How to design a portfolio in 3 simple steps: step 1/3

Building strong financial foundations.

Before you even start thinking about investing you have to honestly ask yourself a few questions:

1. Why are you investing your money? 
2. What is your current age and till when will you be investing your capital? 
3. What is your risk profile? 
4. How much are you willing to invest initially and what amount will you put into your portfolio?
5. How much time do you have to monitor your portfolio systemstically?
6. Do you have a possibility to earn more or to cut costs and save more? 

Why are you investing? 

The why is the most important. This is going to help you set a goal. Perhaps you want to:

• retire early,
• save some money for your kids education,
• become rich,
• secure your family,
• help your parents retire early,
• perhaps all of them above.

Whatever the goal is the strategy will be different depening on your age. Investing for future retirement when you are in your late 20s or early 40s is completely different to investing in your 60s. If I were to write a book today and send it to myself in the past I would have witten the tips below. I would have a different strategy if I were 20-30 and 30-50 and then 50 till 60 (this is my preferable retirement age but if you wish to retire at 70 or 80 you can feel free to extend the time ).  

A tip to very young investors 20-30s: start with a small amount of capital being distributed over time into very diversified ETFs. 

Your advantage is that

• you have a lot of time,
• your costs are low ( you probably don't a big car, kids and an expensive houshold to take care of)
• you have a long career life ahead of you and your salary will get better with time,
• you have the lowest amount of debt ( this might differ as some of you might have a students loan to pay back).

Your main disadvantage is:

• lack of experience ( finding a better paid job for some time might be a challange)
• lack of patience ( most begginers want to become quickly rich and retire young and in 90% of cases this is not possible),
• bad spending habits (unless you have a degree in finance or you were brought up in an entrepreneurial family),
• you follow way to many social media apps that infulence your decision making process based mostly on FOMO ( turn off most apps if possible and don't follow any piece of advice from random people on the internet including mine. You could buy a useful book instead ),
• lack of time to learn about companies and instruments as you are possibly still at collage or you have small kids to provide and a demanding boss and a carreer to focus on.

Try not to give your hard earned money to any hedge fund that takes huge managment fees that promise to beat the SPY. Just keep it very simple stupid and learn the habit of investing regardless of the news you get from the social media. Your gole is to also build a muscle that will withstand any market downfall. You have to learn that:

• diversification is key ( If you have Bitcoin and Eth and Cardano and other crypto then this is not diversification because all of these stocks are from the same market),
• volitility is OK as long as you have the muscle stand it (if your max pain is -20% don't invest in Tech or Crypto stocks),
• every crisis is an opportunity,
• during bad times nobody apart from you invests because people are too scared,
• a crash is a opportunity that you cannot afford miss,
• you must not FOMO into hyped stockes,
• at the beggining you shouldn't buy any FAANG stocks ( Facebook-now meta, Amazon, Apple, Netflix, Google).
• you can DCA into them little by little after a 30-70% crash,
• chasing a stock after a big run up is a big fat no no.

My friendly suggestion to you is buying an ETF insted of buying a specific FAANG stock. Through an ETF you are possibly already exposed to those fancy stocks but also at the same time to 500 other stocks. This is how you can lower the volotility of your portfolio. If you want to be exposed to Bitcoin ( less risky) and other crypto ( huge volitility risk) you can feel free to do that as long as it is a small part of the portfolio ( max 2-10%) and remember only invest money you can loose. Having some gold is also a good idea. When speaking of other commodities you should get some more education before you start making trades on the futures markets.

I also have another piece of advice about following your portfolio value, stop doing that! Since you stop following how much other people are paying for a car or house like yours, you could perhaps do the same with your FIRE fund. If you can't do that I guess your investment is slowly changing into an addiction or you are investing far too much money without keeping enough cash on the sidelines for any unexpected event or for buying the dip when a major crash happens. Set an alert and just focus on your school, work or family instead.

A tip to investors aged 30-50: statistically people in their late 30s and early 40s enjoy the best part of the life and the most handsomely rewarding salary in their lifetime. 

