I’m writing this post for a good friend who is starting out trying to build her portfolio. At the same time, anyone could use it, if they’re new to building an investment portfolio. As always however, they are opinions. That you choose to act on them places full responsibility on you. Investing in the markets leaves you liable to lose your shirt. Got it? Got it.
First off, understand that having a portfolio isn’t something optional in the way it used to be in the past. Yes, most companies offer 401k savings plans now and yes, you should totally max out your share of contributions to ensure you get the full match that your employer offers.
But you also know that’s not nearly enough. Even with the best paying jobs, sticking to the mandatory contribution, even at the maximum will not do anything meaningful for your retirement lifestyle. So you want to do more. Great choice.
I’ll tell you then: resist the temptation to jump into picking stocks. As my good friend Zarathustra once said: He who would learn to fly one day must first learn to stand and walk and run and climb and dance; one cannot fly into flying. It’s not that picking companies to invest in is particularly difficult, if you can comfortably estimate earning power (and of course you can, who does not know that whoever is making Coca Cola will be making money for a very long time to come), and you can reasonably judge a good price to pay for ownership (a careful study of past price movements, and valuations will help) then you have the basic tools you need. The rest is effort, discipline, and learning. My point is, if you can read and add numbers, you can invest. What you need protection from, or time to learn how to manage without losing your nerve and selling, is the inevitable gyrations in the value of your stock holdings. Because that is what hurts your returns, statistically speaking. Brokerage fees, trying to time the market, constantly racking up expenses and buying high and selling low are what kills anyone’s investment dreams. So your job as an investor, is to sit there no matter what the market does and try not to get thrown off. They don’t call it a bull for nothing. You’re essentially engaged in a financial game of chicken and your job is not to blink. If you can sit through it, over time, compounding will do the job for you. But this is not easy. This is something only time and experience can teach. And I don’t know about you, but I’d rather not see you use your nest egg to learn that lesson. It’s a very expensive way to learn anything, since you’re not just losing money, you’re also losing time.
So my main advice is this. Take $3,000 and open an account with Vanguard. Make it a Roth IRA. It allows you to put in about $5,000 in that annually. If you cannot come up with three to five thousand dollars in a year, as an employed person, stop reading now. You have no business investing in the stock market, yet. Go make fucking money. The safest index, for this your newly established Roth is the S&P 500. It’s the barometer of the American economy, and in my experience, if politics always moves Left, the S&P500 averaged over time, always moved up and to the right. Invest in that.
Secondly, pick other niche indexes that you’re particularly well informed about and have reasonable expectations that it will do well. For instance, I know the biomedicals/pharma/genetics industry is delivering high growth. What I don’t know is which of the companies will make it and grow up, and which will go bust once it’s new smashing innovative drug/device/chemical/technique thing either fails to get approved or fails to move the market. The companies all look the same, lots of revenue with big losses, or no revenue at all, with big losses. Would I then try to read myself into knowing which technology will make it and which won’t. No. I invest in a broad index. Some will rise, some will fall, but overall, I will be alright. You’re well served doing something similar. Maybe you do know which companies have superior tech. In which case, take out a small amount of money and buy directly, then put the rest in an index. Also, hit me up @eldivyn and tell me about it. I’ll give you 10% of my profits, scouts’ honor.
Now, once you’ve picked some funds and indexes, another thing to do is allocate the money for them in your vanguard account, but don’t buy them at a lump sum. Vanguard lets you buy a little at a time, over a long period until all your money is invested. It’s called dollar cost averaging. The idea is that when you spread your buying over time, you get both periods of undervaluation and overvaluation, which makes for a better overall average price. If you buy it all at once, you run the risk of buying at a time when the price of the index is super high and then enduring negative or little returns for a while. If you take a long enough horizon, it won’t really matter, but you always want to make your own life easier.
Finally, after building a base of passively allocated indexes, put a little money aside for the interesting stuff. Read books about your favorite companies, find out about their financial performance, spend time to get the education and every now and then, buy directly into them, to get a feel for how these decisions work. That’s also the fund you try to ride the next big thing from. Or chase a hot IPO. The size of this play money is entirely up to you.
So that’s all I got for now. On a personal note, I got some Forex education material from a good friend, and I’m getting the education. My first impression is: this demands so much more raw economics, in thinking, versus my more business/finance oriented view. Second, it’s making me much more interested in international stocks than I have been, as a currency risk hedge. So I’ve been looking at Nigeria, London and Continental Europe a lot lately. Maybe this is the year I finally go the Interactive Brokers route. If you have ideas in this area, drop me a comment or hit me up on twitter.