Life is funny. Often we don’t know as much as we really need to know long after we really need to know. In other words, hindsight is really 20/20. Not only is this true for investing, but it is also above all true for investing.
With that as a backdrop, here’s how I’d do things if I started from scratch with $5,000 in start-up capital — and all the cumulative lessons from the mistakes I’ve made since my first foray into the market nearly of three decades.
Half goes into a diversified index fund
It’s advice most investors have heard time and time again, often resulting in eye rolls and groans. Not only is this a clichéd suggestion, but it’s the least interesting way to participate in the market. However, your best first investment really is to take a long-term position in an index fund like the SPDR S&P 500 ETF Trust (TO SPY -0.38%) or the Vanguard Total Stock Market ETFs (VTSA.X).
Reality: Your primary goal as an investor is not to beat the market; it’s just not underperforming the market, confident that over time, market-based investments in index funds will yield good results. On average, the S&P 500 gains around 10% per year, although most years it does much worse or much better. Time is the key.
But playing defensive – playing not to lose rather than playing to win – isn’t that the fearful investor’s way of avoiding picking stocks? Maybe, but be aware that an aggressive effort to beat the market by picking individual stocks is a tricky business that often leads to delaying it. Even professionals can’t do it consistently.
In its 2021 year-end report on the matter, Standard & Poor’s notes that nearly 80% of U.S. equity funds have underperformed the S&P 1500 Composite Index. Over the past 10 years, 86% of those funds lagged the index. Over the past 20 years, 90% of mutual funds have failed to keep up with the market. So if the pros can’t even do it…
Moral of the story? Start simple and keep it simple.
Four smart actions to get started
Index funds are the starting point, but they don’t have to be where you end up. Once you have this fundamental building block of your portfolio in place, it is easier to confidently stick with individual stocks, even when they may be losing ground. The key is to limit yourself to names with real staying power.
Not that owning just four individual tickers is considered adequate diversification for the remaining half of this hypothetical portfolio, but these four stocks are a good start to that end.
Alphabet (GOOGL -1.81%) (GOOG -1.62%) continues to be my preferred name for almost every investor. With its years of greatest growth likely in the rearview mirror, this parent of Google and YouTube, as well as the owner of the Android operating system, continues to crush it. In just two quarters since 2010, its year-over-year revenue has plummeted, and one of those quarters relates to the arrival of COVID-19 in the United States. This is because it dominates the web search, online video and mobile operating system markets. As long as the world craves short video entertainment and relies on its mobile devices and needs a way to search the internet, Alphabet will have something to monetize.
I’m also a fanf Verizon Communications (VZ 0.00%) for a similar reason: as long as consumers depend on the call phones and wireless Internet connections they offer, Verizon will have many customers willing to pay for their mobile service every month.
There’s little to no growth here, to be clear — Verizon is strictly considered a revenue machine. And I would be strongly tempted not to reinvest its dividends in more Verizon stock, but rather to plug into its current reliable 5.2% yield to fund purchases of other stocks as they show up.
Bank of America (BAC 0.12%) manages two roles as the third individual stock pick for a new portfolio. One of these roles is to generate money. The current 2.6% yield isn’t terribly exciting, but it’s something to reap now while you hold onto the stock for its capital appreciation potential.
In this vein, the other role it plays is to give you exposure to the highly cyclical but very profitable financial sector. BofA comes and goes with the best of them, but it’s a name among the best among banks with a strong long-term track record. Barring a complete societal collapse, the world will always need a way to connect savers to borrowers and investors to businesses in need of capital.
Finally, I would complete the launch of this new $5,000 wallet with a coin from a fairly young company called Assets received (UPST -5.30%). Think of it as the indulgent, risk-seeking element of your portfolio that, if nothing else, makes things fun and gives you something interesting to discuss at cocktail parties.
Simply put, Upstart does what traditional credit bureaus love. Trans Union and Equifax should have done it a long time ago: using an AI algorithm to determine an individual’s creditworthiness rather than reducing people to a score based on faulty metrics (which often paint the wrong picture anyway). Upstart’s approach leads to 75% fewer defaults than most banks’ current loan approval regime, or in other words, it authorizes 173% more loans without increasing the rate of loan loss. Helping lenders make more loans (but at lower risk) is the main reason revenues are expected to rise 48% this year.
Common sense is always king
These are just five suggestions, of course, and not yet a full portfolio. The Motley Fool recommends owning a portfolio of at least 25 different stocks, and while dedicating half of the hypothetical $5,000 to an index fund technically verifies that standard, four names still isn’t enough to fully complete half of the individual stocks. of your assets. I would aim for at least a total of 10, but you can add them in time.
Anyway, the only thing worth adding to this “getting started” discussion is to make it clear that a little common sense goes a long way, even if you’re not a veteran. investment. Namely, if something seems too good to be true, it probably is. is Too good to be true. Stay away.
And, while the constant media coverage of the stock market gives the impression that you should always buy and sell something, it really is a long-term game, won by people who play it as such. It means having the will to leave your wallet alone even when things get a little uncomfortable. That’s because time — not stock-picking prowess — is an investor’s best friend, even if you don’t start out with a fortune.