ôô

Are You Making Investing Too Complicated?

Laura answers a common question about how to start investing and which investments to choose.

By
Laura Adams, MBA,
Episode #420
Are You Making Investing Too Complicated?

One of the easiest ways on the planet to become a part owner of a business is to buy shares of a publicly traded company, like Apple (AAPL), Nike (NKE), or Google (GOOG). Not only do the various exchanges, such as the NASDAQ and New York Stock Exchange, allow you to buy shares, but you can sell them at any time.

Stocks, which are also known as equities, provide the greatest opportunity to make money, but they can also be extremely volatile. A company’s stock price can fluctuate wildly over the short- or long-term, which means you can lose some or all of your investment.

So I generally recommend that you do not buy individual stocks. Instead, spread out your risk by owning many of them. Since that’s difficult and impractical for average investors, the solution is to buy funds, which are made up of hundreds or thousands of stocks.

Choosing a stock mutual fund, stock index fund, or a stock exchange-traded fund (ETFs) gives you convenient, baked-in diversification.

What Are Bond Investments?

The other primary way to make money that I mentioned is to be a loaner. Even if you aren’t flush with cash to lend out, you can buy investments that do it for you, called bonds.

When you purchase a bond, you lend money to a government entity or a company. They might need money to build a bridge or a new factory. In return, they agree to repay the loan over a set period of time at a fixed interest rate.

Since bonds provide a fixed income, they’re much safer than stocks. However, safety always comes at a cost because they offer lower rates of return.

Just like with stocks, you can diversify by purchasing many bonds at once through a bond mutual fund or a bond exchange-traded fund. That makes it simple to invest small amounts without having to be an expert.

How to Buy Investments

Since stocks and bonds are the building blocks of investing, most of us need both of them in our portfolios, plus some amount of cash for emergencies. But how much of each type of asset should you own?

The answer depends on your appetite for risk, plus other factors like your age and when you want to retire. While there’s no one-size-fits-all asset allocation, in general, the younger you are, the more stock you should own.

A general rule of thumb to calculate a reasonable amount of stock to own is to subtract your age from 100 or 110. 

If you’re in your 20s or 30s with many years to go before retirement, your asset allocation should be relatively aggressive because you have a long time horizon. That means you might want to own 80% stocks with the remaining 20% in bonds and cash. 

When you’re in your 50s or 60s, you have a shorter time horizon and need to preserve the wealth you’ve accumulated. You might own 40% in stocks with the remaining 60% in bonds and cash.

A general rule of thumb to calculate a reasonable amount of stock to own is to subtract your age from 100 or 110. For example, if you’re 30, consider allocating 70% to 80% of your entire investment portfolio to stocks. Likewise, if you’re 60, you might need a maximum of 40% to 50% in stocks.

See also: Should You Invest Emergency Funds or Keep Cash?

Which Investments You Should Choose

Now that you understand the basics of stocks and bonds and how much of each type you should own, you’re probably wondering how to buy them.

If you have a retirement plan at work, like a 401k or 403b, your choices are easy because there’s a pre-selected menu of funds. The names of the funds will vary depending on which brokerage firm your plan is with, such as Fidelity, Vanguard, or Merrill Lynch.

But funds are usually grouped together as stock or growth funds and bond or income funds. You may also see a category called balanced funds, which hold a combination of stocks and bonds.

Let’s say you want to invest 80% in stocks. You could choose one or several stock funds that add up to 80% of your contribution. The remaining 20% could go into one or more bond funds.

Pages

The Quick and Dirty Tips Privacy Notice has been updated to explain how we use cookies, which you accept by continuing to use this website. To withdraw your consent, see Your Choices.