May 29, 2013
You pay your bills each month. You have a cash cushion that covers several months of living expenses. And you have some extra money that you want to invest, to grow for the long term.
But you aren’t sure exactly what you should buy. Perhaps you are new to investing. Or maybe you’ve dabbled in investing before, but haven’t been especially successful.
So let’s start over. With a focus on building a solid portfolio that will protect you on the downside, but still give you plenty of opportunity for growth over the long term. A portfolio that you don’t have to watch every single day. One that will keep chugging along, month after month, year after year, making you money. With only a minimal bit of tweaking now and then to keep it in line.
Safe, profitable investing is not difficult. Many people want you to think it is. All those financial advisors who charge you big management fees. The pundits on TV news shows who want you to keep watching. Everyone wants you to think you can’t do it without them. But you can.
How? Keep it simple. Focus on building a strong core portfolio.
So, what do you buy first?
a) The hot new growth stock that everyone is talking about?
b) A safe, solid blue chip company that pays a good dividend?
c) Maybe something with exposure to China?
Answer: none of the above.
A few months ago, an evening of irrationally exuberant dancing left me with an aching hip and a tingling feeling down my left leg. My orthopedist diagnosed an inflamed nerve, and sent me to five weeks of physical therapy to strengthen my core muscles. Thankfully, it worked and I am now pain free. But I still have to do those core-strengthening exercises every day to stay in shape.
You need to do the same. Focus on building your core positions first. You need something solid and basic. A new homeowner filling a tool box starts with a hammer and screwdriver, not a miter saw. To create a versatile wardrobe, first buy a good pair of basic black pants, not a sequined top. Start with the core. Save the sizzle for later.
Your first investment purchase should give you broad exposure to the market. You can get this through index funds, actively managed mutual funds, or exchange traded funds, commonly known as ETFs. I prefer ETFs because of their low expense structure and the ability to purchase them at any time during the day, not just at the closing price as with mutual funds.
An S&P 500 ETF is a basket of the five hundred largest publicly traded companies in the U.S. By buying a basket of stocks, you spread out your risk. In a given year, some of the stocks in the basket will do very well. Some will do poorly. But because you reduced your risk to any one stock by buying the whole basket, you will get the market return.
Is this good enough? Many active managers would be overjoyed to get the market return. They struggle to beat their benchmark S&P 500 return each year, and not very many of them are successful. They might have eye-popping returns one year, but what about the next? Two years in a row? Five years? Beating the index year after year is very difficult. So don’t try to beat it. Just buy it.
There are a lot of choices in buying S&P 500 exposure. I have three suggestions for you: the SPDR S&P 500 ETF (ticker SPY), the Vanguard S&P 500 ETF (ticker VOO), or the iShares Core S&P 500 ETF (ticker IVV). All of these are large, easily traded ETFs with low turnover, low expense ratios, and market performance. Pick one to begin building your portfolio.
The top ten stocks in each of these funds are the same, accounting for 17-21% of total assets. These stocks are Apple (AAPL), Microsoft (MSFT), Johnson & Johnson (JNJ), Chevron (CVX), General Electric (GE), Google (GOOG), International Business Machines (IBM), Pfizer (PFE), and Proctor & Gamble (PG). By making one single buy decision, by picking just one of these ETFs, you gain access to all of these high quality stocks. Plus all the other stocks in the basket.
This will be the beginning of your core portfolio. Your hammer and screwdriver. Your pair of really good black pants. In future blogs we will build around this position. I will show you how to add other ETFs, mutual funds and individual stocks to build your market exposure. The end result will be a diversified portfolio that has good potential for upside growth, without too much downside risk. One that lets you grow your money, without losing your shirt.
Disclosure: I do not hold a position in SPY, VOO, or IVV. I do own APPL, MSFT, and GE.
This information is for educational purposes only. I am not a registered investment advisor. Do your own research or consult your financial advisor before making investment decisions.