When I first started GradMoney, I announced that I would be starting a series called “Investing 101” that will hopefully help new investors (or even experienced investors) who are looking for a fresh start. If you missed the first entry of this series, I highly suggest that you go back and read THIS ARTICLE FIRST!
Once you have decided what brokerage account you will use, how much money you will put into the account and the account is full of cash, ready to invest, here are a few common questions about the next steps when it comes to putting your hard-earned money to work!
How much of my portfolio should be in cash?
The most you need to know is there is no exact formula to determine this magic number. However, I never recommend that your portfolio contain 0% cash or be 100% invested at any given time. This is because you want to have enough cash on hand to be able to make a new trade if something sparks your interest, and if all of your money is invested you won’t be able to buy a new idea.
My suggestion is that 10%-30% of your portfolio at any given time should be in cash. When the stock market is doing well, the cash amount should be lower. When the stock market is on a decline, the cash amount should be higher so that you can buy stocks at the bottom. This is hard for people to get used to doing, but this is how you will make money.
What is the difference between diversification and asset allocation?
Diversification refers to the different sectors a portfolio is exposed to while asset allocation has to do with which investments you are looking to buy for your portfolio for exposure: equities, bonds, mutual funds, money market funds, options and cash. The exposure ratio of equities-to-everything else depends on 1) your risk tolerance, 2) how close you are to retirement, 3) how much money you are actually trading.
My area of expertise lies with equities and these are the simplest for the average investor to understand. A while back, I discussed the benefits of portfolio diversification and why it is so important. If you would like a refresher, you can read up on it by CLICKING HERE.
What is the optimal breakdown for my portfolio?
There is no magical template for a stock portfolio, however it should be noted that any major changes in the market should also be reflected in the number of positions, or weights, you hold for each stock in your portfolio. For example, gas prices are dirt cheap right now and there is currently no sign indicating that this will improve any time soon. Therefore, energy stocks will likely underperform for the next year at the very least. This means that it would not be wise for you to hold many energy stocks at the moment since the gains will be minimal. On the other hand, healthcare prices are skyrocketing which means higher profit margins for the healthcare sector. Therefore, you should have more healthcare stocks than energy stocks. See the difference?
Here is an example of how weights can be determined in a portfolio with the major stock categories, or sectors, that I like to use. The number of names you should hold in each sector should change depending on the news, though you can create your own formula in Microsoft Excel that will tell you how much money should be in each stock based on a percentage of the total portfolio:
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