How to Get Rich(er) Ch. 3
Investment Strategies for YOU
Now that I have discussed the types of investments you have to choose from and how you can use mutual funds to invest in these securities, it makes sense that I discuss how you should invest your money. I’ll start first with taxable accounts and then discuss how to invest your 401(k)/403(b) and Roth IRA funds.
Taxable Savings
The number one goal of your savings is to provide a comfortable lifestyle in the event that you are not currently working. Assuming that you are in a stable job and under thirty years old, you probably do not need to access your savings in the near future unless you plan to buy a house. That said, I strongly recommend that you use short-term money market investment options for any money you may need in the event of an emergency. If you can easily liquidate stock investments and are willing to absorb losses if necessary, then you probably don’t need more than one month of living expenses in short-term investments. This is my current strategy.
As for the rest of your money, if you have less than $10k in savings, you are probably better off investing in one large cap stock mutual fund. I think an index fund that tracks the S&P 500 is probably ideal, but you can look for actively managed funds as well. An index fund will diversify your money across the larger, more established stocks and result in a better return than using a savings account for just about any 5-year period.
If are have more than $10k but less than $20k to invest, I still recommend using one or two index funds, but consider putting about half of your savings into an index fund that tracks small and mid-cap stocks. A fund that indexes the Russell 2000 might be a good choice for your second mutual fund. You could also look for an actively managed small or mid-cap mutual fund. The additional risk should reward you more, but you aren’t gambling your entire savings on more volatile stocks since you are also invested in the S&P 500 index.
Once you build your savings into the $20-100k range, you should probably still stick primarily to mutual funds. However, now you want to consider diversifying across the market a little more. Consider putting $5-10k in each of the following types of mutual funds:
1) International Stocks
2) Small-Cap (in addition to the index fund you probably already hold)
3) Additional Large-Cap Funds
4) Safe Bonds (probably only if your are closer to $100k in savings or if you are wary of a looming bear market)
5) High Yield/Junk Bonds (just as risky as small cap stocks, but different market factors drive the price movement in these securities)
For a single person in his/her twenties with >$20k in savings who does not need to liquidate their savings very soon (i.e., to buy a house), your overall portfolio should probably break down as follows:
80-85% Stocks
10-15% Bonds
0-5% Short Term (outside of short-term holdings within any of your stock/bond mutual funds)
Of the 80-85% in stocks, you should probably hold about 30-40% in large cap U.S. stocks, 10-15% in international stocks (of all sizes), and 50-60% in small and mid-cap stocks. As you get older, you should hold less in small cap stocks since you want to reduce the volatility in your portfolio as you near retirement.
Of the 10-15% in bonds, you should probably split equally between safe bonds (AA-AAA rated bonds), investment grade bonds (BBB and higher), and junk bonds (BB and lower). Start with the safer bonds and then move towards more risk as you start investing more in bonds. As you get older, you want to increase your bond holdings at the expense of stocks since bonds provide more interest income.
If you have less in savings, it makes less sense to hold bonds since you probably cannot meet the minimum deposit requirements to hold more than one or two funds.
When looking to purchase mutual funds to meet your intended portfolio breakdown, look closely at the prospectus to better understand the normal investment strategy.
For those who have savings in excess of $100k, the strategy outlined above still applies. You may want to consider picking some individual stocks if you are comfortable enough with this approach and have established a diverse base with the rest of your savings. If you are buying individual stocks, be sure to diversify across different industries and also make sure you have a target entry and exit price before buying the stock (both to realize strong gains and to cut your losses if necessary). Note that you will pay less in capital gains taxes if you hold a stock for more than one year. Don’t use individual stocks strictly to gamble. Penny stocks are extremely volatile and risky, so you should never overexpose yourself here. Better yet, stay away from penny stocks.
My current portfolio in my taxable account breaks down almost the same as the allocation I recommended above (including individual stock holdings). Fidelity’s website has great tools that allow me to check out my asset allocation in total and by each individual investment.
