Diversification diversification diversification! Everyone always shouts the importance of diversifying your portfolio despite all of your holdings being in the stock market; where a bear market will take everything down with it. So what are our options in creating a portfolio for our retirement? Below are several ways you can diversify your monies in the stock market and a quick thought on investing in other assets.
ROTH IRA/Traditional IRA
IRA's offer the least amount of effort in investing for your future. By maxing out your IRA each year ($500/month) until you are 60 you can easily 2x-8x your $200,000 investment depending on market conditions. In the past 50 years, the market has returned on average 9% annually on your investments (see Motley Fool); 14% in the last 10 years.
Investing from the age of 22 to 60; 38 years
Average interest rate of 9%
Maxing your ROTH IRA would give you $1.69 M by the time you are 60
Most importantly, IRA's offer a care free method of investing without you having to do anything once you set it.
There are two types of index funds that focus on the general market
Index Funds
Target Date Index
Index Funds
Index funds are mutual funds or ETF's that often mimic the general market, follow leading companies across various industries, or developed to vary growth/risk with larger/conservative returns
Index funds are generally considered ideal core portfolio holdings for retirement accounts; as an example, SPY follow 500 of the largest leading stocks across various industries
Index are often viewed as a conservative /passive strategy that looks to minimize risk and provide steady returns over time; and in the long term will outperform any single investment
Index funds have lower expenses and fees than actively managed funds.
Selecting an Index Fund
History - We want to see index funds that have been around for longer than 10 years. The more bear markets it has overcome the stronger the likelihood it can survive another
Performance - Just like our credit history being used for our Credit Scores, we want to see the past performance of the index. One good year does not make a great fund; nor does a fund that plummets rapidly in a bear market.
Expense Ratio - We want to see a low expense ratio:
Index funds < 0.2% (0.002)
Mutual Funds/ETF's < 0.5% (0.005) to 0.75% (0.0075)
Typically, the expense ratio is used against annual revenues to pay the company prior to any other payments to investors
In some cases, like leveraged ETF's, expense ratios could be calculated daily and the amounts are taken directly out of the share price. Leveraged ETF's often have high expense ratios; closer to 1% (0.01)
Target Date Index Fund
Similar to Index Funds, these offer a timeframe to begin pulling money out of your account for living expenses
The farther you are from your target date (typically 60 years of age or higher) the greater the investment in growth stocks and small caps to grow your money exponentially.
The closer you are to your target date, the more conservative approach will be taken; moving into large/mega caps or high yield bonds that offer stable and consistent returns
Take a look at Vanguard's Targeted Date Funds. Note the following things:
Expense Ratio
Portfolio Composition (Stocks, Bonds, Short-Term)
Holdings
ROI (1-Year, 3-Year, 5-Year, 10-Year)
*I do not endorse, work for, or make any commissions from Vanguard. Information provided is to teach students how to access investments.
Dividends (click to learn more)
Offers investors a small percentage of the shares value, typically every quarter (3 months), for investors who hold their stock
Hedge Fund managers and long term investors with wealth, like Warren Buffet, will often hold shares that offer dividends as they can add up with a large investment
As an example, his hedge fund Berkshire Hathaway owns 915.56 M shares of Apple (AAPL)
AAPL gave out 23 cents, 23 cents, 24 cents, and 24 cents last year for a total of 96 cents per share
Based on 915.56 M shares, they would have made $878,937,600 from the dividends
Remember, while this can be a great strategy to make money, share prices can rise and fall
Covered Calls (click to learn more)
This strategy works well in stocks that are trending upwards
You can sell one contract for every 100 shares that you own of a stock
This can be a great way to make extra money for holding shares that seem stagnant or not moving in any direction (up or down)
You can collect a premium (money) for holding a contract for a specified period of time (DTE - Date to Expiration) the right for others to purchase shares (100 shares) at a specific price (Strike).
Example
You sell a 5 DTE (days to expiration) contract for $50 at a strike of $100; current price is $95
At the end of the week the price is $99. You keep the $50 premium and the shares
At the end of the week the price is $100. You sell the shares at $100 and you get to keep the $50 premium
At the end of the week the price is $105. You sell the shares at $100 (your strike) and you get to keep the $50 premium
Specific Entry Point Analysis (SEPA) has been popularized by many investors over the years; including two time US Investing Champ Mark Miniverini.
