Portfolio Building
Many people make the mistake of treating investing as a way to get rich quick by finding the one perfect stock. While that may happen every once in a while, it’s best to think of investing as a tool, rather than a lottery ticket. If used carefully, you can minimize risk and maximize your chances for slow but significant gains.
Your investment portfolio is not one single thing. Instead, it’s a way to collectively refer to all of your investments. A diversified portfolio is one that includes many different types of investments. This is important because it helps protect you from major fluctuations in the market. For example, if you only invested in one area, let’s say real estate, and the real estate market were to significantly fall, all of your investments would also fall, as opposed to only a part of them.
There is no single “best” way to create a portfolio. Instead, your portfolio should reflect your unique goals, life scenario, and risk tolerance. This means that your portfolio should look different from your parent’s or your grandparent’s or even your friend’s. You may be focusing mainly on retirement savings while someone else is focusing on short-term gains, and that will change the way you invest. Before you begin building your portfolio, you’ll need to think seriously about what you’re hoping to achieve and how best to allocate your funds in order to do that.
In general, you can think of risk and reward as corresponding forces in investment. The higher the risk you’re willing to take on, the more potential for reward (but, of course, the more potential for loss, as well). Similarly, the smaller risk you take, the smaller potential reward. In investment terms, this is often referred to as aggressive vs conservative investing. An aggressive portfolio or investor takes on more risk, whereas a conservative portfolio and investor takes on less.
The longer you have until you’ll need the money, the more risky or aggressive you can afford to be. For example, if you’re investing for retirement in your mid 20s, you can take on more aggressive investments since you’ll likely have plenty of time to make up for any losses. But if you’re in your 60s and nearing retirement age, you should shift to more conservative investments, because you have less time to recoup major losses.
More than just your life situation and age will impact your risk tolerance. If taking on a risky investment will cause you to constantly check on or worry about it, it’s probably not worth the sleep you’ll lose. And if you’re okay with the idea of potentially losing money on an investment, you may be comfortable taking on a riskier investment even when others in your situation would not. Your individual personality and preferences should help guide how much risk you take on.
Some people really like the idea of researching investments for themselves and tracking how things are changing day by day or week by week. But many others feel overwhelmed and apprehensive about that commitment. They simply don’t have the desire or time to devote that much effort to their investments. This is where a broker can make all the difference. A brokerage is, essentially, a middle man that allows you to buy and sell stocks. You generally cannot purchase stocks without an account with one and brokerages can also help facilitate other kinds of investments. There are different types of brokers with different levels of involvement.
- Full-service brokerage: A broker buys and sells stock on behalf of an investor and provides specific advice about the investor’s portfolio. Investors generally pay fairly high commissions and other fees for this service. Popular options include Edward Jones, Fidelity, and Charles Schwabb.
- Robo-advisors: Algorithms manage the investor’s portfolio for them, optimizing for various things and requiring very little work on the investor’s part. The cost of these advisors is typically less than their human counterparts, but investors are generally charged a fee for the service. Popular options include SoFi Automated Investing, Wealthfront, and Betterment.
- Online self-directed brokerage: The investor researches and chooses their own investments, the brokerage just executes them. The platform may charge a small monthly or per-transaction fee, and they will often charge additional fees for advanced insights. Popular options include E*trade, TD Ameritrade, and Robinhood.
It’s important to note that, even if you pay a professional to manage your investments, there is still no guarantee that you’ll get a return on anything.
Once you have an idea of what your goals are and how aggressive you want to be, it’s time to actually start selecting investments. There are three general categories of investments: equity, fixed income, and cash and cash alternatives. An equity is an investment where you own part of something, meaning your potential increase is tied to how that company or enterprise performs. Equities, in general, are one of the more risky types of investment. A fixed-income investment is, essentially, an investment where you loan money to something or someone, and they pay the money back to you, plus a set amount of interest. Fixed-income investments tend to be in the middle in terms of risk–some are very safe, some are less so. Cash and cash alternatives are low-risk investments that earn a small amount of interest.
Of course, there are lots of different kinds of investments within those categories. Here’s a brief overview of a few of the most common:
Stocks or Shares
- Definition: Partial ownership of a company.
- Category: Equity
- How it works: When you buy stocks or shares, you become a “shareholder” and, thus, you profit when the company does. The easiest way to buy stocks is to open an online brokerage account. Once you’re set up on the platform of your choice, you can research companies of interest and purchase as many shares as you prefer. The most common way to make money with stocks is to buy when a stock is price is low (the company’s stocks aren’t high in demand, possibly because the company isn’t doing very well) and sell it when it’s high (the company’s stock is in high demand because the company is thriving). You may also earn dividends, which are payments to shareholders based on the company’s earnings.
Bonds
- Definition: A loan made to an entity by an investor.
- Category: Fixed-income investment
- How it works: Bonds are like loans to businesses, entities, or governments. You agree to give them the money, and they pay it back with interest. You can also sell a bond before it matures and make money if its value has gone up. Bonds are not guaranteed, as the person you loan the money to may default and not pay it back. You need to do your research to ensure the bond issuer has a history of paying back their debts. Treasury bonds, however, are considered very safe investments as the government is pretty good at paying back its debts. You can buy bonds through a broker or treasury bonds directly from the government.
Funds
- Definition: A collection of investments purchased by investors pooling their money together.
- Category: Equity
- How it works: Some of the most common types of funds include mutual funds, exchange-traded funds (ETFs), and index funds. Funds are generally managed by professionals and, since they are inherently diversified, can come with lower risk than other investments. The trade-off is that you as the investor have less power in the specifics. You make money by earning dividends from the investments within the fund, when an investment in the fund is sold for higher than it was purchased, or if you sell your share of the fund for more than you paid.
CDs (Certificates of Deposit) & Share Certificates
- Definition: An agreement to leave your money at a financial institution for a certain amount of time in exchange for a set interest rate.
- Category: Cash/Cash Alternative
- How it works: You can open a CD at most banks and a share certificate at most credit unions. The two have small differences, but are essentially the same from the investor’s perspective. You agree not to withdraw the money until the agreed-upon date arrives. If you get a CD or share certificate from an insured institution, there is no risk of losing your money, unless you invest more than what the FDIC or NCUA would cover. The only risk involved is if you need the money before the agreed date. If you take it out early, you’ll likely forfeit any interest you earned and may even need to pay additional fees.
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