Selecting investments is a lot like trying on clothes: What fits you really well might not look good on someone else. Some people take a conservative, traditional approach to what they wear -- and what they invest in. Others go with what is new and trendy -- the hottest clothes and the hottest stocks. When building an investment portfolio, you need to consider your stage of life, your financial objectives and your willingness to accept risk.
Decide how much time you want to commit to investing. If you want to pick individual stocks by reviewing publications such as the Value Line Investment Survey, which includes rankings of 1,700 stocks, you will have to devote the time it takes to study potential investments. If you don’t have the time or interest in learning about stock selection, let the professionals do it for you by investing in mutual funds. These are funds with groups of stocks and bonds, and numerous types of funds are available to fit aggressive or conservative investors’ needs.
Diversify your investments. It’s never a good idea to put all your investment capital into one or two stocks. Spreading your money over a half-dozen or more stocks or mutual funds can help limit your risk. One stock performing particularly well can mitigate the effect of another one that is dropping in price.
Decide on an asset allocation model. It is considered prudent to own a mix of stocks and bonds and to keep a portion of your funds in cash should you need to use some of the money. A standard model is to subtract your age from 100 to determine the percentage of funds to hold in stocks. For example, a 25-year-old would have a portfolio 75 percent invested in stocks. Another traditional model is to have 55 percent in stocks, 35 percent in bonds and the remainder in cash.
Consider your attitude toward risk. Decide whether you can accept the possibility of losing a significant portion of your investment if the stock market severely declines. If risks like these make you uncomfortable, build a risk-averse portfolio with stocks of large, stable companies, along with quality bonds and some risk-free investments, such as a savings account.
Resist the urge to jump into the stock market with all the cash you have accumulated. Try a dollar-cost averaging strategy, investing the same dollar amount each month or quarter. This method allows new investors to become patient, long-term investors through good markets and bad rather than trying to time the swings in the market, which is difficult to do.
Review your investments and investment strategies at least twice a year. Being a long-term investor doesn’t mean you simply buy stocks and ignore them. Sometimes, it's best to sell a stock or mutual fund that is performing poorly and redeploy the capital in a better one.
- The Morningstar website has extensive analyses of mutual funds and can be an invaluable guide to helping you select the funds that meet your risk vs. reward criteria.
- Visit your public library and see if it subscribes to Value Line or other investment guides.
- Be sure to look at the mutual fund’s return for the last three to five years, not just the last year. Many times, funds that have extraordinary returns one year are not able to repeat the performance the following year.
Brian Hill is the author of four popular business and finance books: "The Making of a Bestseller," "Inside Secrets to Venture Capital," "Attracting Capital from Angels" and his latest book, published in 2013, "The Pocket Small Business Owner's Guide to Business Plans."