Dear Young Portfolio Holder, I am very excited that you have started or plan on starting an investment portfolio. Today, I am going to discuss the early stages of diversifying your portfolio. So, let’s get started.
First…What do I mean by Investment Portfolio?
The term “investment portfolio” is sometimes used to refer to a person’s collection of stocks (and maybe bonds). In today’s letter, I am using an alternative definition of “investment portfolio.”
The definition of “investment portfolio” that I am using is…
a collection of all your assets, which are things that you own that earn you income on a regular basis. This definition can include more than stocks and bonds. It can include things such as real estate, royalties, and more.
What do I Mean By Diversifying Your Portfolio?
Diversifying your portfolio means making sure that your portfolio has more than one asset class.
For instance, if you have stock in your portfolio, then you have some other type of assets in your portfolio, also.
In other words, when it comes to collecting assets, “Don’t put all of your eggs (assets) into one basket.”
Why Should You Be Diversifying Your Portfolio?
In short, your investments should be diversified as a way to make it more likely that your portfolio will survive in a variety of economic environments.
(For more information on why you should diversify your investment portfolio, please check out the post, Is Your Portfolio Diversified?
Diversifying Your Portfolio
The First Part of Your Portfolio
The first part of most portfolios is cash.
The reason that the first part of your portfolio usually should be cash is because this is the cash in your emergency fund. Before you start diversifying, you should have at least $2000 cash in your emergency fund.
The reason that you want to start with an emergency fund is that your emergency fund acts as “insurance.”
(There are cases in which someone starts with another type of asset first, like when they inherit an asset early in their life.)
Insurance for What?
One of the main purposes of having an emergency fund is to insure that you do not have to sell your other assets in case you have an emergency. So, get that emergency fund started.
(By the way, your retirement account is one of the assets that you want to protect. Don’t be tempted to pull money out of your retirement account. The older you will appreciate you for not doing that!)
While it can take a long time to build up a complete emergency fund, you can start diversifying your portfolio after you have this starter emergency fund (the $2000).
Moving On To Diversifying Your Portfolio
Once having the starter emergency fund, I like to move into the stock market. Specifically, I like to start this part of the journey with an S&P 500 index fund.
If you have an IRA, you can buy index funds there. However, in addition to your retirement account, it’s good to have a taxable investment account, because that is an asset that you will be able to use much later in your life, but earlier than a retirement account. In that taxable investment account, I like to start with an S&P 500 index fund, too.
The Third Asset Category That I Like for Diversifying Your Portfolio
While some people may disagree with my third category for portfolio diversification for a young person, it is what I recommend for my daughter.
My third category for diversification is treasury bonds.
I am not talking about having a lot invested in bonds for those ages 30 and under. But, I subscribe to a version of the 120 rule of investing.
As I mentioned above, I like Treasury bonds.
But, how much would I put into Treasury bonds? This is where the 120 rule of investing comes into play.
What Is the 120 Rule in Investing?
The “120 rule for investing” says that by subtracting your age from 120, the resulting number tells you what percentage of your stock and bond portfolio should be in stocks. The remaining percentage should be in bonds.
For instance, if you are 22 years old.
120-22=98
That means that 98 percent of your stock and bond portfolio should be in stocks, while 2 percent of your portfolio should be in bonds.
What is My Version of Using the 120 Rule in Investing?
My version of the 120 rule in investing is the same, except that instead of using the bond percentage as the percent of the portfolio, I use the bond percentage as the percent of each year’s total investments. But, the bond investing doesn’t start until after there is $10,000 in the S&P 500 index fund.
So, to make this clear. I suggest to my daughter that she:
First saves her $2000 emergency fund.
Second, start investing in an S&P 500 index fund.
Then after she reaches $10,000 in the S&P 500 index fund:
Third, invest 1% of the money that she invests each year in Treasury bonds.
Diversifying Your Portfolio: Bonus
The 3 ways listed above is how I would start diversifying as a young investor.
However, if you are able to do what I like in terms of housing, you will have a fourth asset area…real estate. I like buying a multifamily as a first home, which means that you would gain rental income.
Key Takeaways:
- You should have an investment portfolio.
- Your investment portfolio should be diversified starting pretty early on.
- The first part of your portfolio should be the money in your emergency fund.
- I like investing in the stock market via index funds as the second type of asset in a portfolio.
- For portfolio diversification, I like treasury bonds as the third asset class.
- Bonus Early Diversification Step: If you buy and move into your own multifamily property, you will gain real estate in your portfolio.
- So, some things that can be in a diversified portfolio include: cash, CD’s, bonds, rental real estate, individual stocks, index funds, mutual funds, royalties, and more.
That’s all for now. I hope that you are inspired to diversify your portfolio.
Remember, I truly want you to succeed!
Rich Mom
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Would you like to get more ideas about investing and investment portfolios? Check out:
What is an Investment Portfolio?
Do You Have An Investment Portfolio?
Is Your Investment Portfolio Diversified?
A Small Passive Income Is Better Than No Passive Income
Start Creating Passive Income Today
Looking for financial resources? Check out the Rich Mom Poor Kid Resources Page.
Who is Rich Mom?
If you’re wondering who Rich Mom is, check out my “About Rich Mom” page.
Also, please note: I am not an investment advisor. Always do your own due diligence and research before investing. Check with your own investment advisor.
The information shared here is not intended as financial advice, just education and entertainment.