We’ve covered a lot of basics and theory so far. We haven’t yet given you a framework to help build your first stock market investment portfolio. So, let’s get right to it.
I’ll discuss what you should invest in, when to do so, where to do it and, ultimately, why you need to do it.
What do you invest in?
Leave just enough cash in a savings account to cover six months worth of living expenses — this is an emergency fund.
Allocate a very, very small portion of your portfolio to side projects and start-ups (like this blog) and allocate another small portion to personal development; Learning a new skill each year is a very effective way to compound yourself.
Place the remainder of your savings in the stock market (split between stocks & bonds, of course).
So the ideal split looks something like:
How much do you invest in stocks vs bonds?
A good rule of thumb to adopt when figuring out your asset allocation is:
Take your age and subtract it from 100. This is the percentage of your stock market portfolio you should put in stocks. The rest goes into bonds.
This way, the older you get the more you will have allocated to the safe haven and low volatility of bonds. The younger you are, the more you can withstand volatility in the markets and, therefore, the more you should be exposed to stocks.
How much do you leave in cash?
The calculation behind how much cash you need depends on whether you are still working or have retired. We’ll do a full post covering these scenarios and more in greater detail.
For now, and assuming you are working, keep 6 months worth of living expenses in cash. Your cash cushion will protect you in case you lose your job and scramble to find a replacement. It will deter you from tapping into your long-term stock market portfolio – something you should never be doing.
If you are retired, make sure your cash cushion can last you for 2-3 years if needed. Your retired cash cushion doesn’t necessarily need to be in cold hard cash, but it does need to be liquid and cashable immediately. Again, the details of this calculation will be covered in greater depth in a full dedicated post.
If you are 25 years old and have $50,000 saved, you will invest 75% of your portfolio into stocks, 25% into bonds, and some to cover six months of emergency living expenses:
- VTI: $37,500
- VWRD: $12,500
- Cash: 6 months of living expenses
Which specific stocks & bonds?
As I covered in my posts on stock market profitability and asset classes, stocks and bonds are the cornerstone of every passive investment portfolio. Here is the purpose of each of the ETFs I recommend:
U.S. domiciled ETFs:
- VTI: Represents nearly all investable companies in the U.S.
- VT: Represents most investable international companies, including U.S. companies
- BND: Represents a combination of U.S. government bonds and high quality corporate bonds
- TLT: Represents long term treasury bonds with maturities of 20+ years
Ireland domiciled ETFs:
- VWRD: Represents most investable international companies, including U.S. companies (VT’s Irish cousin)
- VDTY: Represents long term treasury bonds with maturities of 1+ years (TLT’s Irish cousin)
Combining the above, the ETFs I’d recommend for the simplest portfolio are:
- Stocks: Choose to invest in VTI first until you accumulate a maximum of $60k in VTI
- Stocks: After $60k, switch to VWRD
- Bonds: Allocate all of your bond investments to VDTY
You may now be wondering, “why do you recommend both U.S. and Ireland domiciled ETFs if the two are cousins?”. Good question. The detailed explanation is covered in our post about estate taxes and dividend tax rates. For those of you who are impatient, the answer is: “to avoid paying estate taxes after you die”.
A friendly note before the “No, buts” come in:
The specific choice of ETFs above can and will probably be aggressively debated amongst investors.
Of course, you could replace VWRD with VT if you felt inclined to do so. You can also replace VDTY with BND or TLT. After all they represent nearly the same thing. The exact ETF you choose depends on your needs, situation, beliefs, and inclinations. At the end of the day, these substitutions will have little effect on your overall performance. The principles of asset allocation remain the same.
To make this clearer: This post is targeted at new investors who want to build their first portfolio in 30 minutes. As a new investor, you learn and grow over time. You may start forming your own opinions and start needing personalized customizations to these ETF choices. For now, sit back, relax, and start with the advice above. More reading will come in handy as you go.
When do you invest?
Indecision is worse than wrong decision.
As I discussed in the post about timing the market, there is never going to be a perfect time to invest. Markets are always doing really well — in which case you’ll say “maybe I should wait until they drop a bit?”, or doing poorly — in which case you’ll say “what if they drop even further?”. If you sit out, doubting yourself and your “timing”, you’ll never actually begin.
Prepare to invest as soon as you can. If you are worried about volatility, use dollar-cost averaging (DCA) to keep your fears in check; Break up your total savings into 12 equally sized chunks and invest each chunk at the beginning of the month for the next year.
This way, you space out your entry into the markets and reduce the impact from any one of those entries being at the “wrong time”.
Where do you invest?
When it comes to stock market investments, you will need to open up a trading account at any online stock brokerage company. There are lots of them out there but I primarily use: Saxobank and Interactive Brokers.
I will be writing an entire blog post covering the various stock brokerage options here in the Middle East, but, for now, use those two.
Do your own research or get in touch with me to discuss pros & cons of each.
Why do you invest?
Although this sounds like a philosophical question, I really want you to ask yourself why you’re investing.
I’d be curious to hear back from you and understand your reasoning.
My reason was to become financially independent and financially secure. I didn’t want to feel like I had to work to pay the bills or survive. I wanted to work on projects that I found interesting and that made an impact.
However, I also got very interested in earning money easily, without doing much. It does sound like something a lazy person would say, but I eventually realized that what intrigued me about the world of investing is that it is extremely scalable. It allowed me to grow the value of my time as I got older.
My earning potential today is probably going to be half of my earning potential in 3 years. So will yours.