My Diversi-What Portfolio? An Investing & Mutual Fund Explainer for Beginners
For my previous explainer on college-finance, click here!
Here’s something most people don’t think about: when money sits in a standard checking account, it makes little to nothing. However, by investing, we have the opportunity to receive dividends (a part of a company’s profits which are typically divided out by shareholders each quarter) and make our money work for us while we sleep.
Financial guru and Harvard Law Graduate Jim Cramer has quickly become my personal go-to for all things investing and markets. He’s routinely featured on CNBC’s Squawk on the Street and has his own show and podcast, Mad Money w/ Jim Cramer.
Recently, one of the questions Jim was asked was “what index fund [or mutual fund] should a young investor put his first $1K?” I’ll let him explain:
For a lot of us beginners, even having $1,000 lying around seems a little steep. Yet, even with a little money set aside, Jim is right that mutual funds should be our first point of entry into investing. This is where I personally made a mistake. I followed the crowd and ran to Robinhood (which is still great for understanding the market and playing with spare change). However, a safe index fund should have been my first choice.
The main idea of a mutual fund is to diversify your portfolio, which simply means that you’re varying the places in which you make investments to protect against losing all your assets at once. This provides access into the market without having to go in-depth to research stocks, and is relatively lower risk in comparison to individual stock trading.
According to Jim, you’ll want to find a “cheap index with low fees that mirrors the S &P 500 that way you have exposure to American equities”. First of all, low fees and an affordable price means that more of your money will actually be in the market. Second, since the beginning of the S & P 500 in 1928 and up until 2016, the average return was around 10%. If your index fund mirrors the S & P 500, then in theory, it should be making money for your money.
Mutual funds, while not in the game of immediate gratification like the mirage of promises with which individual stocks try to grab your attention (and your money), they are still incredibly valuable and beneficial to a strong diversified portfolio. A healthy portfolio usually does not have more than 20% of your assets invested in one sector.
Don’t get me wrong. Stocks are great. Although, my mistake of rushing to buying up individual stocks didn’t cost me (in fact it yielded a 22% return over the past 5 months) it still was something I should have thought through more prior to acting.
When the time comes to return to the topic of stocks, I will be able to better understand how to divide my money among sectors (usually 1-2 stocks in domestic oil, tech, retail, healthcare and entertainment) and how to research those companies before investing. Until then, Vanguard 500 Index, I’m coming for ya!