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I understand the idea behind an investment portfolio (investing one's money in diverse ways), but I'm not sure where to begin.

I have a 401k with my current employer and a savings account at a bank, but that's it. I have no money in mutual funds or IRA's or bonds or anything.

As some of you may have seen in my other questions, I've been instructed by users on this board to pay off all of my existing debt that has high interest rates first, and then look to investing my money. So lets assume that I've paid off my existing debts, which I haven't, but just for the sake of looking to the future where should I first begin to invest my money? How much of my portfolio should be going into my 401k (which, for the record, I have no confidence in)? Should I put in money in gold hedge funds? How much of my portfolio should be in an IRA?

  • What's wrong with your 410K? What choices do you have in it? – C. Ross Aug 6 '10 at 16:26
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    You wrote: "I have a 401k" and then you wrote "I have no money in mutual funds or IRAs or bonds or anything". One of those statements is false. (i.e. if you have a 401k, it is certainly invested in stocks or bonds) – Michael Pryor Aug 6 '10 at 17:29
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    @Jagd - A 401K is just going to perform as the financial markets do (usually the stock markets). So investing in Mutual funds or Bonds isn't going to be any safer than a 401K. Don't fret too much about the losses in your 401K that is, by design, a long term investment that will fluctuate in both directions. Over the long haul, if history serves, it should fluctuate up more than down. You just have to stomach the occasional plummets. – JohnFx Aug 6 '10 at 21:37
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    @Michael - ignorance on my part, I suppose. I do have a 401k, but I have little control over where my money is invested in it, so for the most part I ignore it. I realize that it is invested in mutual funds, etc., but since I have little control over it I don't see myself as being fully vested in the stock market and so on. Now if I had a broker that managed it for me and gave me a say in it then I'd probably give a hoot about it and I'd consider myself vested in stocks. Am I wrong to think this way? – Jagd Aug 6 '10 at 21:38
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    @Jagd It can't be true that you have no control over your 401k. Are you able to log in to the web interface for it? Can you verify the money exists and that it is invested in (and what it is invested in)? If it's just some magical thing that you don't have any details on, I'd do some research to make sure your 401k isn't just sitting in cash (or being stolen). – Michael Pryor Aug 8 '10 at 23:44
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Most people carry a diversity of stock, bond, and commodities in their portfolio. The ratio and types of these investments should be based on your goals and risk tolerance. I personally choose to manage mine through mutual funds which combine the three, but ETFs are also becoming popular.

As for where you keep your portfolio, it depends on what you're investing for. If you're investing for retirement you are definitely best to keep as much of your investment as possible in 401k or IRAs (preferably Roth IRAs). Many advisers suggest contributing as much to your 401k as your company matches, then the rest to IRA, and if you over contribute for the IRA back to the 401k. You may choose to skip the 401k if you are not comfortable with the choices your company offers in it (such as only investing in company stock).

If you are investing for a point closer than retirement and you still want the risk (and reward potential) of stock I would suggest investing in low tax mutual funds, or eating the tax and investing in regular mutual funds. If you are going to take money out before retirement the penalties of a 401k or IRA make it not worth doing.

Technically a savings account isn't investing, but rather a place to store money.

  • So it sounds like I need to look into an IRA then. Would it make any sense to do both a Roth IRA and a traditional IRA? – Jagd Aug 6 '10 at 21:51
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    @Jagd - Only if you've maxed out your Roth IRA should you look at a traditional IRA. A Roth IRA is superior to a regular IRA for almost everyone. – Eric Petroelje Aug 6 '10 at 22:50
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    And I would most certainly look into a Roth IRA if your 401k is not employer matched – Bryan Denny Aug 20 '10 at 14:24
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Paying off the high-interest debt is a good first start. Paying interest, or compound interest on debt is like paying somebody to make you poor.

As for your 401k, you want to contribute enough to get the full match from your employer. You might also consider checking out the fees associated with your 401k with an online fee analyzer. If it turns out you're getting reamed with fees, you can reduce them by fiddling with your investments. Checking your investment options is always a good idea since jobs frequently change them.