Your advantage is that:

• you still have a lot of time but if you want to retire early you have to invest fare more than a 20 year old.
• you have more experience and you understand more about finance (perhaps you even have a strong business and managment background by now which you can use),
• you should have some savings by now,
• you have a possibility to use your doświadczenie, network and have some side hustles.
• you have a lot of friends that might have experience in investing ( avoid trading by all means wealth is not generated that way ).

 Your main disadvantage:

• you are in the max spend period: your kids are growing up and their education is expensive, you are living in the biggest home and you are diving the biggest car in your lifetime,
• you might have bad spending habits that have deloped over time,
• you might possibly have the biggest amount of debt in your lifetime,
• your cost of life might be higher than 60% of your household income ( you + your partner's income),
• cutting costs will require a serious discussion with your partner,
• if you and your partner have a completely different view on money you might will be in a conflict with your partner ( my advice is to talk to your partner about your rich life, start talking about your common goal and also talk about your childhood, try to understand your partner or give him/her a credit of trust with money if they had been on continous spending sprees),

 A tip to investors aged 50-60 or just 5 years before retirement: 

If I were 50 I would say to myself "holy moley I've got only a few years left to retirement!"

As an empty nester I would not need any extra rooms in my house and a big car would be usless. I would start focusing on grandchildren and on downsizing my living costs and boosting my savings ( with the exemption on grandkids and perhaps on my hobby). 

Investors just before their retirement should choose less volitile and safer options that provide safe and sound dividend or interest. I would focus on the following:

• T-Bonds up to 60% of the portfolio ( a mix of 10y and 2y and shorter duration),
• ETFs of the main index ( not more than 30% of the portfolio),
• Value stocks paying a high dividend with a low volitility ( beta at 1 or below that) and I would not keep more than 1% of my portfolio in a single stock.
• I would have a property or 2 to rent or even better a diversified REIT (Real Estate Investment Trust) in different geographical locations far from any possible conflict zone.
• Tech company allocation not more than 5%,
• Crypto allocation 0%,
• Gold allocation not more than 5%.
• Selling covered calls to boost the dividend - a big thumbs up!
• Selling puts to buy cheap value stocks back and getting a premium - a big thumbs up!

The older you are the less time you have for covering any losses. This is why here Warren Buffet's investing principle has to be seriously considered (Rule #1 don't loose your money! Rule #2 remember about rule #1!).

What is your current age and till when will you be investing yoir capital?

Age does play an important role. Unfortunetly younger investors tend to have less capital to invest but on the other hand they can invest in more volitile instruments and the risk can be offset with time. On the other hand the older you are the more money you must invest if you are thinking seriously about your retirement. Also you have to be more prudent with risky investments.

If you are in your 60s unfortunetly you have to forget about volotility and choose capital preservation. What I can say to a 60 year old is that tech stocks and crypto is definitly out. Bonds and value stocks are very welcome. Since you possibly already have a big dividend stock portfolio you could learn how to boost your income from dividend stocks by selling covered calls ( only if you have 100 or more shares per contract but here you need more education if you do not know what a put or call option is ).

What is your risk profile?

Investing comes with risk. Looking at profits and losses will affect you. There will be times when you will be too greedy to sell the stock and you will think the price will go up for ever. You will also be greedy when the price goes down and you will be willing to wait till the price goes super low. You will be euphoric and scared. Unless you start even with a small amount of money and win couple of times and loose a lot of times you will never learn anything about yourself. From my experience I can tell you that there is always risk. Even holding cash at the bank is risky as you watch inflation eating up all your stored purchasing power. Crossing the street is a risk. Owning a car is a risk ( it can get crashed or stolen). You have to learn to:

1. manage risk,
2. that time and diversification lowers your risk significantly.

Over time I learned that the stock market will go up and down. I also learned that in the long run the stock market goes up no matter what ( war, covid, inflation, bankrupcy of some states or huge companies etc etc.).

Now you will learn something about yourself quite fast. 