Retirement Accounts
For those of you that put money aside into retirement accounts, here is where you should take more risks, especially if you are in your twenties. If you are not contributing to a 401(k)/403(b) or a Roth IRA and are able to make annual contributions, you should start ASAP. The 401(k)/403(b) allows you to put money aside from your paycheck. This income and all investment gains associated with this money are tax deferred until after you withdraw the funds. Normally, your employer will match some of your contributions, so the 401(k)/403(b) is a great way to get a little extra money from your employer each year. You cannot take this money until you are 59 ½ years old without penalty except in a couple specific situations. A Roth IRA allows you to put after tax income aside for investing. The same age restrictions apply as did with the 401(k), but all investment gains are tax-free. There are restrictions for how much you can put aside in either of these retirement options in a calendar year, so make sure you are aware of these restrictions (or ask me if you really want to know and you are too lazy to do your own research).
Since you cannot touch these funds until well into the future, you should use a much more aggressive investment strategy, focusing almost entirely on small-cap equities. Since the long-term return is highest with small-cap stocks and your time horizon is long enough to absorb some volatility, I strongly recommend at least 50% of your retirement account to be invested in small-cap and mid-cap stocks. The rest should go towards large cap stocks (including index funds) with possibly a small amount in bonds. Once again, you should invest about 10-15% in international stocks to diversify somewhat against the U.S. equity market.
My 401(k) does not follow my recommended strategy at this time. I have a few mutual fund options, but I have avoided them until now and focused on company stock and an S&P 500 index fund. I should do some research soon because I can probably invest my 401(k) funds better. My Roth IRA is fairly consistent with the recommendation I have provided.
I’ll write about how I research stocks and mutual funds in the fourth and final chapter on this topic. I’ll also pass along which industries should perform well in the near future and my non-expert opinion about what will happen in the overall stock and bond market over the next couple years.
Please let me know if you found this helpful. As usual, comments are welcome and encouraged!
Now that I have discussed the types of investments you have to choose from and how you can use mutual funds to invest in these securities, it makes sense that I discuss how you should invest your money. I’ll start first with taxable accounts and then discuss how to invest your 401(k)/403(b) and Roth IRA funds.
Taxable Savings
The number one goal of your savings is to provide a comfortable lifestyle in the event that you are not currently working. Assuming that you are in a stable job and under thirty years old, you probably do not need to access your savings in the near future unless you plan to buy a house. That said, I strongly recommend that you use short-term money market investment options for any money you may need in the event of an emergency. If you can easily liquidate stock investments and are willing to absorb losses if necessary, then you probably don’t need more than one month of living expenses in short-term investments. This is my current strategy.
As for the rest of your money, if you have less than $10k in savings, you are probably better off investing in one large cap stock mutual fund. I think an index fund that tracks the S&P 500 is probably ideal, but you can look for actively managed funds as well. An index fund will diversify your money across the larger, more established stocks and result in a better return than using a savings account for just about any 5-year period.
If are have more than $10k but less than $20k to invest, I still recommend using one or two index funds, but consider putting about half of your savings into an index fund that tracks small and mid-cap stocks. A fund that indexes the Russell 2000 might be a good choice for your second mutual fund. You could also look for an actively managed small or mid-cap mutual fund. The additional risk should reward you more, but you aren’t gambling your entire savings on more volatile stocks since you are also invested in the S&P 500 index.
