As you start your career, it is wise to start saving and investing your money. You may think that you’re too young to start saving and investing, but the power of compound interest can grow your savings substantially if given enough time. If you are young, time is your greatest asset. In a previous posting, I wrote about why I love exchange traded funds (ETFs). I personally use them to build my portfolio to avoid having to spend too much time researching stocks. They have allowed me to maintain a balanced portfolio that will grow over the long-term and ride out the recessions in the short-term.
Before I give you my top ETFs, let me demonstrate to you the power of compound interest. Additional time in the market can substantially add to your returns. It can even make up for a lower rate of return and lower contributions. See the three scenarios below.
I have modeled out three scenarios, each returning 7% annually until age 65:
The best outcome is if you invest $10,000 at age 22 since you’ll end up with $183,444. Investing early at age 22 more than makes up for the $5,000 gap at age 30 and the $10,000 gap at age 40.
As you can see, the differences are very substantial if you give yourself more time in the market. Although my scenarios only assume that you invest in your initial year, if you invest every single year starting when you are young, you will have a substantial nest egg by the time you retire.
So, what do you invest in? As you probably guessed, I recommend exchange traded funds for most people since they are low maintenance, low cost, and diversified. An exchange traded fund simply tracks an index, which contains a basket of stocks. Since you are investing in a group of stocks, you spread your risk around. If a few companies perform poorly, that's fine since you have other companies that will perform well. You simply invest a similar amount of money on a regular basis and watch it grow over time. You’ll ride out the recessions and take advantage of bull markets. There’s no need to research companies or time the market. You just need discipline, patience, and consistency. Also, make sure each purchase is large enough so transaction costs are insignificant. Here are my top exchange-traded funds with their ticker symbols in parentheses.
1. iShares Core S&P 500 ETF (IVV)
IVV tracks the S&P 500, which is representative of the US market as a whole. It contains all the sectors in our economy, and its holdings are weighted by their relative market caps (size). The largest holdings are Apple, Microsoft, Exxon Mobil, GE, and Johnson & Johnson. It is a good representation of the U.S. market and a safe long-term play barring a zombie apocalypse.
2. Vanguard High Dividend Yield (VYM)
VYM is another broad, diversified industry fund but the focus is on dividend paying stocks. The largest holdings are Microsoft, Exxon Mobil, GE, Wells Fargo, and Johnson & Johnson. Here’s another safe, long-term play that will allow you to collect increasing dividends.
3. Vanguard Intermediate-Term Bond (BIV)
BIV is a bond fund. Although it is a stock, you are investing into a stock backed by a variety of US treasury notes. When you are young, I don’t recommend investing too much of your money into bonds since your expected return is lower. However, having bonds will protect you against a down market, since bonds tend to perform well when the stock market performs poorly (investors sell speculative stocks and buy safer bonds). As you get older and capital preservation becomes more important, you can shift more of your assets over to bonds.
4. Vanguard Small-Cap Growth ETF (VBK)
VBK is a broad industry fund, but it is focused on smaller growth companies. Your expected return is higher than an S&P 500 fund, but you’ll experience higher volatility in stock price. You also won’t receive much of a dividend. When you are young, you can hold more of this fund, but as you age, you should move money away from it.
5. Vanguard REIT Index Fund (VGSIX)
VGSIX is a real estate investment trust (REIT). In other words, you are investing into a company that has real estate holdings. REITs are nice to have for diversification purposes since it is a separate asset class than stocks or bonds. I recommend only having a small portion of your portfolio in REITs to provide protection when the stock and bond markets suffer.
6. Motif Investing
If none of these funds meet your needs and you can’t fund any other funds that do, consider motif investing. Motif investing allows you to create your own basket of up to 30 stocks. If you have a trend or theme that you believe will take off, motif investing is the perfect way to profit on that idea. You can also invest in funds that other people have created based on themes such as cleantech, office space, and online gaming.
Here’s a summary of these funds (minus the motifs).
Although the 1-year returns as of December 2015 haven’t been all that great for stocks (equities) since the market underperformed that year, the 5-year and 10-year average annual returns look much more promising. The 10-year return doesn't look as good as the 5-year return since the Great Recession happened in that period. Despite the Great Recession, there is still approximately a 7% annual return from the overall market. Therefore, you should invest in the long-run to ride out the short-term dips and recessions.
Most of these funds have a low expense ratio. The average expense ratio for funds in general is .43%. All these funds are below that. Over time, high expenses can eat into your returns.
For your own portfolio, I recommend keeping the majority of your holdings in broad based, market funds such as IVV or VYM. Then you can use other asset classes to protect your portfolio in case stocks underperform. As you get older, you should allocate more of your capital away from risky stocks and more towards conservative stocks and bonds. Ultimately, when you retire, you want a stable portfolio that you can rely on for retirement. Remember, consistently investing in high-quality stocks is one of the tried-and-true ways of building wealth.
Note: I am not an investment professional and not responsible for your portfolio gains or losses. Please consult your investment advisor for advice on how to manage your portfolio.
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