Opening an IRA is a good call. If you're eligible for both Roth and Traditional IRAs, consider the following:

  • if you're certain you'll be in a lower tax bracket when you retire, choose Traditional since you'll pay less tax on withdrawals
  • if you're sure you'll be in a similar or higher tax bracket, Roth is better since you'll already have paid your taxes
  • if you make an early withdrawal from a Roth IRA, you won't be penalized
  • since you already have a 401k, which is tax-deferred like a Traditional IRA, it makes sense to diversify your options by opening a Roth

Most financial institutions (brokers or banks) can help you open an IRA in a matter of minutes. If you shop around, you will find very cheap or even no fee options. Many brokers might try to get your business by giving away something for ‘free.' Just make sure you read the fine print so you understand the conditions of their promotional offer.

Whichever IRA you choose, you want to make sure that it's managed properly. Some people might say, ‘go for it, do it yourself’ but I strongly disagree with that approach. Stock picking is a waste of time and market timing rarely works.

I'd look into flat fee financial advisors. You have lots of options. Just make sure they hear you out, and can design/execute an investment plan specific to your needs At a minimum, they should:

  • keep a small slice of your portfolio in cash/cash equivalents
  • spread your money over various asset classes
  • invest in a wide variety of dynamic allocation strategies
  • offer portfolios with systematic risk management
  • use best means of trade execution (so you don't lose money to poor tech or taxes)

Hope this is helpful.

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An investment portfolio is typically divided into three components:

  • US stocks
  • International stocks
  • Assorted bonds (mostly US treasury and corporate bonds with good credit ratings)
  • Cash (US dollars) (doesn't really count because until you're reeally close to retirement you shouldn't have any appreciable sums here because you can do a lot better elsewhere. note that having an emergency fund in a bank account is worthwhile but shouldn't be counted with your investment portfolio.)

All three of those can be accessed through mutual funds or ETFs. A 401(k) will probably have a small set of mutual funds for you to pick from. Mutual funds may charge you silly expenses if you pick a bad one. Look at the prospectus for the expense ratio. If it's over 1% you're definitely paying too much. If it's over 0.5% you're probably paying too much. If it's less than 0.1% you have a really good deal.

US stocks are generally the core holding until you move into retirement (or get close to spending the money on something else if it's not invested for retirement). International stocks are riskier than US stocks, but provide opportunity for diversification and better returns than the US stocks. Bonds, or fixed-income investments, are generally very safe, but have limited opportunities for returns. They tend to do better when stocks are doing poorly.

When you've got a while to invest, you should be looking at riskier investments; when you don't, you should be looking for safer investments. A quick (and rough) rule of thumb is that "your age should match the portion of your portfolio in bonds". So if you're 50 years old and approaching retirement in 15 years or so, you should have about 50% in bonds. Roughly.

People whose employment and future income is particularly tied to one sector of the market would also do well to avoid investing there, because they already are at risk if it performs badly. For instance, if you work in the technology sector, loading up on tech stocks is extra risky: if there's a big bust, you're not just out of a job, your portfolio is dead as well.

More exotic options are available to diversify a portfolio:

  • Commodities, especially precious metals (gold, silver, platinum, palladium) - potentially a crisis hedge
  • Emerging market stocks (a particularly risky international investment)
  • Emerging market bonds (similar)
  • Currencies (other than the US dollar)
  • Real estate (possibly through investment trusts)

While many portfolios could benefit from these sorts of holdings, they come with their own advantages and disadvantages and should be researched carefully before taking a significant stake in them.

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Don't over think about your choices. The most important thing to start now and keep adjusting and tuning your portfolio as you move along in your life. Each individual's situation is unique. Start with something simple and straight forward, like 100 - your age, in Total Stock market Index fund and the remaining total bond market index fund. For your 401k, at least contribute so much as to get the maximum employer match. Its always good if you can contribute the yearly maximum in your 401k or IRA. Once you have built up a substantial amount of assets (~ $50k+) then its time to think more about asset allocation and start buying into more specific investments as needed. Remember to keep your investment expenses low by using index funds. Also remember to factor in tax implications on your investment decisions. eg. buying an REIT fund in a tax advantaged account like 40k is more tax efficient than buying it in a normal brokerage account.

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