing and meeting their financial goals.
We’ve covered the mechanics of how to get started, but I wanted to save the best for last. In this post, we’ll wrap basic investment ideas around two concepts:
- Diversification – Invest in different assets (stocks, bonds, real estate) and investments in each asset to ensure your portfolio doesn’t all plunge with a stock market crash.
- Life stage investing – Investing according to how much time you have left for major purchases and the amount of risk you can manage.
Diversification is one of the Most Important Investment Ideas.
Diversification gets a lot of talk from investors, but few people do it correctly. To understand diversification, understand that different investments react differently to the economy and other headlines. Strong economic growth is significant for stocks because it usually means corporate profits are heading higher.
If you were investing in bonds, a booming economy might not be great because it might mean higher interest rates and lower bond prices. Conversely, stocks sink when the economy falls apart while bonds hold up much better.
If you invested in stocks or bonds, your portfolio would jump or plummet with the economy and other factors. If you had both, the ups in one investment would smooth out the downside in the other, and you wouldn’t lose sleep every time Wall Street takes a nosedive.
But diversification doesn’t stop at just stocks and bonds. You need to hold other asset classes like real estate and even personal loans through Lending Club. I put together a chart of the major asset classes and investment ideas in a previous article.
For real diversification, you need to own a few investments in each of the asset classes:
- U.S stocks of large and small companies
- Foreign companies
- Bonds of U.S. corporations
- Personal loans
- Real Estate
- Real Estate Investment Trusts (REITs) trade just like stocks
- Cash Investments
- CDs and Money Market accounts for short-term cash needs
Within stocks, there are nine sectors in which you need to invest. These are broad groups that operate in common industries in the economy. Just as the value of asset classes reacts to factors differently, stocks within different sectors react differently as well. Companies within utilities and consumer staples do better when the economy is slowing, while energy and technology companies do better when the economy is growing.
Picking stocks individually is relatively straightforward on most online investing platforms. I’m using the stock screener below, but most are similar. I like TradeKing for its super-low fees and advisor support. TradeKing advisors are SEC-registered, and the website waives the first year of fees for new customers. It’s a great way to get started and get your questions answered for the lowest price possible…free.
On the stock screener, you will want to break the total investment you will make into nine buckets and look for at least two or three stocks from each of the nine sectors. Avoid stocks from the Micro Cap selection as these are extremely small companies with a high risk of failure. Choose more Large and Mega Cap companies but invest in a few small and mid-cap companies as well.
You’ll come across a lot of ‘analysis’ and commentary on investing that will make you think you should invest more in one particular sector and less in another. This is called ‘market timing’ but should be called ‘I want to lose my money to high fees and panic selling.’ Trying to time the markets is a fool’s game and defeats the purpose of diversification.
It’s best to just split up your investment evenly between the sectors. Deposit savings into your account regularly but wait at least three to six months before investing your savings. This will reduce the number of times you buy stocks and the fees you pay.
Over three to five years, some sectors will do better while others might lag a little. You can do one of two things to even things out again.
- With your regular six-month investing, split your total investment unevenly so that more is invested in the sectors that have lagged. For example, if your energy stocks have done well and total $500 but your technology stocks only equal $300, then you will want to invest more in your technology stocks to even out the sector investments.
- If you’d rather split your regular investments evenly, you can wait to rebalance after several years. Every few years, sell some investments from sectors that have done well to invest in other sectors that have lagged. Set a specific date to do this, not more often than every two or three years.
Investment Ideas around Exchange Traded Funds
A much simpler way to invest is in exchange-traded funds (ETFs) and other fund choices. An exchange-traded fund is a group of stocks held around a common theme or strategy. There are funds for each sector and funds that hold real estate stocks and even bonds.
You buy and sell ETFs just as you would an individual stock, and the fees are much lower than mutual funds. You get instant diversification because most ETFs hold hundreds of individual stocks, but you only have to pay one commission instead of buying each of the stocks.
For investments in each sector, I like the Select Sector SPDRs, which hold the most prominent American companies in each sector. The funds charge a management expense of less than 0.2% of your investment each year, well under the 1.4% average fee of mutual funds.
For an even cheaper way to invest, I have an account with Motif Investing. Motif is an innovative new way to invest funds, reviewed last month. You pick up to 30 individual stocks to group into a fund and then buy the fund for one commission. It’s like creating your own ETF, but you don’t have to pay the annual management fee that comes with ETFs and mutual funds. To decide which stocks to put in your funds, look at which stocks are in the Sector SPDR funds.
Investment Ideas around Life Stage Investing
While investing an equal amount of money within an asset class is a good idea, investing an equal amount in each sector, you should be investing a different amount across asset classes.
The concept is built around life-stage investing, the amount of time you have left to invest, and circumstances around your financial life. Stocks offer better long-term returns than bonds and real estate but are much riskier. Younger investors with several decades left to retirement can hold more in stocks and won’t have to worry about a downturn in the market. Even if stocks lose their value in a recession, the investor has plenty of time to recoup those losses when stocks rebound in the next cycle of growth.
As you age, the time you’ll have to be able to make up for losses on riskier investments decreases. Older investors will want to hold more of their portfolio in bonds and real estate. These safer investments will not grow as fast as stocks but are more stable and will help ensure your portfolio is there when you retire.
The percentage of your money you invest in each asset class will depend on your tolerance for risk and your point in life-stage investing. Younger investors that do not want a lot of risk in their portfolio may opt for more bonds and real estate than normal.
Just as with shifting your balances in stocks, you shouldn’t shift your balance across your asset classes more frequently than every few years. In fact, since life-stage investing changes according to your age, you may hold off to rebalance your asset classes every decade. Every ten years, decrease the amount invested in stocks in favor of investments in the other two asset classes.
These two investment ideas, diversification and life-stage investing, are the two most basic concepts that you will need to start investing. Amazingly, they may also be the only two concepts you need to invest in. Over ten years as an investment analyst, I’ve learned that the investing basics are the best and only tools you need to meet your financial goals. Resist the temptation to make investing more complicated than it needs to be!