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Your First Portfolio: Beginning Your Investing Career
January 28, 2008
You’ve decided to start preparing for your future and invest your money in income-producing assets instead of stockpiling Mad Dog and cheap beer. You’re finally ready to start investing. It can be intimidating to start, but you can have a complete, well-diversified, and inexpensive portfolio quickly and easily if you follow these steps.
1) Create an account with an online brokerage.
Brokerages are just like stores where you can buy stocks, except that all the stores sell basically the same thing. The only differences, really, are the prices to buy and sell, as well as information they can give you. Personally, I use TD Ameritrade and have absolutely no problems with them. I have also heard good things about Sharebuilder , which is cheaper than most other brokerages but has more restrictions. If you want more details about the differences, between brokers, check out this article at The Motley Fool.
2) Pick a Type of Brokerage Account
Your main options are a regular IRA (Individual Retirement Account), Roth IRA, or a normal account. Imagine these accounts as buckets. You can put your money into the regular IRA bucket and you won’t pay any taxes on that money until you take it out. Any money you make from the money in the IRA bucket is not taxed until you take it out. A Roth IRA is the IRA’s cousin. You have to pay taxes before you put the money in the Roth IRA bucket, but you can take money out tax-free once you retire. There are restrictions to taking money out of IRAs, but you can take as much money out of the Roth IRA as you put in, since you already took money out of it. Otherwise, you usually have to wait until you are retired to take money out of either type of IRA. Since your tax rate will probably be higher later, for most people just starting out investing, a Roth IRA makes the most sense.
A normal account is taxed, but since the government encourages investing (and discourages working for money), you pay a lower tax rate on most money you make from investing, and get to write off any losses on your taxes. It’s really a win-win situation. Since you can only put so much money in an IRA every year ($4000 for 2007, $5000 for 2008, for most people under 50), at some point you may have to use a normal account, since there’s no limit on how much money you can put in your normal bucket.
3) Allocate assets
You now need to decide what percentage of your portfolio you want in different sectors. At this point in your investing career, investing in individual stocks is pretty risky. There is always the chance that one will go bankrupt, destroying a large percentage of your wealth. The best thing to do is own funds - basically, a big group of stocks. This diversifies you against major losses. You want funds that track major indexes for the core of your portfolio, because these are usually cheaper and most actively traded funds fail to beat the averages after costs are taken into account.
Although there is a large, confusing mix of funds - there are more funds than stocks out there! -you can start investing in a small portion that are cheap, widely diversified, and have a good track record. Vanguard has many excellent exchange-traded funds. Here is a good portfolio for a person just getting started in investing, with say $3000.
40% ($1200) VEU - FTSE Vanguard All-World Ex-US ETF. This contains basically the entire world outside of the US in one fund. There is a 0.25% expense on your holdings every year, which is very cheap by fund standards - and very cheap for letting you own such a wide variety of foreign firms, including BP, Nestle, Toyota and Nokia.
40% ($1200) VTI - Vanguard Total Stock Market ETF This contains basically the entire US stock market in one fund. The 0.07% expense ratio is dirt-cheap, and allows you to have a share of the entire U.S. economy, including everything from General Electric and ExxonMobil to Google.
20% ($600) BND - Vanguard Total Bond Market ETF This contains the entire bond market. Bonds are like borrowed money, whereas stocks are shares of ownership in a company. Bonds promise to pay you interest just like a bank account, and don’t go up and down as much as stocks (they are less “volatile,” in Wall Street jargon). This will provide some stability to your portfolio.
If you are younger or want more risk, you probably want to increase your allocations of stocks, both foreign and US. If you are older and want less risk, you may want to increase your allocation of bond funds.
4) Keep Adding Money and Don’t Be Afraid
Historically, the stock market has gone up over time. There are going to be times when the value of your holdings go down. Don’t be scared! These are usually the best times to buy. Think of stocks as groceries - when there’s a sale on, that’s the time to stock up! By constantly adding more and more money, your holdings will grow more and more quickly. By setting up a dedicated plan to add money every month or with every paycheck, you’ll be well on your way to a wealthier life.
Bill Laboon owns shares of VTI and VEU. He does not own any other securities mentioned in this article.
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