Risk tolerance = 0

If you find out that your risk tolerance is 0 then I'm afriaid nobody can help you. It's better if you deposit your money at the bank and get 3% with a CPI inflation rate of 5% (at that rate you will be loosing 2% of your ourchasing power). You could also buy a house or land (if this would prevent you from checking the price of that asset every day). Ofcourse you still might experience some stress if somehow you find out that your brother or friend managed to get a better deal than you but you will not treat this as a loss.

 Are you investing in crypto but afraid of loosing more than 15% of your capital? Well that means that crypto is not for you. Even the crypto blue chip ( Bitcoin) can loose over 80% in the bear market and during the bull market there are few crashes of up to 50%. Even Meta teashed from November 2021 to March 2022 over 60% so these are a big fat no no for People with a low risk tolerance or are over 60 years old.

Risk tolerance of up to 20%

OK so now you can consider investing on the stock market but only in ETFs that follow the main index unless you have the knowledge and time to look for good value stocks paying rising dividends. These stocks tend to be bought up during a crash by the long term holders for the dividends that they have been recieving over time so the system should in theory work as perpetum mobile. There could be a crash only if the company cuts or stops paying dividend but the company should not go bust ( first it will lay off workers, stop paying dividends, pay back the debt and they buy back shares ).

Risk tolerance of up to 40%

I take it that you already have some basic knowledge. By now you should understand well that if something goes up it must go down and vice versa. Timing the top is as impossible as timing the bottom is another thing you should have learned. Timing the market is less important that time in the market ( waiting patiently till your discounted stock goes finally up). If that is the case they you can start picking some individual stocks on major crashes. Remember you are an owner of the business not a trader. Buy stocks that:

• you want to hold for a long time,
• you will be willing to buy even if they go down 50% or more.

Perhaps you could consider learning about risk mitigation. The more risky the instrument the more diversification should be done to your portfolio. Even keeping cash to a typical crypto only portfolio is better than having Bitcoin and a bunch of other Altcoins. The cash can always be used to buy the crashes to dollar cost average the price down.

Another thing you could do is invest less of your money. If you are checking the price of the stock or crypto every day it means either you have too much invested in thst stock or you are too greedy and you possibly want the price to crash even more so that with minimum capital you can buy huge moon bags of crypto and become quickly rich. 

Anothet tip is the more risky the i steument the more time you should give yourself to stay in the market.

Anothet tip is to buy only Blue chip stocks and assets on major crashes. Do not expect that with no risk you can gain astronomic results. Like in the story about the famous race between the hair and the turtle the turtle won not because he was fast but because he was motovsted, consistant and focused and he did not boast about his achievments like the hair.

How much are you willing to invest initially and what amount will you put into your portfolio systemstically?

If you are planning to retire early then what you could start with asking yourself how much money would you need to live a comfortable life in the futer ( please include 5% interest p.a.). Once you know the answer to that question the you could assume that:

1. you will be living from the interest or dividends,

2. You will hang out the specific amounts of capital out from your investing portfolio on a regular basis,

3. A combination of one and two above.

 

If you are even thinking of retiring before the age of 67 you can forget about option two and three and we also have to remember that your interest should be high enough for you to not only sustain your living needs but also you should be able to save some of the money and put them back into those dividend and interest paying instrument.

Please also assume that you will get not more than 4 up to even 6% interest from your investment and there could be times where you might even get less than 4%.

So the easiest way is to calculate your monthly expenses and multiply them by 12 months and then divide that amoint by 4%.

As an example if your monthly costs are about $2000 then $2kx12÷4%=$600.000

You would need 600k in your bank account if you want to live 4% interest.

Now we can also make another assumption with the same amount but with a higher interest as in the example below: 2000x12÷6%=$400.000

If I were in your shoes I would also assume the worst case scenario it means having an interest below 4%, let's say perhaps 2.5% and then you can quickly come to a conclusion that you need around $960,000 to survive of such an interest.

