When you are ready to start investing, learning the basics can be daunting. Learning to invest can be like taking a philosophy, math, and new language class all at once. However, investing your money in the stock market can be one of the smartest moves you can make when it comes to increasing your wealth. One of the first things you will learn is how to ensure your portfolio is properly diversified so that it may minimize risk during turbulent times and perform according to your goals and investor profile. So, today we’ll look at how to a new investor’s diversified portfolio.
Before you start building a diversified portfolio, you need to as three important questions.
For most, the reason they start investing is simple, they want to make more money. But if you ask yourself “Why am I investing?” you may come up with a surprising answer.
One reason someone would start investing that goes beyond financial could be personal or aspirational. Many younger investors have made it clear that they would not invest in companies that have environmentally damaging products or businesses that do not subscribe to ESG (Environmental. Social Governance) standards. In fact, in a recent survey 77% of millennial investors said that ESG issues are their top priority when assessing investment opportunities. While this may seem shocking, the numbers don’t lie. Trillions of dollars have poured into ESG stocks and the top impact funds over the past five years.
So, asking yourself this important question is crucial to ensuring you are adding the right stocks to your portfolio.
The next question is “What are Your Financial Goals?”
Once you have established the “Why” next is the “What”.
For new investors, it’s important to understand what you are trying to achieve. An easy way to start this is to organize your financial goals by:
If you are having trouble getting started, we have created a tool that can help. Our Financial Independence Calculator allows you to map your financial goals and then chart the most efficient path to achieve them. This calculator is like a debt calculator, compounding interest calculator, and net worth calculator all in one but specifically tuned to your goals and interest.
For many younger investors, goals such as paying off debt or buying a home become an essential part of establishing an investing game plan.
Understanding what you need to achieve these goals will help guide your investing decisions. You may want to buy a house next year but realize that you need to make a 30% return on your investments in order to hit your down-payment goal.
When you understand what it takes to achieve your goals, you will be able to make calculated decisions when it comes to your investments. If your goals are more short-term focused, you may be willing to take on more speculative investments with a higher return potential over the short term.
However, you may decide that even though you need a greater return in the short term, it’s too risky for your liking. At this point, you may decide to move your short-term goal to long term or change the parameters of your goal altogether.
This brings us to the third question – “What is your Risk level?”
All investments contain risk in varying degrees with higher risk investments providing better returns.
While there are universal factors such as age, income and existing capital that help determine how much risk you may willing to tolerate, everyone – even with similar circumstances – have different thresholds of risk they are willing to accept.
Everyone is different but many investors can be classified into three separate risk categories:
Cautious – avoids risk; fears loss of capital; invests in cash and government bonds
Prudent – manages risk; risk tolerant; moderately increases risk to achieve goals; in corporate bonds and mutual funds
Risk Taker – embraces risk; utilizes high risk to achieve goals; predominantly invests in stocks, ETFs and options
Once you have answered these three questions, you will be in a better place to not only create a diversified portfolio but create one that is suited toward your personal investor profile and goals.
Let’s take a close look at an example of a well-diversified portfolio.
For beginners, a great way to balance a portfolio is to break it down in 4 parts. Now, again, there are many ways to balance a portfolio, but this is an example of a well-diversified portfolio for beginners.
It is important for investors, no matter their level of experience, to understand what they are investing in. That knowledge guides the critical buy/sell decisions – what stock or ETF, at what price and when – that determine financial success. In order to build both returns and knowledge, the Buy What You Know segment utilizes a two-pronged approach. In the first part, establishes a “Core Four” of well-known, profitable, and enduring companies high in brand awareness. These are names with easily recognizable products or services and will be the anchor of the BWYK stocks.
For the second part, screening companies based on past and future earnings growth, revenue growth and return on equity. These stocks will be in industries and sectors diverse from the Core Four, but equally understandable and profitable.
While they may not exhibit a vast track record of stability and performance, the potential earnings growth from the potential innovations outweighs any recent fundamental shortfalls.
Innovative and disruptive companies create new industries or unsettle existing ones, permanently transforming them. Instead of competing with industry leaders, they bypass them, establishing new paradigms. Tesla has disrupted the automotive industry while Netflix has changed the entertainment industry, both utilizing new technologies to topple the traditional favorites. And, importantly, these companies grow dramatically no matter what type of market – bull or bear – investors find themselves.
Impact investing targets those companies that benefit society or the environment. Included under the Impact umbrella are stocks that fall within both Socially Responsible Investing (SRI) and Environmental, Social and Governance (ESG) benchmarks. These companies must follow ethical management guidelines, demonstrate measurable reductions to adverse business operations and positively influence their communities.
There are many who denounce Impact investing due to perceived weaker returns from the increased costs of compliance. This isn’t so. Companies that actively utilize SRI and ESG guidelines as standard operating procedure have been shown to be equally productive and profitable. We see opportunities in a variety of investment vehicles and companies throughout the world.
Markets are cycles. They rise and fall. It is fiscally responsible to acknowledge that risk and provide for the inevitable market trend change, especially during extreme valuations.
When utilized, Contrary stocks will predominantly focus upon broad-based ETFs to expand overall portfolio exposure. While the Contrary segment will not be a major component of a diversified Portfolio, it should help elevate an investor’s risk recognition and provide portfolio protection.
Building a diversified portfolio isn’t as straight forward as it seems on paper. You must first take important steps before creating a portfolio.