How to Allocate Your Investment Funds
April 3, 2018, 11:11 am
Some of the questions I get most often are related to allocation – how much money to put into your portfolio, how many stocks to own, how much to invest in each one and so on. These are important questions, so let me share a few thoughts as you get started.
First, there is no magic formula that applies to all of us. I know it would be easier if there were, but it’s important to remember that everybody’s situation is different. We all have different amounts of money we can invest. We all have different risk tolerances. We have different time frames for when we’ll need our money and different purposes for it — a mortgage down payment, college tuition, retirement, a vacation home, day-to-day needs and more. With that in mind, I’d like to offer some guidelines for you to consider as you build your own portfolio.
One very good rule of thumb is that you want to be more conservative with money you will need in the next few years. Most people, if they have a specific financial obligation coming up, can’t afford to lose the money they need to pay for it. It’s a good idea to keep this kind of money in cash or cash-like investments such as savings accounts, money market funds, CDs and some conservative bonds.
Another excellent rule of thumb is to try to diversify, which is a way of saying, “spread out your risk” and “don’t put all of your eggs in one basket.” Tempting as it is to bet big on a stock you really like, there is no danger greater than being too heavily weighted in one investment.
My general advice is to put no more than 5% of your investable dollars into any one stock, as this will help spread out your risk. From there, I would love to see you own at least four or five stocks, but I understand many investors need to start with fewer than that and build over time.
Most important of all, I always encourage you to invest in a way that makes you most comfortable. Ideally, you’ll be able to consistently reinvest your profits, which unlocks the magic of compounding, a simple but extremely powerful concept. Your money keeps earning money, which in turn earns more money.
I’m sure many of you have seen this in action, especially with earned interest. If your savings account earns 3% interest on $100, that initial amount becomes $103 in a year’s time. That $103 earns 3% the next year to move up to $106.10. So both your interest and principal are earning interest.
Compounding works the same way with trading. It can be an effective way to turn even a modest investment into a real and life-changing sum. Taking those quick gains and rolling them back into the next trade gives you the potential to make solid profits and truly build your wealth over time.