Imagine trying to determine how to invest $50,000 of your hard earned cash.
For many, that's a year's salary. For others, that's MORE than a year's salary.
Does how much money you have to invest have anything to do with how you should invest? I think so.
If you only have a thousand dollars to invest, you don’t have a whole lot room to lose so you might want to be more conservative.
But if you had a large amount, say $500,000, you’d probably want to spread your investment wings into different investment classes, maybe even including some speculations.
How should you invest $50,000?
That’s the kind of portfolio size where you start having to make some important decisions. It’s not enough to spread your investments all over the map, but it’s certainly enough that it’s time to move beyond the “cookie jar”.
So how to invest $50,000 – let’s look at it with your whole life in mind.
Start by Stocking Your Emergency Fund
No matter how large your investment portfolio is, you should always have an emergency fund. The basic purpose of the fund is to make sure that you have enough liquid cash available for either unexpected major expenses, or a temporary disruption of your income.
I think that an emergency fund serves another important purpose, at least in connection with investing.
For example, let’s say that you decided to invest 100% of your money – meaning that you decide to forego having an emergency fund. What happens in that situation when an emergency actually happens?
I can think of two outcomes, and neither of them is likely to end well:
- Either you will use a credit card, or
- You will be forced to liquidate investments.
The credit card route has the potential to put you in a situation where you will be paying more in interest on your debt than you will be earning on your investments.
But if you are forced to liquidate investment positions, you might sell off investments at a profit, and that will create a tax liability. Conversely, if you sell off losing positions, you will lock in those losses permanently.
This is why I think that an emergency fund is a critical component of a well-balanced investment portfolio. It keeps both of those scenarios from happening.
Where should you invest your emergency fund?
That’s the point – you shouldn’t. An emergency fund shouldn’t be held in anything riskier than money market funds or very short-term certificates of deposit.
You need to concern yourself with safety of principal, as well as liquidity in an emergency. Return on investment shouldn’t be a major factor here.
How much should you have in your emergency fund?
The conventional wisdom is that you should have at least three months of living expenses if you are salaried, and six months if you are either commissioned or self-employed.
If you are salaried, and you need $2,500 per month to cover your living expenses, then the first $7,500 of your $50,000 portfolio should be held in your emergency fund.
Determine Your Investment Allocation
There are a lot of theories when it comes to developing an investment portfolio, but there really are no hard rules.
Traditionally, the rule of thumb was investing 100 minus your age in stocks. This is convenient because it’s easy to calculate.
For example, if you are 35 years old, then 65% of your portfolio should be invested in stocks (100 – 35). If you’re 65, then 35% of your portfolio should be invested in stocks (100 – 65), and the balance in bonds and cash.
The calculation enables you to have a higher stock allocation when you are younger and have a longer investment time horizon, and a lower stock allocation as you get toward retirement, and should have less risk.
More recently, the thinking is that 100 minus your age produces an investment portfolio that’s too conservative. For that reason, the base number has been increased. For example, 125 minus your age has become something closer to the new standard.
I think this kind of calculation as merit. However, you should also adjust for personal factors. For example, if your income is less stable, you might want to have a lower stock allocation. But if your income is very stable, then you could probably afford a higher stock allocation.
You should also adjust your allocation for your own personal risk tolerance. If you find losing money in your portfolio to be especially stressful, then you might want to keep your stock allocation lower than what is recommended. But if stress doesn’t bother you, can go even higher.
Investing in Cash
With $50,000 to invest, your emergency fund is going to eat up a large percentage of your total portfolio. For example, $7,500 will represent 15% of your total portfolio.
In that situation, you might consider investing most or even all of the rest of the portfolio – $42,500 – entirely in stocks, using the emergency fund to represent the cash/bond allocation. But again, it all depends on your own risk tolerance.
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Cash held within the investment portion of your portfolio itself should be held in a money market fund. That will enable you to earn a little bit of interest while you keep the money completely liquid in case a buying opportunity comes up.
In most situations, you should have cash equal to about 5% to 10% of your investment portfolio. So, if you have $50,000 in your portfolio, between $2,500 and $5,000 should be a liquid cash form. In bull markets, you want to be on the lower end of that range, and at the higher end during bear markets. The basic ideas the build cash in declining markets to buy stocks at a discount, but to be more fully invested in stronger markets.