SEPA is a method of entering into trades based upon several factors, but not limited to, technical analysis, fundamental analysis, and news. By timing your entry and exits, the idea is that you wait for the optimal time to enter into a position and sell that position before there is a huge sell off. By entering and exiting, in contrast to long term holding, this allows us to maximize positive movement and have more control over our money; especially when the market is experiencing bad news or other world events.
As mentioned above, diversifying your investments into stocks from various industries is still having your money in one place; the stock market. It is just as important to consider other options that can get you a return on your investment. We do not mention insurance policies as many policies that have growth potential are based upon the stock market.
Bonds
Offered/backed by the US Treasury department. These offer a fixed interest rate and are guaranteed unless the entire country does not exist.
The money collected from bonds are often used to offset government spending, fund future government projects (It helped to finance World War I for the US), and to control the money supply.
These are time sensitive, so their is a maturity date (when you can have access to your money). Time frames include 3 months, 6 months, 1 year, 2 years, 5 years, 10 years, and 30 years. see current bond rates
Note that the interest rates change based on the length of time. Shorter terms can often come with higher interest rates as they fluctuate based on interest rates changing. Longer terms offer similar percentages to lock them in for longer periods of time.
People often look to diversify some of their portfolio when interest rates are high and the stock market is down. This is also another way to protect your money when you are in retirement or close to retirement.
Interest rates are nowhere near what the market can return on average, but when the market trends downwards bonds are a wonderful way to protect your money and guarantee a return.
CD's (Certificates of Deposit)
Similar to bonds, except they are backed by your local/national financial institution
Financial institutions (FI's) offer CD's to hold on to your money for a specific period of time in exchange for giving you higher interest rates on that money.
FI's then use that money to:
Manage their cash reserves (how much money they must have available at any time) as required by the Federal Reserve. This allows other customers to take out money at any time without worry of a FI not having their money.
Use the money to create more money for them through lending that money at higher interest rates, than what you are receiving, to other customers: car loans, home loans, business loans
Purchase bonds at a higher interest rate than what they are paying you
Businesses
Venture Capitalists (VC's) are always looking for businesses to invest in order to get a higher return on their investment (ROI)
You could invest in someone else's business and get interest on your loan or earn a percentage of their profits
You could also run your own business; a simple laundromat can often make 25-30% ROI in a year
Your ROI should be based on the risk you are taking and the time you will need to devote to that effort
20% of businesses fail in the first 2 years, 45% in the first 5 years, and 65% in the first 10 years
Real Estate
In most cases, real estate often appreciates (rises) in value over time.
In the meantime, owning property can allow you rent out the property (lease). The monies collected can offset your initial investment/pay for the investment.
While renting a property comes with many benefits, it can also be stressful: no one renting, renters not paying (think about covid when many owners could not collect rent from renters), maintenance, or paying property managers to manage the property for you.
Average rental property percentage is 8-10%.
(Rental income for a year - Expenses) / Amount Invested
Cryptocurrency
Created as a monetary system free from government and banks that have often devalued currency of their respective countries.
Digital currency that allows users to potentially not be traced by the government or other users. Can be held in storage outside of the internet or physical cations to avoid theft or tracking.
Digital currency that is almost primarily based on supply and demand; If no one wants it or uses it then it is worthless
Look for crypto that:
Is finite and cannot continue creating more of it; then it is no different from the US dollar and the government printing more and more money potentially devaluing the US dollar.
Widely accepted across multiple major crypto platforms for trading
'Utility' beyond it holding a monetary value. When it can be directly tied to other things of value or used towards access to a platform for gaming or other products/services.
Everyone wants the next crypto that will 10-100x your money. Much like any other investment, you would be best to limit your exposure if you are interested in the crypto market.
10% or less offers exposure without jeopardizing your total investments should crypto go to zero.
Previous Metals
Gold and other materials are often seen as items that tend to appreciate over time
They also are subject to swings in supply and demand
The greatest value of them are based in the fact that it is widely used and accepted by everyone independent from the economy
But, much like everything else (stocks, currency) it is subject to fluctuations in price