Once you build your savings into the $20-100k range, you should probably still stick primarily to mutual funds. However, now you want to consider diversifying across the market a little more. Consider putting $5-10k in each of the following types of mutual funds:
1) International Stocks
2) Small-Cap (in addition to the index fund you probably already hold)
3) Additional Large-Cap Funds
4) Safe Bonds (probably only if your are closer to $100k in savings or if you are wary of a looming bear market)
5) High Yield/Junk Bonds (just as risky as small cap stocks, but different market factors drive the price movement in these securities)
For a single person in his/her twenties with >$20k in savings who does not need to liquidate their savings very soon (i.e., to buy a house), your overall portfolio should probably break down as follows:
80-85% Stocks
10-15% Bonds
0-5% Short Term (outside of short-term holdings within any of your stock/bond mutual funds)
Of the 80-85% in stocks, you should probably hold about 30-40% in large cap U.S. stocks, 10-15% in international stocks (of all sizes), and 50-60% in small and mid-cap stocks. As you get older, you should hold less in small cap stocks since you want to reduce the volatility in your portfolio as you near retirement.
Of the 10-15% in bonds, you should probably split equally between safe bonds (AA-AAA rated bonds), investment grade bonds (BBB and higher), and junk bonds (BB and lower). Start with the safer bonds and then move towards more risk as you start investing more in bonds. As you get older, you want to increase your bond holdings at the expense of stocks since bonds provide more interest income.
If you have less in savings, it makes less sense to hold bonds since you probably cannot meet the minimum deposit requirements to hold more than one or two funds.
When looking to purchase mutual funds to meet your intended portfolio breakdown, look closely at the prospectus to better understand the normal investment strategy.
For those who have savings in excess of $100k, the strategy outlined above still applies. You may want to consider picking some individual stocks if you are comfortable enough with this approach and have established a diverse base with the rest of your savings. If you are buying individual stocks, be sure to diversify across different industries and also make sure you have a target entry and exit price before buying the stock (both to realize strong gains and to cut your losses if necessary). Note that you will pay less in capital gains taxes if you hold a stock for more than one year. Don’t use individual stocks strictly to gamble. Penny stocks are extremely volatile and risky, so you should never overexpose yourself here. Better yet, stay away from penny stocks.
My current portfolio in my taxable account breaks down almost the same as the allocation I recommended above (including individual stock holdings). Fidelity’s website has great tools that allow me to check out my asset allocation in total and by each individual investment.
Retirement Accounts
For those of you that put money aside into retirement accounts, here is where you should take more risks, especially if you are in your twenties. If you are not contributing to a 401(k)/403(b) or a Roth IRA and are able to make annual contributions, you should start ASAP. The 401(k)/403(b) allows you to put money aside from your paycheck. This income and all investment gains associated with this money are tax deferred until after you withdraw the funds. Normally, your employer will match some of your contributions, so the 401(k)/403(b) is a great way to get a little extra money from your employer each year. You cannot take this money until you are 59 ½ years old without penalty except in a couple specific situations. A Roth IRA allows you to put after tax income aside for investing. The same age restrictions apply as did with the 401(k), but all investment gains are tax-free. There are restrictions for how much you can put aside in either of these retirement options in a calendar year, so make sure you are aware of these restrictions (or ask me if you really want to know and you are too lazy to do your own research).
Since you cannot touch these funds until well into the future, you should use a much more aggressive investment strategy, focusing almost entirely on small-cap equities. Since the long-term return is highest with small-cap stocks and your time horizon is long enough to absorb some volatility, I strongly recommend at least 50% of your retirement account to be invested in small-cap and mid-cap stocks. The rest should go towards large cap stocks (including index funds) with possibly a small amount in bonds. Once again, you should invest about 10-15% in international stocks to diversify somewhat against the U.S. equity market.
My 401(k) does not follow my recommended strategy at this time. I have a few mutual fund options, but I have avoided them until now and focused on company stock and an S&P 500 index fund. I should do some research soon because I can probably invest my 401(k) funds better. My Roth IRA is fairly consistent with the recommendation I have provided.
I’ll write about how I research stocks and mutual funds in the fourth and final chapter on this topic. I’ll also pass along which industries should perform well in the near future and my non-expert opinion about what will happen in the overall stock and bond market over the next couple years.
Please let me know if you found this helpful. As usual, comments are welcome and encouraged!
posted by GaryGinew at 4:59 PM
0 Comments:
Post a Comment
<< Home