Setting up a new investment or retirement account is a fairly straightforward process. However, the hard part comes when you’re asked to pick which investments you’d like to have.
There are literally an infinite number of combinations you could choose for your investment portfolio. So how is someone (especially a non-financial professional) supposed to know which assets are the good ones to pick?
Whether you’re looking to build long-term, sustainable wealth or just become familiar with investing in general, there are a few key elements you’ll want to consider holding. In this post, we’ll explore which assets should be in your portfolio as well as offer a few highly effective shortcuts.
The Elements of a Good Portfolio
Whenever you’re thinking about your investment portfolio, it helps to think of it like a giant pie. Each slice of this pie can be any flavor and size you want.
When it comes to investing, this is called “asset allocation”. Asset allocation is deciding how much of each type of asset you want in your investment pie. Here are a few of the most common ones to consider.
Stocks
Stocks are the bedrock of most long-term and high-growth portfolios. This is because out of all the publicly available investment types, stocks have classically experienced the greatest returns.
To put this in perspective, $100 invested back in 1928 would be worth $624,535 today. No other asset class comes anywhere close to producing those kinds of returns.
What’s even better is that some stocks pay quarterly dividends – distributions of the earnings the company has made. These payments are on top of the potential gains you could make from buying and selling the stock.
While stocks work well for growth, they can also be highly volatile. This will depend largely on whether you buy shares of large, well-known companies or smaller ones that are just starting out. The company’s business strategy will also play a role in this.
Because stock prices fluctuate all the time, it’s not a good idea to use them with money that you’ll need in the short term (like an emergency fund or savings for a down payment). The longer your time horizon is for investing, the more these fluctuations will smooth out and gradually trend upward over time.
Bonds
A bond represents a debt that must be repaid with interest. As an investment tool, they tend to be much more conservative than stocks and can work well to add stability to an investor’s portfolio.
Most bonds are either from the government or corporations. Government bonds are ultra-safe but pay the least returns (since there’s very little risk of default). Since a company always runs the risk of going out of business, its bonds tend to pay a little higher yield than those from the government.
Although they’re safer than stocks, bonds can sometimes lose money. As interest rates change, the overall yield of a bond can fluctuate causing some ups and downs. Again, investing with a long-term mindset will help you to overcome these changes in price.
Real Estate
Real estate is another great element to include in your portfolio because it tends to be uncorrelated with the movements of stocks and bonds. When the financial markets are down, people and businesses still need a place to live and operate, so being the owner of real estate can help you diversify your asset allocation.
Generally, to make real estate a part of your investment portfolio you’ll need to buy what’s called a REIT. REIT stands for “real estate investment trust” and is a company that owns and operates various commercial properties. Similar to dividend stocks, REITs pay distributions to their owners which can translate into healthy cash flow. However, REITs can also be very volatile.
Commodities / Alternatives
Although they’re generally the smallest slice of your pie, commodities and alternatives are still ones to consider. These would be items like gold, silver, oil, energy, cryptocurrency, etc. Like real estate, this asset class isn’t necessarily tied to the stock or bond market, so it can be another good mechanism for diversification.
What Kind of Asset Allocation Should I Have?
The age-old question of investing is how much each type of asset should I hold? For this reason, financial professionals will often recommend something called the Rule of 110.
The Rule of 110 is simple to use. If you consider just the two main asset classes (stocks and bonds), then do the following:
- Take your age. Example: You’re 30 years old.
- Subtract your age from 100. The result is the percentage of your portfolio you should have in stocks. Example: 110 – 30 = 80% in stocks.
- The remainder of your asset allocation is how much you should have in bonds: 100 – 80 = 20% in bonds.
Obviously, this is just an easy to follow guideline. You’re always free to set your asset allocation any way you wish based on your specific investment goals and tolerance for risk.
The Simple Way to Diversify
If still unsure of how to structure your portfolio, an easy solution is to let someone else do it for you. This can be done with two other types of financial products: mutual funds and ETFs.
- A mutual fund is a large collection of assets (stocks, bonds, real estate, etc.) where investor money is pooled together. This helps give investors automatic diversification at a fraction of the price.
- ETFs (exchange-traded funds) work similar to mutual funds but they trade on the open stock market instead of direct through brokerages. Therefore, they can be very popular on investment apps like Robinhood.
Mutual funds and ETFs are helpful because they allow you to own a large number of assets all at once. In fact, some even come with pre-set asset allocations making them essentially ready-made portfolios. For example, the well-known STAR fund from Vanguard has a pre-set asset allocation of 60/40 stocks and bonds making it a one-stop shop for investors looking for this mix.
Another simple way to diversify is to buy the whole stock market. This is done by purchasing shares of something called an index fund – a fund that mirrors the same holdings of a major market index like the S&P 500. There are many financial experts who believe that index fund investing is the ultimate way to go because history has shown that the majority of other funds fail to outperform them.
No matter which way you choose to go, what’s important is not to wait. Investing is more about consistently contributing to your portfolio than it is about hunting down the right assets. For that reason, I encourage you to take a good look at your budget and start devoting as much money as you can toward your investment goals each month. The sooner you start building your investment portfolio, the better your chances of having long-term success.
Featured image credit: Pexels
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