Let's face it -- investing can be a stressful prospect, especially when you're fairly new to the game and aren't quite sure what you're doing. But investing in stocks is one of the most effective ways to grow wealth, and so it's worth stepping outside your comfort zone to make that happen.
Of course, your goal as an investor should be to build a portfolio you're comfortable with -- one that gives you the confidence you need to sleep well at night. If you're not quite there yet, here are a few important guidelines to follow.
1. Understand basic asset allocation rules
Stocks are a riskier proposition than bonds, but they also tend to deliver much stronger returns -- returns you'll need to grow enough wealth to meet your long-term goals. As such, you shouldn't shy away from stocks. Rather, you should make sure you have an appropriate level of them in your portfolio.
Now the extent to which you invest in stocks will hinge largely on your personal tolerance for risk, but your age should be a factor as well. As a general rule, the closer you are to retirement, the less aggressive you should be with regard to holding stocks, whereas when you're younger, going heavy on stocks is a solid move.
Want to narrow down your stock allocation a bit more specifically? If so, you can use the rule of 110, which states that if you subtract your age from 110, you should have that percentage of your portfolio in stocks. A 60-year-old, for example, would be advised to have 50% of his or her assets in stocks based on this formula, while a 30-year-old would be 80% invested in stocks.
Again, there's wiggle room here, and risk tolerance can, and should, come into play. But if you follow this basic rule, it'll help you assemble a portfolio with an appropriate level of stocks given your age.
2. Load up on index funds if individual stocks intimidate you
Buying individual stocks can be a daunting prospect. You need to research each individual company and make sure it aligns with your investment strategy.
A less stressful bet may be to fall back on the performance of the broad market, and you can do that by investing in index funds. Index funds are passively managed, low-fee funds that aim to match the performance of the market indexes they're tied to. An S&P 500 index fund, for example, will have the goal of doing as well as the S&P 500 itself, which is an index that's comprised of the 500 largest publicly traded companies.
When you buy index funds, your portfolio will gain value as the broad market does well. Of course, your portfolio will also lose value when the stock market crashes, but that way, you'll know your investments aren't outliers -- they're simply down because the entire market is down, and they'll recover once the broad market picks back up.
Holding a diverse mix of investments in your portfolio can help you avoid losses during market downturns or periods of volatility. Now you can diversify by buying stocks from different corners of the market -- for example, some tech stocks, some bank stocks, some energy stocks, and some healthcare stocks -- or you can revert to index funds, which can help you achieve the same goal without having to do as much research and make as many transactions.
Now if you're going to go the individual stock route, you should generally aim to hold at least 12 different stocks across at least four market segments. If you buy 12 different tech stocks, for example, and tech stocks tank, your portfolio value will plummet overnight, whereas if you only have about 25% of your stock investments in tech stocks, the damage won't be as extensive.
It's important to invest -- but it's also important to feel secure in the way you're investing. These tips will help you put together a portfolio that's a source of comfort rather than a source of panic.