A college education can put you on a successful career path, but what is often left out of traditional education curriculum is practical advice on personal finances—especially how to invest your savings for the future.
So how should you start investing? Should you invest in the stock market, bonds, gold, or real estate? How much should you keep in cash? Crafting a thoughtful investment portfolio requires an understanding of investments and how they can help you financially. Once you know this, you can then review your personal needs to find the best available investment strategies for you.
Why Do You Need an Investment Portfolio?
Investing and the terms used can be a little intimidating at first, but don’t be deterred. You’ll catch on quickly. First, let’s understand the need for an investment portfolio. An investment portfolio is a group of investments that can include stocks, bonds, commodities, real estate, cash, and more. When you put together an investment portfolio, you try to collect assets that grow over time. Investment portfolios serve as a way to preserve the purchasing power of your savings and offer growth.
But why invest? When looking at your savings, consider that $1 today is worth more than $1 tomorrow. With the rising costs of goods, the cash you leave in the bank can become less valuable every day. The Federal Reserve sets a target annual inflation rate of 2%, and investing can be used to combat that inflation.
One way to look at this inflation is that your cost of living could go up 2% per year. If your investment portfolio has also increased by at least 2%, then you can cover increasing costs. A successful portfolio generates returns on your savings while protecting your money from inflation risk.
What Are Example Components of an Investment Portfolio?
Financial markets have created a plethora of investments to choose from. Here are two of the most common options and ways people invest in these asset classes.
Buying equities is most commonly known as owning stocks. Typically, you purchase shares of a company’s stock at the price listed on a stock exchange, plus any fees charged by your broker. In buying a stock you become a partial owner in a publicly-traded company.
As a shareholder, you generally have voting or dividend rights. If the company decides to pay regular dividends, you receive regular cash payments.
Owning a bond means that you are loaning your money to another entity, with the agreement that the borrower will repay your original principal plus interest. The two main entities that issue debt (bonds) are governments and corporations. Each bond has financial terms that are agreed upon before issuance, for example, the timing and amount of interest payments and payback period.
Bonds are generally seen as less risky investments than equities. There are scheduled cash flows, and creditors can seek recourse by pursuing the company’s assets if the company stops paying. However, keep in mind that the rate of return on bonds historically has been lower than equities.
Mutual Funds vs. Exchange Traded Funds (ETFs)
Common investment strategies for beginners often include either mutual funds or exchange-traded funds (ETFs).
Mutual funds pool together investors' money and invest in various bonds, stocks, and other types of financial securities. Mutual funds typically have a defined investment strategy that may focus on a specific asset class or strategy type. Under that scope, the fund’s portfolio manager picks appropriate investments. You are effectively trusting an investment professional to understand which individual securities are best suited for your portfolio.
Similar to mutual funds, exchange-traded funds are a collection of individual securities pooled together into one investment vehicle. ETFs are a popular vehicle to invest in a broader market index, which is a large portfolio of stocks. For example, the S&P 500 Index is a basket of five hundred stocks in the US, chosen by Standard & Poor’s. Investors follow the S&P 500 Index to gauge whether the market is going up or down. Investing in a market index is a strategy known as passive investing, where investments track the performance of an index. Fees should generally be fairly low, and ETFs are typically considered a cheaper way to invest.
There are a few notable differences between mutual funds and ETFs. While ETFs typically mirror a broad market index like the S&P 500, mutual funds have managers that make active decisions on the portfolios. ETFs also have the ability to trade during all market hours (9:30 a.m.-4:00 p.m. EST), while mutual funds only trade based on their end of day price.
How Do You Create an Investment Portfolio?
Once you understand different types of asset classes, you can select individual investments for your portfolio. Your personal situation will dictate the right mix of investments for your investment portfolio, so having a plan is crucial.
Consider Your Risk Tolerance
A key concept to keep in mind is your risk tolerance. How much investment risk are you willing to take to earn a return? Theoretically, there should be a positive relationship between risk and return. Higher risk can lead to higher return, while lower risk may lead to lower returns, though neither is guaranteed. Generally, individuals that want less risky investments will allocate less money towards equities and more money towards fixed income/bond products.
Age and time are important factors to consider when examining risk. Broadly speaking, older individuals tend to want less risky investments because they need cash flow sooner or have fewer working years to invest income. Younger investors often are still building their wealth and have the ability to ride out volatile markets.
Consider Your Future Goals
Planning out future life events is also a fundamental part of creating an investment portfolio. Each individual has to consider the expenses and planning needs of their entire family. Goals like going to a graduate school, getting married, or having a child can change investment decisions. Parents might also create trusts or college savings accounts, so it’s important to keep these things in mind.
Building an investment portfolio takes time to plan out, but once you take the necessary steps, it can have many benefits for you and your finances. If creating an investment portfolio seems overwhelming, don’t hesitate to reach out to us. Our Trust & Financial Services Team can guide you along the way.