Investing 101: A Beginner’s Guide to Building a Diversified Portfolio

Investing can seem overwhelming, especially for beginners. With so many options available, it can be challenging to know where to start. However, building a diversified portfolio is a crucial step in achieving long-term financial success. 

In this beginner’s guide, we will walk you through the basics of investing and help you build a diversified portfolio that aligns with your investment goals.

What is investing?

Investing is the process of allocating resources, usually money, with the goal of generating profit or income. Investing should not be a one-time event; it’s a long-term commitment to a financial strategy that involves researching, buying, holding, and selling assets such as stocks, bonds, and mutual funds.

Investing could also be used to describe time spent improving or adding value to an asset. For example, a person can invest their time in their business, hoping to generate more income. For the purposes of this post, we’ll stick to investing money in the long-term.

Why is diversification important?

Diversification is a key factor in any successful investment strategy. It involves spreading your investments across various assets, such as stocks, bonds, and commodities, to minimize your risk. When one asset underperforms, the other assets can help offset any losses, and you can still achieve your investment goals.

For example, suppose you invested all your money in a single stock and the company went bankrupt. In that case, you would lose all your money. However, if you had diversified your investments across various stocks, bonds, and other assets, you would still have other investments that would potentially offset any losses.

As people grow older, they tend to diversify more towards stabler assets like bonds rather than stocks since they rely on the portfolio to serve as their income. If their portfolio was heavily allocated towards stocks and a recession impacted the stock market significantly, their portfolio would take a massive hit which would impact their retirement. 

How to build a diversified portfolio

Determine your investment goals

Before you start investing, it’s essential to determine your investment goals. Are you saving for retirement, a down payment on a house, or your child’s education? The answer to these questions will help you decide how much money you should invest and what type of investments to choose. 

Choose your asset allocation

Your asset allocation is the mix of different asset types in your portfolio, such as stocks, bonds, and cash. The right mix for you depends on your investment goals, time horizon, and risk tolerance.

For example, if you’re investing for the long term and can handle more risk, you may want to allocate a higher percentage of your portfolio to stocks. If you expect that you’ll need the money in the short term for a down payment, you might want to invest in less-risky assets or keep it in a high yield savings account like M1 Finance or Marcus. This protects your capital until you need it. 

Choose your investments

Once you have determined your asset allocation, it’s time to choose your investments. The investments you choose should align with your investment goals and risk tolerance.

There are many investment options to choose from, including stocks, bonds, mutual funds, and exchange-traded funds (ETFs). It’s essential to do your research and choose investments that are diversified across various sectors, industries, and geographic regions.

The most diversified are mutual funds and ETFs which can track an industry or market. I recommend low-fee index funds and ETFs like $VTSAX, $VTI, $VOO, and $FZROX, which have very low or no fees and are as diversified as they come. 

Monitor and rebalance your portfolio

Once you have built your portfolio, it’s essential to monitor and rebalance it regularly. As the value of your investments changes, your asset allocation can shift, and your portfolio may become less diversified.

For long-term investors, it’s important to think about the overall value of your portfolio long-term. Buying and selling is a more active approach to investing compared to keeping a set schedule on your investing no matter how the market reacts. 

Think about the impact of the stock market when the COVID-19 pandemic hit in March 2020. The stock market was in a freefall. Many investors sold off their stocks anticipating that the market wouldn’t recover for a long time. Meanwhile, long-term investors didn’t change their investing schedule and were better off in hindsight. 

Final Words

Investing can be a powerful tool for building long-term wealth, but it’s essential to approach it with a clear plan and an understanding of the risks involved. By building a diversified portfolio that aligns with your investment goals, you can reduce your risk and increase your chances of achieving your financial objectives. While the stock market is known for making money, you can’t control the market nor predict the direction it will go in the short-term.

Personally, I continue to invest in the stock market because I stand by the principles of long-term investing. I’ve learned my lesson with actively trading. While I had some success on certain trades, I’ve lost more than I would’ve if I just kept to the principles.

Most professional fund managers, whose job it is to make a profit, LOSE money in the stock market. Even with their intellect and costly tools, most fund managers still lose money. Consider that before you think about actively trading for a quick return.