Expand Your Horizons With Basic Investing Concepts
Now that you know some basic terms, let's keep going with some solid strategies and easy-to-grasp tactics.
What is your risk tolerance?
- Your risk tolerance depends on your age and goals
- An aggressive portfolio will likely contain more stocks than bonds
- A conservative portfolio will likely contain more bonds than stocks
Risk tolerance is how much risk you can tolerate. But what does this actually mean and how does it play out as an investor?
It may be easy to think you can tolerate a lot of risk, but even daredevils may not be so adventurous when it comes to the potential of losing money. It may be easy to get cozy with the idea investment risk, but when it comes down to it, it can be a very negative experience to have the value of your investment drop significantly.
However, the longer you invest, the more you learn how to gracefully and strategically weather the highs and lows of the market.
What is an aggressive portfolio vs. a conservative portfolio?
Generally speaking, a conservative portfolio will contain more bonds. Investment grade bonds are considered one of the safest and least volatile investments out there. It’s all about slow and steady growth.
On the flip side, an aggressive profile will often have lots of stocks. Stocks can gain or lose value quickly because their value is based on market sentiment and public opinion. However, this potential for loss also comes with a higher potential for gains.
At Stash, we assign you a risk level when you sign up for the app based on your age, income, assets, and goals.
This is so we can assess which investments are the most appropriate for you. No matter how you choose to invest, it’s important to keep your risk tolerance in mind. We have your back.
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What investment strategy should I use?
- There are various strategies that investors can use
- Dollar-cost averaging vs. lump sum
- Dollar-cost averaging lets you capture the highs and lows of the market
Plenty of people try to sell their investment strategies on the internet. Whether they are suggesting particular investments, the best days and times to invest, or trying to sell you on their particular expertise of the market, we want you to remember one thing: no one knows what will happen with the market.
And as Stash CEO Brandon Krieg often says, “If someone tells you they know what the market is going to do, run the other way.”
Rather than focusing too much on complex strategies, focus on three things: start now, diversify, and invest on a regular basis.
Investing small amounts on a regular basis is called dollar-cost averaging. It’s part of the Stash Way.
What’s dollar-cost averaging vs. lump sum investing?
Dollar-cost averaging simply means that rather than investing in a lump sum, you invest small amounts on a regular basis. The main reason to do this is so you can take advantage of price fluctuations as the market goes up and down. (We’ll talk more about volatility in the next chapter.)
When you invest a lump sum of money, you are buying an asset at a particular price, you go all in on that price, and hope it goes up from there. When you apply dollar-cost averaging, you invest small amounts regularly. Sometimes the price of an investment will be higher, sometimes lower, but in the long run, you get the average price, which helps weather the highs and lows.
This is particularly useful when you continue to dollar-cost average over years, or even decades.
Check out the chart below. You can see how with a dollar-cost averaging strategy you can purchase more shares at a lower cost with the same amount of money as you would if you would have invested a lump sum.
Why do the prices of investments go up and down?
- Understanding volatility
- Stocks and bonds behave differently
- Diversification can help you temper your losses when either market goes down
We won’t lie, understanding the nuances of volatility can be complicated. Many investment sites will start describing beta coefficients and quantifiers of volatility that can make your head spin.
So here’s what you really need to know.
Volatility is a measure of risk related to stocks, bonds, and other financial securities. There are many ways that financial analysts measure volatility, but the most important thing for you to understand is that volatility is related to risk, and risk is not always a dirty word when you’re investing.
Investments that tend to vary in price more regularly are considered more volatile, while investments that tend to stay fairly steady in price are less volatile.
Putting it all together
- Your portfolio should be diversified
- You should contribute to it as often as you can
- Buy and hold and don’t let market fluctuations faze you
Diversify, diversify, diversify
If you’ve gotten this far in this learning guide you’ve read the word “diversification” more than a few times. But it really is that important.
And it’s super simple. Exchange-traded funds (ETFs) are inherently more diversified than single stocks because they are a basket of investments bundled together. You can also add some single stocks to your portfolio.
You can also diversify your portfolio by including international investments in your portfolio. Many things that shake the market in one country (political anxiety, a disappointing quarter for a certain economic sector, a catastrophic weather event) may not affect the markets in another.
Think back to what we said in Introduction to Investing. Your portfolio is an expression of who you are and what you want your future to look like.
The next step is investing on a regular basis. Turn on Auto-Stash to make your investments automatic. It’s a great way to create good habits.
Even if you start out with $5 a week, gradually increasing that amount as you are able, a little bit can go a long way when you add time and regularity to the equation.
Investing just $30 a week over the course of 30 years at an average rate of return of 7% (the historical average for the S&P 500 over the last 30 years, not adjusted for inflation) adds up to over $100,000.
Stay the course
The last step is not overreacting to volatility or fluctuations in the market. You’re investing for your future, particularly if you’re investing for retirement. Don’t sweat the ups and downs of the market. Save it, hold it. add more money over time.
You’re an investor. You’ve got this.
Risk tolerance is...
The level of variability in returns an investor can withstand. Risk tolerance is an investor’s ability to endure market volatility
Which of the following factors does not affect your risk tolerance:
The state of the market. At Stash, we assign you a risk level when you sign up for the app, based on your age, income, assets, and goals. Your risk level should generally remain the same, regardless of what’s happening in the market. As you age, however, your risk tolerance may decrease. Younger investors tend to have a higher risk tolerance than older investors.
Which of the following is a drawback of lump sum investing?
It can be difficult to achieve an optimal buying price. When you invest a lump sum of money, you are buying an asset at a particular price, and you go all in on that price, and hope it goes up from there. A drawback to lump-sum investing is that it’s very difficult to time the market or predict what will happen in the future.
What does dollar-cost averaging mean?
Investing small amounts on a regular basis. Dollar-cost averaging simply means that rather than investing in a lump sum, you invest small amounts on a regular basis. Sometimes the price of an investment will be higher, sometimes lower, but in the long run, you get an average price, which helps you weather the highs and lows of the market.
An investment with high volatility...
Will have greater variability in price. Volatility is a measure of risk related to stocks, bonds, and other financial securities. Investments that tend to vary in price are considered more volatile, while investments that tend to stay fairly steady in price are less volatile.
How can diversification safeguard your portfolio?
It spreads your risk across a greater variety of investments. The market may be volatile at times, and volatility will affect different investments in different ways. When you have multiple, diversified investments in your portfolio, you can help temper your losses when markets drop.
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