To many, investing sounds overly complicated especially if it involves investing in more than one financial asset. Building a simple but effective portfolio is a dream that every investor holds close to their hearts, and can be done by everyone. Here are the steps you can take to do the same!
Step #1: Open an investing account and select a Robo advisor
Like they say the journey of a thousand miles begins with a single step. Opening an investment account is the first and most basic step in your investment journey, and you can open an investment account with your bank or with an investment firm, the choice is yours. For most people, the urge to open the investment account with their bank is often too strong based on simple reasons such as bank loyalty or rigidity to migrate to other banks or firms.
Whatever option you choose is fine as long as the institution will have your investing interests at heart. You can visit your bank and make inquiries if they deal with investment portfolios and try to absorb as much knowledge as you can about the combinations of portfolios that they offer and the terms and conditions of operating specific investment accounts. Once you are satisfied and open your investment account, you can choose to link your savings account with your investment account for an easier and more disciplined channeling of funds into your investment account.
The most common investment account is the individual retirement account (IRA) and more specifically a Roth IRA where the earnings on your investment build-up without any tax being charged on them. Another option would be online brokerage firms that will help you make a dent in the stock market. Whichever investment account you choose, keep in mind the amount of money you want to invest and the expenses that will stem from running that investment account.
Next, you will need to select a Robo advisor, and I’m sure most of you are scratching your heads wondering what a Robo advisor is. Well, this is simply a software product that is customized to offer guided investment and financial advice to investors. Robo advisors have gained immense popularity over the years, and we can attribute this to their automated nature.
With your investment goals in mind, these digitized platforms will strategically allocate your wealth to investment assets that will see your money snowball over time. A Robo advisor saves you the bucks you would otherwise use to hire a fund manager or financial advisor. All you have to do is select a Robo advisor, answer a couple of questions concerning your ideal investment, and watch as your money grows with time.
Step #2: Set your investment target
As you already know, any goal whatsoever needs to be SMART. In the investment world, this means clearly outlining your overall investment goals both in the short-run and in the long run. Doing this helps you have a focused mind towards achieving your investment target because after all, you can’t achieve something if you are not sure what it is.
Goal setting is such an inclusive activity. Inclusive in a way that you have to list down what you own, your earnings, and also your debts. You don’t have to shy away from listing your debts even if you know you will settle them sooner or later. By doing so, you get a clear view of your individual financial position and whether you know it or not, it boosts up your morale to go about your financial life in a better way. Develop a debt payment plan by paying off your debts such as credit card debts so that you have more money left to save. Consistency is key and thus your goal should be to create a plan that you can keep up with and not one that is overly strenuous on your finances.
When setting your investment target, several factors come into play, and shortly, we shall have a look at some of the major factors. The factors include; the time period of the investment, your financial capability, your risk tolerance levels, and your age bracket, just to mention a few. Now let’s see how they affect your goal setting. For example, financial capability. Your savings amount depends on your earnings and to be realistic enough, you can only set a target that you can afford. Getting on top of that financial ladder comes with a lot of sacrifices, discipline, and determination which I know most of us can commit to. The trick is to set your priorities and targets appropriately.
Step #3: Select an index fund to invest in
If you have a big appetite for risk, then the stock market is a viable investment option for you, and selecting an ideal index fund is a good starting point. Index funds simply refer to mutual funds or Exchange Traded Funds(ETFs) that track an indexed market and mirrors its performance.
For example, let’s assume that you’ve invested in an index fund that tracks the performance of the S&P 500 stocks. The S&P 500 is an index that follows the 500 top-performing companies in the stock market, and at the moment, it stands as the most followed index fund in the stock market. By default, you will have invested in a share of each of these 500 companies.
Through an index fund, you can buy into diversified securities within the stock market, and as a result, will end up with a well-rounded investment portfolio. Index funds are an easier and low-cost method of including multiple stocks in your portfolio without buying each of them individually. Investors love index funds because it enables them to mitigate risks that come with a strict, non-diversified portfolio.
But even with all these benefits, selecting an index fund that you will hold onto for many years can be a tricky endeavor.
Typically, your fund manager or Robo advisor picks up an index fund that resonates with your investment goals. The best index fund should consist of diversified investments (i.e. a mix of stocks and bonds) because diversity comes with a large field to spread the risks associated with the investment fund.
With that said, there comes a need to allocate the assets depending on a number of factors. First, always choose an index fund with a low expense ratio. This means that you will have to pay low costs and expenses to the fund, hence being better positioned to maximize your returns.
