How to Build a Simple Set-and-Forget Portfolio for Newbies
Many people don’t invest because it seems too complicated. But if you want to get rich, investing now is the easiest way to do it, and anyone can do it. Here are a few basic steps to building a simple beginner investment portfolio that makes you money while you sleep.
Investing is easy: just install and (in most cases) forget about it.
When many people think of investing, they imagine painstakingly picking out individual stocks, tracking their daily performance, and buying and selling all the time.
It could make good TV, and of course you could hire a financial advisor to do it for you, but the fact of the matter is that most financial advisors fail to outperform the market .
So why pay a financial advisor a ton of money for something you can do on your own? (However, if you are dealing with an abnormally large amount of money and are exaggerating a little, getting a good financial advisor can be worthwhile.)
Most smart investors try to match a market that tends to improve over a long period of time. Past performance is not an indication of future performance, but that is all we have, and in the long run the stock market averages around 7% annualized return . Pretty solid!
All you have to do is pick a couple of funds that are trying to mimic market behavior in general, and – for the most part – leave them alone for 20 or 30 years. It is very simple, and everyone can and should do it. In fact, it’s one of the best ways to effortlessly build wealth over the long term.
Many people call this “buy and hold” or “set and forget” investing because it requires little effort and does not need to constantly monitor your portfolio. You will have to register about once a year, but this requires minimal effort. You can leave that alone for the most part – which is perfect for us regular people, Joe.
Step zero: open an investment account
If you don’t have an employer-sponsored 401 (k), you need to open an investment account to actually start investing. If this is your first investment account, you probably want to open an Individual Retirement Account or IRA. Here are the basics:
- Decide if you want Traditional or Roth IRA. If you are self-employed, you may need a SEP-IRA. Check out the differences here .
- Choose an investment firm that offers an IRA, such as Vanguard or Fidelity . Many banks also offer them.
- Open an account. If you have assets in the old 401 (k) that need to be added to the account, make sure to reconfigure properly .
- Connect your checking or savings account to your investment account and start buying index funds.
Once you’ve got everything set up, it’s time to start thinking about what to invest in.
Step one: determine your asset allocation
There is more to the market than just stocks, and a good portfolio usually includes several different types of investments. At the very least, you need a mix of stocks and bonds with options on both US and international.
How many depends on your age, risk tolerance and investment goals. General rule of thumb:
110 – your age = the percentage of your portfolio that should consist of stocks
So, if you are 30, you would invest 80% of your portfolio in stocks (110-30 = 80), and the remaining 20% in bonds with lower risk. However, if you are more conservative, you can invest 30% in bonds instead. It’s up to you, but it’s a good starting point.
As you get older, you should adjust your asset allocation accordingly. If you follow the 110 rule above, you will want to buy more bonds when you turn 40 so that you have 20% bonds instead of 10%. The idea is that the closer you get to retirement, the less volatile your portfolio becomes.
If you are having trouble making an asset allocation decision, there are several tools that can help you. Bankrate has an asset allocation calculator to help you, or you can use a full service like Personal Capital .
Stocks and bonds are not the only types of assets you can hold, but for the sake of simplicity, we’ll start with them.
Step two: choose index funds
The best way to start investing is to pick a couple of index funds . An index fund is a collection of stocks or bonds that is designed to reflect a specific portion of the market.
They are good because they have particularly low commissions (or expense ratios ). This, combined with the fact that they are trying to match the market, means higher profits for you in the long run. If you’re interested, you can read more about index funds (and how they differ from other funds) in this article .
Of course, there are many index funds out there, so let’s talk about how to choose which one is right for you.
Ideal Scenario: Choose Lazy Portfolio.
You can create a complex portfolio from many funds, but you only need two or three to get started. You also don’t have to start from scratch and choose funds at random – one of the best ways to get started is with a lazy portfolio.
Think of it as a “starter pack” for index funds: a pair of fixed assets that will give you a simple, balanced portfolio that fits the market in several different classes.