So after this is clear then you can start thinking what to do with your extra free Capital which is just lying on the bank account and basically doing not much. Remember that the capital you are keeping at a bank or invested in a bond unfortunately always loses value since the CPI inflation is not really the actual inflation that you're going to have to tackle. Please include that the average inflation rate is between 5 to 7%, so if you're planning to put your money to work you have to choose an instrument which gives a rate of return higher than that. The more Capital you have right now the faster you are going to achieve the final goal. I can only add here that if you are a young person with some kids that depends on you then I would recommend investing with a cash and also buying a life insurance that could guarantee the whole family some capital in case some thing permanent happens to your health or in case of death.

How much time do you have to monitor your portfolio? 

I guess this is pretty simple because you know how much free time you have to do things apart from taking care of the family and work. If the answer is 10 hours per week then you should have no more than 10 instruments in your portfolio. In other words if you are a a salaryman then it's best if you simply KISS (Keep It Simle Stupid) your portfolio. Just consider dollar cost averaging into major index funds since they are Diversified over hundreds of companies and even many different markets. If you are young you can consider investing even into technological ETFs and Emerging Markets but if your risk tolerance is lower then simply investing in the Spy is the best choice or even into Bond ETFs.

Phone the other hand you have much much more time than the things that you should focus on is looking at any news connected to your company's earnings report and any information about dividend raises or dividend cuts. You should also consider a rebalancing your portfolio at least once in 6 months or once in a quarter and to reinvest the capital back into the highest dividend paying and most undervalued stock.

Do you have a possibility to earn more or to cut costs and save more?

Unless you are Japanese you might have never heard about Kaizen ( from Japanese  continuous improvement). It is a phylosophy with the objectice to:

• reduce waste,
• increase efficiency,
• make continuous improvement involving everyone in the organization.

Most people answer this question by simply saying that they are happy with the current living standards and they don't want to change anything and that includes getting any side hustle or getting rid of any useless things in their house. And there are also those that tackle this problem alone without reaching out to other members of the household.

To do challange this problem first sit down with your partner and crunch the numbers on a piece of paper. You could start making a list of things that you do not use. Perhaps you could sell them or give them away and save some money on your storage unit or parking space.

Another thing you could consider is doing some extra side hustle for an hour or 2 every day after work. In some states you do not need to open your own business if you you do not exceed a specific amount per month (75% of the minimum salary but this might differ from state to state so financial consulting is a must).

 As an example I can share my experience. I had a car but I was going to work using public transport since parking a car in the city center is almost impossible and it is expensive. I was paying car insuance, parking costs and maintenance costs and also depreciation ( the car looses about 40% of its value in the first 4 years and 60% after 10 years depending on the model). By selling it I managed to:

• raise a lot of cash which I invested into my FIRE fund,
• cut the losses on the depreciating value of the car,
• cut monthly costs related with parking,
• cut costs with yearly maintenence.

I was shocked to learn how much I have been spending on a thing that was not used on a daily basis. Had I done it at least 2 years earlier I would have not only saved a couple of thousand dollars US but also I would have been able to get dividend payments and my portfolio would have gone up in value. Had I failed to have done that I would have ended up with a worthless thing that ,with rising inflation, would cost me a little fortune to keep ( inflation affects the cost of insurance, parking costs and repairs). 

I also have a friend that is a teacher. She started a side hustle. She worked her 9-5 job and then started a side hustle for about 2h per day after work. Thanks to that she could save up to 30% of her monthly income and boost her own FIRE fund. She also asked her kids about the extra activities that they had if they like them. To her surprise her children did not like all of the chess, horse riding lessons or dancing lessons. She discontinued half of them and saved a lot of money that way and found out that her kids chose the lessons just because of their classmates but they did not enjoy them at all.

These are just a few of the most important tips. Hopefully thanks to this post you will start thinking more Kaizen. Remember to engage your family ( partnera and kids). Perhaps all of you have a something to say. You are not alone and you can always ask others for their ideas and oppinions. You could engage even your kids. Most folks when asked about their childhood say that they never spoke to their kids about money and expenses and savings not mentioning about taxes, loans and investment. 

If school won't teach them about money, who will? 

Do you want your kids to be financially enslaved to debt? 

If they make bad choices in their adult life who will eventually have to help them if not you?