Investing in Bonds
What’s the purpose of investing in bonds? Historically, they’ve acted as a counterbalance to stocks. While stocks have the potential for higher returns, due to capital appreciation, bonds add stability to your portfolio. They do this through a combination of predictable interest payments, as well as a guarantee of full repayment of your investment principle.
That arrangement has been weakened in recent years. Very low interest rates have made bonds less rewarding than stocks. That has a lot to do with the rule of 100 minus your age being replaced by 125 minus your age.
The second rule allocates more money to stocks, and less to bonds and cash. That situation could change if interest rates rise substantially, and that’s why we need to talk about bonds.
If you have a fully stocked emergency fund, plus some cash with your stock portfolio, you may or may not want to invest in bonds. Even using the more conservative rule of 100 minus your age, if you are 35 years old then 65% of your portfolio will be in stocks, and 35% will be in the bond/cash combination.
But if you have $7,500 in your emergency fund, and another $2,500 in cash for your stock portfolio, that will cover 20% of the cash/bond allocation.
If you wanted to invest 35% in a combination of cash and bonds, that would leave you with 15%, or about $7,500, to allocate toward bonds ($50,000 X 15%).
What kind of bonds would you buy?
It really is difficult to diversify into individual bonds when you only have a few thousand dollars to invest in them. There are different kinds of bonds – corporates, municipals, convertibles and US Treasury bonds.
For most small investors, the best way to invest in bonds is through bond funds. You can invest in funds that specialize in each of the above bond types, or you can even invest in a bond fund that holds all of them at the same time.
Investing in Stocks
This is where we really get into the “meat” of investing. Up to this point, the investments that we’ve been discussing – cash and bonds – are about capital preservation. Every investor needs at least some of those types of investments.
Stocks on the other hand are primarily about capital appreciation. With capital appreciation comes risk of loss – and that’s why we spent so much time on capital preservation investments.
But let’s focus on discussing stocks here. Just as is the case with bonds, there are all different types of stocks. There are common stocks and preferred stocks. There also what is known as “sector” stocks, such as energy, natural resources, technology, healthcare, and emerging markets.
For most small investors, the best way to invest in stocks is through funds.
And more specifically, index funds. The benefit of index funds is that they are invested in an actual index of stocks, such as the S&P 500. That gives you the broadest possible market exposure, without taking on the specific risks of loading up in a small number of stocks or a limited number of sectors.
The other advantage of index funds is that they are typically held through exchange traded funds, or ETF’s. These are low-cost, no-load funds that don’t trade actively. For that reason, they’re perfect for buy-and-hold type of investing, which is what you should be doing as a long-term investor.
If you feel comfortable doing so, you can allocate a very small percentage of your stock portfolio to certain individual stocks. The general rule here is that you should invest only with money that you can afford to lose.
Individual stocks are subject to all kinds of risks, including industry shifts, regulatory changes, and competition. That makes them much riskier than index funds, and that’s why they should only be a small slice of your stock allocation.
An option to consider if you don't feel comfortable selecting and managing your own investments is using a robo advisor. The top robo advisor platform is Betterment.
They’ll determine your risk tolerance for you, then design a portfolio for you. All of the management of your portfolio will also be handled by Betterment, including portfolio rebalancing and dividend reinvesting, giving you a fully automated, professionally managed, hands-off investment portfolio.
All you’ll need to do from that point on is fund the account.
What Will a $50,000 Investment Portfolio Look Like?
Let’s wrap it up with a summary of what this portfolio might look like, keeping in mind that it will include variations based on your own personal circumstances and preferences.
If you’re 35, the portfolio might look something like this:
- Emergency fund – 3 months living expenses in bank assets – $7,500 (15%)
- Cash in your stock portfolio – money market funds – $2,500 (5%)
- Bonds – bond funds – $7,500 (15%)
- Stocks – index funds – $32,500 (65%)
- Total – $50,000 (100%)
That would provide a 35-year-old with a solid mix of both investment growth and capital preservation. You’ll get different opinions from different people, but the basic idea is to create a portfolio that gets you to your investment goals, while also making a provision for the reality that “life happens” as you invest.