Let’s take a look at a few simple ones.
In an IRA or a regular investment account, you can choose whatever index funds you want, so let’s talk about this ideal scenario. (If you are investing in 401 (k) with limited choices, we’ll get back to that shortly.
Let’s say you want to allocate assets of 90% of stocks and 10% of bonds. The simplest portfolio is Rick Ferry ‘s two-fund portfolio, which uses two very popular Vanguard funds:
The general fund of world stock indices tries to reflect the dynamics of the world stock market in one fund. The bond fund does the same. Of course, you would adjust the percentage of bonds and stocks according to your asset allocation (e.g. 90-10).
The general fund of world stock indices contains about 50% of US stocks and 50% of international companies. If you prefer to change this weight – for example, some investors may want to invest less than 50% in international stocks – you can use a portfolio of three funds like this :
Again, adjust the percentages to match the desired distribution. (In this case, the portfolio is 60% of stocks, 40% of bonds).
Also keep in mind that some index funds have minimum buy-ins. This means that you may have to buy a fund worth at least $ 3,000 in order, for example, to buy any at all.
Please note that as you invest more in your account, you may qualify for lower net spending ratios like Vanguard’s Admiral Shares or Fidelity’s Advantage Class .
That’s all you need to get started. Invest in two or three funds, make sure they have low expense ratios (ideally less than 0.25% or so, but the lower the better), and make sure they match your ideal asset allocation. Again, there are many other things you can invest in too – real estate, precious metals, and so on – but you don’t need the perfect portfolio right after that. The goal is to get started, and this is a great starting point.
Non-ideal scenario: if you have a 401 (k) limit
The above option is ideal for a basic investment account or IRA where you have many options. However, if you have a 401 (k) through your employer or a similar retirement plan such as 403 (b), you may have more limited options in your funds. Some are decent, some are terrible – anyway, your 401 (k) is worth taking advantage of the tax breaks.
Let’s say you have a 401 (k) with some decent funds, but nothing is easier than the general stock and bond market funds listed above. For example, perhaps you have a general bond fund but you are missing a general stock market fund.
You can roughly estimate the general stock market with some of the other tools available. For example, you can combine:
- S&P 500 Fund (which includes the 500 largest US companies)
- Mid-cap index fund (which includes mid-size companies that compensate mid-size companies not included in the S&P 500).
- Small-cap Index Fund (which includes smaller companies that offset smaller companies not in the S&P 500).
Of course, this combination only works if your 401 (k) offers such options. It doesn’t have to be exactly the same; just focus on achieving the right ratios.
If you’re lucky, your 401 (k) will include enough funds so that you can roughly determine your desired asset allocation. Remember: look at the fund’s net expense ratio to make sure it’s not too high!
Bad scenario: if your 401 (k) has a poor selection of expensive funds
Okay, so let’s say your 401 (k) lacks some of the funds you need to “round off” your asset allocation. Or maybe your plan just sucks and offers nothing but funds with an expense ratio above 1%. What do you do then?
As we said earlier , there are many benefits to having both 401 (k) and IRA, and this strategy is especially useful if your 401 (k) doesn’t offer much flexibility. If you choose to purchase both, ideally you would invest in them as follows:
- Submit just enough in 401 (k) to take advantage of employer compliance.
- Bring any additional savings to an IRA that has more flexibility.
- If you still have money after maxing out your IRA (you can see the limits here ) then go ahead and put it in your 401 (k).
- If you are making the most of your 401 (k) and IRA (wow, good for you), you can open a regular taxable investment account. These accounts are also suitable for more medium-term purposes, as retirement accounts do not allow withdrawals until a later age.
You can do this no matter how good your 401 (k) is. But here’s an important trick if you have a crappy 401 (k): use your 401 (k) for the lowest cost fund (s) you can find – that have performed well in the last 10 or 15 years – then use your IRA. to invest in cheap index funds that you lack to ensure perfect asset allocation. Just make sure the money you put in matches the overall percentage you listed in the first step.
