What Young Investors Need to Know about Asset Management - GBTI

What Young Investors Need to Know about Asset Management

What Young Investors Need to Know about Asset Management

Too many young people fail to invest as a part of safeguarding their future. Part of this issue likely relates to the stress of entering the investment markets.

The learning curve can seem very steep from the outside, and a lot is on the line if you make the wrong choices. While the market itself is complicated, so is creating, managing, and growing a portfolio.

Beginning investors need to understand basic concepts like diversification, compounding interest, stocks, and bonds before they start to invest, which can make getting started seem daunting. However, investing early is the best way to grow a significant nest egg. Plus, we often learn by doing, and getting a head start makes it easier to recover in the event of a misstep.

The Basics of Asset Allocation and Portfolio Creation

The first step in the asset management process is understanding what exactly an asset is. In short, an asset is anything of value, including real estate, cash, and even vintage wines.

From an investor standpoint, there are three main asset classes: cash, stocks, and bonds. You can also purchase real estate, foreign currency, private equity, natural resources, and more. However, beginning investors will likely focus on stocks and bonds. The term asset allocation refers to the specific mix of assets that you have in your portfolio and relates to both diversification and strategy.

Think of asset allocation like filling a shopping cart at the grocery store. The cart itself represents a portfolio and the items in the cart are the specific assets that are added to it. Just as we diversify our diet and fill our cart with a variety of different food items, young investors must diversify their portfolios.

Furthering the metaphor, most shoppers simply throw items they find appealing into a cart, but these items can be later organized into proteins, produce, and so one. These classifications resemble asset classes within a portfolio. Investors typically hold several different assets within a specific class, just as shoppers might buy several different types of protein and different types of vegetables.

Asset allocation helps manage risk while still earning a return. While market risk is always a factor, diversification can help with everyday shifts. Generally, when one asset class takes a hit, another will hold steady or maybe even increase in value. Having assets from different classes buffers the hit that a portfolio will take if one class declines in value.

All investing involves some degree of risk, but so does every choice made about money. Even the money in our savings accounts becomes worth less over time (i.e., the interest rate in your account is not keeping up with the rate of inflation, causing you to miss out on opportunities for growing your money).

A Basic and Formulaic Approach to Asset Allocation

Asset allocation decisions depend on how long you want to invest and how much risk you feel comfortable taking. When investing for retirement, people can take on much more risk at age 25 than they can at 50 because they have more time to recover from any losses. Additionally, younger investors can choose more aggressive investments with higher growth potential, as they can take on the greater risk.

However, closer to retirement, any losses you experience are felt much harder and can cause serious damage. As a very basic formulation, you can subtract your age from 100 to determine the appropriate percentage of your portfolio that can be dedicated to stocks, which are riskier than bonds. The rest of the portfolio can be dedicated to bonds.

While this formulation is a good starting point, you need to think not just about these broad classes, but also subclasses. Buying stocks in a single industry or geographic area increases risk. You will also need to diversify within specific asset classes. This could mean buying a mix of American and international stocks or buying stocks in several different industries. The same concept applies to bonds. Government bodies and companies both issue stock (purchasing a mix of both helps protect against certain problems).

How Personal Preferences and Goals Affect Asset Allocation

The process of asset allocation also depends on personal comfort and goals. Not everyone is able to accept the possibility of losing 30 percent of their money in a given year, which can happen with a portfolio heavily weighted toward stocks. While the money will likely be regained in time as the market swings back the other way, the psychological effect of this loss can be devastating. Those who are risk-averse may prefer to have a higher allocation of stocks than the above algorithm suggests.

Time is also an important factor. Depending on your goals, you might change your investment strategy. If you’re investing over decades, such as for retirement, taking an aggressive approach makes sense. However, you may also be investing for a home down payment or some other goal that is much closer than retirement. In this case, bonds, or at least a mix of both asset classes, may make more sense. If you think you will need the money within the coming five years, stick with bonds, as they often mature in that time frame.