Another factor to consider is age. If you are a young person between age 20 -30 and you are saving for retirement, you will most likely choose to invest more in stocks compared to bonds and other index funds. Now, you’re probably wondering why that is? Well, here’s the reason, stocks are higher-risk investments, and the higher the risk, the greater the return. However, this is not always the case because sometimes investing solely in an investment portfolio with high risks can lead to massive financial losses. Remember, the market can be unpredictable.
Also, whenever such unfortunate situations occur, younger people have a greater window of time to recover from the losses and re-balance their portfolios since they are still far from retirement. However, with older individuals, it becomes a difficult and emotional task to recover from such losses, because there is usually not enough time to start over. Sad, right? And that’s why you should consider your age before making that index fund decision.
Additionally, your risk tolerance levels should be assessed before selecting an index fund. If you are a risk-taker, you will most likely go for the riskiest index fund as long as it promises the highest returns. To be such a risk-taker, you have to be psychologically prepared that you can either lose close to everything or gain a lot, depending on the market fluctuations. On the contrary, there are risk-averse people who would do anything just to avoid the risks. If you are part of the risk-averse community, then it is more sensible to select a fund that won’t have your adrenaline levels spiking with every market fluctuation that occurs.
Step #4: Set up regular contributions
All the other three steps were just the tip of the iceberg in this investment journey. Because let’s face it, what use is a plan without bringing it to reality? Once you set up an investment account, it’s now time to deposit money into it periodically.
You can deposit funds into your account weekly or monthly depending on your financial ability. In every market there are usually the boom and recession seasons, so once you maintain your regular contributions, your investment fund has a higher chance of surviving chronic market conditions, compared to an investment fund with a shaky contribution arrangement. Remember this is your investment and so you have control over it. Also, you don’t have to mimic other people’s saving plans or do what everyone else seems to be doing. Just go at your own pace while keeping your ultimate goals in mind because investments grow over time. Whatever financial destination you have in mind, you will get there.
An easier approach to making your regular contributions is by linking your savings account to your investment account such that the funds are channeled directly from your savings account to your investment account. This lifts off a lot of emotional involvement from your plate and makes the contributions strict and timely. All you have to do is authorize the transfer and leave the rest to the fund manager or the Robo advisor.
Treating your investment fund as a bill is another trick that will keep you on toes in making your regular contributions. Be it electricity bills, water bills, or car maintenance bills, bills simply have a way of keeping us up in the middle of the night wondering how we will pay them on time. So automate these contributions and reaching your financial goals will be a breeze!
Step #5: Re-balance your fund as needed
With the constant changes in the market trends, re-balancing of the investment fund is paramount. Re-balancing is normally done after a year or so. Let’s say you had initially invested in 60% stocks, 30% bonds and 10% international stocks and the market rates changes in favor of the stocks, you might find it necessary to re-balance your portfolio so that a greater chunk of your investment is in local stocks and by doing so, reap more returns. For example, your rebalanced portfolio may look something like this; 80% stocks, 10% bonds, and 10% international stocks.
Depending on the performance, you might opt to sell some of your investments like the international stocks and reinvest the money in more promising equities. However, this can be costly and you really need to think these decisions through.
Not only does re-balancing your portfolio depend on market trends, but also it depends on factors like age. As I mentioned earlier, younger people have a tendency of investing more in higher-risk equities, but as you get older, it goes without saying that your investment fund becomes less volatile hence the need to re-balance and hold more of your portfolio in bonds compared to earlier. There are certain rules of thumb on how to determine the percentage of your portfolio to be held in stocks. Even though they differ, the rules serve as great pointers to which investment portfolio to choose and at what time.
For example, there’s the rule of 110 which states that 110- your age = % of investment in stocks. So for instance, if you are 40 years old, 70% of your portfolio should be in stocks (110 -40=70).
Alternatively, there are other investment funds known as target-date funds. As the name suggests, these are funds that adjust the portfolio over time. They are set according to the time period of investment. So if you don’t want to go through all the work of researching for the most suitable investment fund, this is an easier way out. Put your money into a target-date fund, set your investment period, and leave the target-date fund to balance your money into a combination of investments. In short, it runs your portfolio. While the deal sounds too good to be true, target-date funds attract quite higher charges and leave you with no control over your investment.
So there you have it! Those are the five critical steps that will help you build a simple and effective portfolio!