Investing can be challenging for anyone, but for those in their mid-20s to mid-30s, it can be especially daunting to build a portfolio from scratch — especially while paying off student loans, credit card debt and establishing some savings. Add in 2020’s pandemic-inspired sell-off and the 2008 financial crisis and investors have a number of concerning not-so-distant memories that may dissuade them from getting their financials in order.
But learning how to build a portfolio is something that can end up creating huge rewards down the line.
“People should start saving and investing as early as possible,” says Adam Green, CEO of YieldX. “The growth of savings and the power of compounding gives an enormous head start to those who can put money aside and invest in the early stages of their lives and careers.”
One thing to consider before launching into the following steps is whether you have easily accessible savings for a rainy day — such as three to six months’ worth of living expenses socked away in a bank savings account in case you get laid off.
“It is highly recommended that you have adequate emergency savings before you begin investing,” says Eric Thompson, director with Round Table Wealth Management.
However, Robert Johnson, finance professor with Creighton University, says building wealth and achieving financial independence isn’t a linear process that must begin with established savings.
“One must juggle many goals simultaneously — funding a retirement plan, building emergency savings, saving for a child’s college, paying down student debt, etc.,” he says.
Here are four vital steps to take as you start building an investment portfolio:
1. Determine your target asset allocation.
2. Start investing in an employer-sponsored savings plan.
3. Open an IRA or standard brokerage account.
4. For more help, consider a robo advisor.
Step 1: Determine Your Target Asset Allocation
If you hang around Wall Street types long enough, you may end up hearing about the 60-40 portfolio. It’s often referred to as a typical balance of stocks and bonds, with 60% in stocks and 40% in bonds. There’s also a formula that says 100 minus your age should be your percent exposure to equities.
But both of these can be simplistic, and setting your target allocation — a mix of stocks, bonds and other investments — may call for a little more homework.
Return expectations, risk tolerance, time horizon, tax situation, career path, lifestyle and liquidity requirements are all important factors to consider when trying to come up with your target asset allocation.
The younger you are, the more risk you can take because your portfolio will have a longer time to recover than that of someone close to retirement. People who have high job security and high earnings can also afford to take on greater risk.
Still, even if you’re young and have a solid job, you might have a hard time accepting volatility, especially on the downside. In that case you may want to have less exposure to equities, or at least have more defensive stocks in your portfolio.
“An investor’s ability to take risk and willingness to take risk may not be the same, so marrying the two can take some time and education,” says Ryan Johnson, director of portfolio management and research with Buckingham Advisors.
Going beyond the simple diversification of having stocks as well as bonds, new investors may also want to consider other types of diversification, such as the mix of domestic and international stocks and bonds, corporate versus government debt, large- versus small-cap companies and a mix of aggressive and defensive sectors.
Fortunately, exchange-traded funds, or ETFs, and mutual funds can make this type of diversification much easier than it would be if you had to pick individual stocks. And funds like these offer diversification within a specific niche simply by having multiple holdings.
Diversification beyond stocks and bonds is also a possibility. “Cash is king” is a saying for a reason, and during times of market decline, investors often flee to the relative safety of the U.S. dollar or Japanese yen.
Alternative assets such as real estate, commodities, precious metals and cryptocurrencies can also behave differently from traditional stocks and bonds and serve to enhance portfolio diversification, says Liz Young, head of investment strategy with SoFi Technologies (ticker: SOFI).
Step 2: Start Investing in an Employer-Sponsored Savings Plan
Employer-sponsored savings plans, such as a 401(k), can be an excellent and simple place to start gaining exposure to the stock and bond market.
A common perk is for employers to match an employee’s contribution up to a certain percentage. It’s a good idea to contribute to one of these plans at least up to your employer’s match. It’s almost like free money.
“People should do whatever it takes to participate in their company’s 401(k) plan to the level to get the full employer match,” Johnson says. “And yes, even if that means a slower repayment of student loan debt or other debt or delaying the purchase of a home or buying a smaller home.”
When investing in a 401(k), new investors can refer to their target asset allocation, or they can make it easier by using target-date funds or asset allocation funds.
Target-date funds are mutual funds that adjust their allocation over time to become more conservative as the investor nears retirement. Asset allocation funds are like target-date funds that never change, so you’ll have to switch them as your time frame or goals change.
Step 3: Open an IRA or Standard Brokerage Account
If you’ve maxed out your 401(k) but still have more money to invest, a brokerage account, whether it’s tax-deferred like an individual retirement account or after-tax like a standard brokerage account, offer more investing options than a typical 401(k).
Different tax treatments of each type of account are what can ultimately sell an investor, given that money is subject to taxation at some point in time.
“If you have earned income and you are starting small, opening a Roth IRA could be a better long-term choice than a traditional taxable brokerage account,” Buckingham’s Johnson says. “For either, money goes in after tax, but with a Roth IRA it grows tax-free and comes out tax-free in retirement.”
With a taxable brokerage account, tax consequences at the end of the year become a consideration in your investment decisions, Young says.
“Receiving a dividend, being paid a coupon on a bond, selling a security for a gain or loss, and many other actions have tax consequences that should be considered when reviewing a holding and calculating performance,” Thompson says.
Step 4: For More Help, Consider a Robo Advisor
If all of this still sounds overwhelming or like you’d rather be doing anything else, there is an easier way to build a portfolio: with robo advisors.
These platforms use algorithms and modern portfolio theory to create portfolios based on an investor’s goals. All you need to do is set up an account, answer a short questionnaire and the robo will recommend a portfolio for you. Many also help you stay on track with automatic rebalancing.
Robo advisors bridge the gap between complete do-it-yourself investing and full-service financial advisors, Young says. “There are a lot of investors who fall into that gap,” she says.
Robo advisors can be particularly good for new investors who need help removing the emotion from investing, she says.
The biggest drawback to robo advisors is that they are largely a one-size-fits-all option, Johnson says.
“The biggest advantage of utilizing a human advisor is that when the market exhibits volatility, the advisor can reassure the client that they are on the right path,” he says. “My belief is that the greatest contribution of an advisor is to explain why a certain strategy is correct and to talk the individual off the ledge in times of market turmoil.”
More from U.S. News
Update 07/13/21: This story was published at an earlier date and has been updated with new information.