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Attention New Investors: Invest That Cash

Dan Newman
June 12, 2012

You win the lottery; your great-uncle bequeathed you his fortune made during Prohibition; or, more likely, you worked slavishly while saving pennies to amass a pile of cash. No matter the way in which the cash appeared in your account, inflation is slowly eating away at its value unless you do something about it.

For example, if you have $1,000,000 in cash sitting in your account, even at today's inflation rate of 2.3%, it will lose 20% of its purchasing power over 10 years, and after 30 years, it will only be able to buy half as much as it can today. And with today's low interest rates, it's unlikely the cash sitting in your bank is earning very much. To beat inflation, invest that cash.

How should you invest it? Here are plans for two different hypothetical investors: one for an investor not interested in researching and following companies, and one for an investor who finds such research fascinating.

For the investor with other passions
Researching stocks isn't for everyone. If you have absolutely no interest in learning about how a specific company operates, who leads it, and envisioning the potential future of the company, then picking single stocks isn't for you. And that's OK.

If you fit this description, you can use a portfolio of low-cost funds that track major indexes. Make sure to rebalance it every so often, and it is likely that you will outperform a majority of actively managed mutual funds. How is that possible? Well, about 84% of those mutual funds underperformed their benchmark indexes last year.

Many such example portfolios with specific fund selections are available through the Motley Fool's Rule Your Retirement community. Here's a general example of such a portfolio that's aimed at those who are getting closer to retirement:

Fund Components
Large-cap stocks 30%
Mid-cap stocks 10%
Small-cap stocks 10%
International stocks 15%
Bonds 35%

Source: Rule Your Retirement.

These can be made up of mutual funds or exchange-traded funds, like the Vanguard Total Bond Market ETF (NYSE: BND  ) and the Vanguard Large Cap ETF (NYSE: VV  ) .

While this takes away the anxiety from investing in specific companies, you might still worry about investing at a market top. To solve this, take smaller chunks of your cash and invest them over a longer time period (called dollar-cost averaging).

For the investor with passion
On the other hand, if you love learning about how a company operates, who runs the show, and fantasizing about a company's future, don't be afraid to select companies that you think will outperform the market. Read The Motley Fool's "13 Steps to Investing Foolishly," which will give you the basic knowledge required to make your first investments, such as:

  • Spread out your risk. Just as the portfolio above is spread across different geographies, sizes, and types, a portfolio made up of single companies should be spread across a wide range of classifications. This ensures that if one stock goes to zero, your entire portfolio isn't worthless.
  • Look for sustainable competitive advantages. Companies that have no competitive edge, or moat, won't survive long. Look for companies that benef