There is a lot of information out there on what investing is, and how to tackle risk etc. but there are very few places where they actually give you a guide on how to get started. So I will outline some of my experiences on how I got started and what I was thinking about, simply in 4 steps to start investing.
1) Initial Capital and Saving Scheme
My initial capital was a shy $2,000, which I had earned from selling ice cream all summer, but you could even start as low as $1,000. Since I started investing when I was 14 I didn’t really need the money and saved most of my income. I could also apply more risk to my portfolio, as I didn’t care if I lost any money. After that, I continued to save most of my income and put it into the market. Here’s how my suggested savings schedule would look like:
- [14 – 20yrs] – save 40% – 70% of your part-time salary
- While in college, it’s hard to save but keeping your money in there is good enough. You’re actually still investing, but in human capital. If a college tuition of $40,000 lands you a job that pays you $12,000 more, annually, it would definitely be considered a good investment.
- [22 – 30yrs] 10% of your salary (You still need to have some fun)
- [30 – 50yrs] 15%
- [50+yrs] 20%
2) Selecting the Right Investment Goals and Appropriate Risk
I like to divide my portfolio up in to goals and different risk buckets. Initially, I only invested for my financial buffer but later on I focused on saving towards my college tuition. Here are some other examples;
Financial Buffer [High risk]
- This is your play money that you would have wasted on stupid stuff anyway.
- Think about this as an emergency fund for pleasure and travel. The benefit of this part is that you can apply much more risk to it, as it’s more of a perks generating part of your investments.
House [Medium risk]
- Set an estimated timeline when you want to buy a house.
- Also set a price range that you’re aiming for. The bigger range between the lower number and the higher number, the more risk you can apply to your portfolio.
Emergency Fund [Low risk]
- I like to call this the extra pillow that makes me sleep well at night. An emergency fund can be in the range from 4 months salary to 2 years salary, depending on your preference.
Retirement [Medium -> Low risk]
- We got a great inforgraphic showing how much you need to save for retirement.
- The farther away you are from retirement, the more risk you can apply to it.
3) Risk profile
Now when you have figured out what you’re saving for it’s easier to allocate your investments and find your risk profile. There are tons of guidelines and methods out there for portfolio allocation. According to CNN Money you should take [100 – your age] to see how much percentage you should hold in stocks. E.g. if you’re 30 years old you should have 70% in stocks.
It is true that you should adjust your risk as you get closer to your retirement age or when you want to withdraw your money. I like to compare this to a boat trip, it doesn’t bother me if there are big waves (volatility) when I’m out at sea but when it’s time for me to step of the boat and get on to dry land, I prefer if there is a smooth disembarkation. It would really be a bummer if I have to sell an investment that is down 15%, only to see it up 50% next year, you guys get the picture.
4) Creating a Portfolio
A portfolio is a fancy way of referring to any collection of financial assets such as stocks, bonds, and cash. Everyone is talking about having a diversified and optimized portfolio. My take on it is that you should have an optimized portfolio to your needs and diversified to your interests. Let me show you how I divide my portfolio.
Initially, I have my financial buffer. This can vary anywhere from 10% -40% of your total portfolio. The more dependent you are on your savings the smaller this part should get, since this part of your portfolio has a higher risk tolerance. I prefer to have shorter investment horizon on this part, in order to focus on high-growth stocks and market discrepancies. For someone who doesn’t like to do his or her homework, it’s better to place this part on less volatile investments such as growth stocks and blue chip stocks.
Here’s where you should see the bulk of the return in your portfolio. It’s a bit more risky than your blue chip stocks but, in return, they often given you higher growth. If you’re looking to buy a car or a house then this bucket could help you level up to the next level but it can also make you buy an older model, depending on the markets and when you have to cash out. If you’re starting out saving for retirement at a young age, then this is also a bucket that could be around 20% of your portfolio, and as you get closer to cashing out you should decrease these holdings.
These are your cash cows. A lot of these are blue chip stocks, giving you a decent cash flow plus a potential increase in the stock price may result in a nice return. The beauty of this investment is that even if the market goes down you’ll still get your dividend payments and it’s often pays much better than having your money in a savings account. If you’re looking to grow your capital then this bucket could be combined with the blue chip bucket and focus more on the growth stock bucket. If you’re looking to maintain your capital and having a decent cash flow, this should be a larger part of your portfolio, up towards 20%.
#Blue Chip Stocks
These are companies that have been around for a long time, and seen multiple business cycles but still kept on running business as usual. These stocks make up for a good foundation to any portfolio. However, don’t expect to see a 20% annual return on these portfolio locomotives. These are for folks that seek to have a slow, but secure, growth in their portfolio.
Exchange traded funds are great for the lazy investor. They’re like mutual funds but better. First of all, I am not a fan of old school mutual funds so this could be slightly biased. The reasons are many; such as fees, inflexibility, and poor returns. To explain it all, will take a whole new post. [Note to self, write a blog post on why mutual funds suck and ETFs rock.] Exchange Traded Funds (ETFs) act like a mutual fund but you have much more freedom on when to buy and sell, plus their expense ration is usually 80%-90% lower than the old school mutual funds.
By investing in ETFs you have them do the dirty work for you. It’s also a good way to diversify for smaller portfolios with less cash. If you wanted to buy every stock in the S&P 500 you’ll have to pay about $8,000, only in transaction fees. Now you can get the same diversification through buying one share of an ETF. There is a vast selection of ETFs, covering everything from Bonds and Commodities to large indices. This is also a great addition to your building blocks for your retirement portfolio. Since there are a lot of choices here it’s important to find one that suits you and your risk vs. reward structure. If you decide to use this for your bond portion of your portfolio you have to keep in mind that you will not receive the cash payments, but the ETF will. Depending on how lazy/active you are, the ETFs can be anywhere from 0-50% of your portfolio.
It’s always good to have cash on hand to invest when new situations arise and you don’t want to sell your current positions. The size of this bucket is more about preference than anything else.
There you have my 4 steps to start investing. The only thing you need to do now; is to set up your own plan, do your home work, and open a brokerage account. Here’s also a some more tips about how to save for retirement. Finally, if you have any questions or want me to explain a certain topic, please comment below and I’ll be sure to answer all of them.