Step three: contribute regularly and change your balance annually
So you’ve bought your funds, and you are all proud of the asset allocation that you have put together. Well done! Now, your best bet is to create a recurring deposit – say whenever you receive a monthly salary – so that you always save some money in your investment account. If you have a 401 (k), this is especially important as this money is tax-free! This will help your investment grow over time. Treat your savings and investments like an account and you will never be tempted to spend too much.
Once you’re done, forget about it.
Seriously. Leave. Don’t check it every couple of days, don’t get hung up on whether the market is going up or down, don’t do anything – remember, you are in this for a long time, and the market dips and peaks do not matter. much like a general trend over the years.
However, you will want to check your portfolio every year or so and “rebalance”. What does it mean? Let’s say you invested 20% in bonds, 50% in US stocks and 30% in international stocks, for example:
And, for example, suppose the international markets do particularly well for one year, while US stocks are down slightly. You will make more money from these international stocks than from other areas of your portfolio, and at the end of this year, your portfolio might look something like this:
You want to rebalance your portfolio to match your original asset allocation. Stop contributing to international fund funds and send that money to the US bond and equity fund (s) instead. After a few months, it should balance out and you can return to your original contribution level. (You can also sell some of your international stocks and reinvest them in US bonds and stocks, but this may incur additional fees.)
A much simpler alternative to all of the above: date-bound funds
If this all sounds too complicated, there is an easier solution: put all your money in a fund with a set date.
Settlement funds (also sometimes called lifecycle funds) aim to do the work for you by splitting your money into a balanced mix of stocks, bonds, and other assets. He then adjusts them over time, regularly rebalancing and adjusting his asset allocation as you get older (so that he automatically invests more in bonds for you with age). Nice, huh?
It’s super convenient: you pick the year you plan to retire, put all your money into it, and let it grow. If you plan to retire in 2055, you should choose a fund with a 2055 target date from Vanguard, Fidelity, or whoever you invest with. If you are planning to retire in 2050, you would choose it.
You can also choose a different one, depending on your risk tolerance. If you prefer to be more conservative, you can opt for one with an earlier retirement date, which can give you more bonds at an earlier age. Or vice versa. Just be sure to check your trust fund prospectus to see how it changes its asset allocation over time. Some of them may be more conservative or risky than you expect.
Likewise, if you are opening an IRA or taxable investment account, you can try a robo-consultant who will tailor your investment based on your goals.
Why waste time picking your own ETFs when automated solutions like fixed date funds are so convenient? Well, due date funds, while excellent, usually have slightly higher fees. Some will be higher than others, so use an expense ratio calculator like this one to see how much it matters in the long run.
To give an example, let’s say you build your own portfolio with Vanguard funds with an average expense ratio of 0.05%, compared to a set date Vanguard fund of 0.18% – still low by many standards, but 0.13 % higher than when used independently.
If you increase your 401 (k) every year for 30 years, that 0.13% savings could add up to $ 50,000 to your bill, simply for putting in the minimum effort to do it yourself. That’s decent money for a little work. Plus, dated Vanguard funds are considered fairly cheap compared to their counterparts, so this is a comparison at best. If you don’t have a perfect 401 (k), the difference can be much more than $ 50,000.
We’re not going to dump funds on time. They’re great for people who don’t want to do a ton of work and might otherwise not be investing at all – and if it’s you, by all means, throw all your money into a set date fund and let it grow! But building your own portfolio gives you more control and lower commissions, which can lead to large sums … while you do your homework.
This all may sound daunting, but once you get past the initial hurdle, you have a simple portfolio to set up and forget to start making money. Note that these are not the only investment strategies in the world, but this is one of the most popular tips and is perfect for a portfolio beginner. And when it comes to investing, the most important thing is to start right now.
This post was originally published in 2015 and was updated on April 29, 2020 by Lisa Rowan. Updates include: validated links for accuracy, updated formatting to reflect the current style, concatenated text, added links to more recent resources and Lifehacker content, and changed the title photo.