April 1, 2004
How To Build Your Portfolio
In the face of it, the markets seem to be swirling, murky, and uncharted waters. Tides rise and fall; fortunes are made and are lost. Dangers — icebergs, sharks, and typhoons — lurk about ready to wreck your investment boat and send your savings to the bottom of the sea.
Once you grasp the basics, though, things suddenly seem to make more sense.…The fundamentals of the markets and investing can give you the same working acquaintance with investing that you have with the weather outside. You will start to see the links between the economy, corporations, interest rates, and investing in general. Just as Al Roker’s forecast helps you decide how to dress for the day, a rudimentary understanding of the stock market and interest rates, added to a smattering of Econ 101, will go a long way in helping you invest wisely.
The Tools: In some ways, solving the mystery of investing couldn’t be simpler. What are the bricks and mortar, rivets, and girders that portfolio managers, financial planners, and individual investors use to build wealth, protect it, and seize new opportunities? They all break down to three basic building blocks. The pros often call them asset classes. You know them as stocks, bonds, and cash.
Stocks are the workhorse of your investment portfolio. Company shares provide the gains you’ll need to realize retirement dreams or help your kids through college.
Stocks have established a track record of consistent, long-term appreciation in the past. They have handily outpaced inflation, and delivered investors a return of just over 11% on average for large company shares and 13% for small company shares. Here’s another way of thinking about it: That average return will double your money in between six and seven years, something that becomes important when you consider costly responsibilities like retirement, college tuition, or even a new home.
Stocks, nevertheless, can be volatile investments. Page through history and you’ll see. Since 1926, the market has risen 30% or more in 18 years, as measured by the S&P 500. There have been famines to accompany the feasts, however. In eight years, the market has fallen 10% or more.
Bonds steady a portfolio. They’re an anchor that pays investors dividends — stable, regular income. All the while, bonds protect your principal, provided you cash them in at maturity, when a bond’s life has come to an end and investors are due to receive their original investment. That becomes important when the stock market goes through ups and downs. Stock values may slide over time; hold a bond for its duration, and you’ll have protected your investment.
The cash portion of your portfolio is a cushion, the kind of protection investors like yourself need just in case something comes up. Cash, too, can be your hunting stash, money you’ll use to seize opportunities in the stock market, or savings you want to keep out of a turbulent market until things calm down a bit. It’s important, however, to distinguish cash on hand for investing from your emergency fund.
Cash in your stock