The best way to start investing if you are just starting out

If you haven’t read my eBook: A Basic Guide to Investing (click here) please do so before diving into this information below. It provides a fantastic foundation on what we are about to cover.

Once you are completely debt free, except for your home, and you have a fully funded emergency fund (3-6 months of expenses set aside) it is time to invest.

Stay involved in your wealth-building plan

You should always know how your money is invested and what role it plays in helping you reach your long-term goals. After all, this is your future we’re talking about!

Stay engaged with how your funds are performing and regularly re-balance your portfolio. Over time, certain mutual funds can start to take up more and more room in your investment portfolio, which can expose you to risk. Remember, you never want your eggs to all be in one basket. You want that risk spread out evenly between the four types of funds I will list below. However, don’t become obsessive about checking it everyday, let it do its thing.

You should always be open and honest about any questions you have in your regular meetings with your financial advisor or financial coach. They can help you create a wealth-building plan and forecast your retirement income based on your whole financial picture.

Brush up on investing lingo

You don’t have to be an expert in investing lingo to choose the right mutual funds. But a basic understanding of some of the most common terms will help. Here are a few to get you started:

• Asset Allocation: The practice of spreading your investments out (diversifying) among different types of investments with the goal of minimizing investment risk while making the most of investment growth.
• Cost: Be sure to understand the fee structure associated with using a financial advisor. Again, talk with several pros to compare commission structures before you make your decision on a financial advisor you’ll use. Also, pay attention to the fund’s expense ratio. A ratio higher than 1% is considered expensive.
• Large-, Medium- and Small-Cap: Cap stands for capitalization, which means money. To most investors though, it refers to the size and value of a company. Large-cap companies carry lower risk, but you’ll make less money. Medium-cap companies are moderately risky, and small-cap companies are the riskiest—but have the biggest payoffs.
• Performance (Rate of Return): You want a history of strong returns for any fund you choose to invest in. Focus on long-term returns, 15+ years or longer if possible. You’re not looking for a specific rate of return, but you do want a fund that consistently outperforms most funds in its category.
• Portfolio: This is simply what your investments look like when you put them all together.
• Sectors: Refers to the types of businesses that the fund invests in, such as financial services, technology or health care. A balanced distribution among sectors means the fund is well diversified.
• Turnover Ratio: Turnover refers to how often investments are bought and sold within the fund. A low turnover ratio of 50% or less shows the management team has confidence in its investments and isn’t trying to time the market for a bigger return.

*That being said, having a financial consultant help you can really improve your investing portfolio*

Diversify your investment portfolio

I recommend investing in four types of mutual funds with your investment spread equally across each type. Keeping your portfolio balanced helps minimize risk against stock market fluctuations over the long term.

Each fund type may respond differently to the same event. That means if one fund is down, another fund could be up.

Below are the four mutual fund categories explained in further detail and the reasons why it is recommended:

• Growth and income: These funds create a stable foundation for your portfolio. Big, boring companies that have been around for a long time and offer goods and services people use regardless of the economy. With growth and income, be sure to look for funds with a history of stable growth that also pay dividends. You might find these listed under the large-cap or large value fund category. They may also be called blue chip, dividend income or equity income funds.
• Growth: This category features medium or large companies that are experiencing growth. Unlike growth and income funds, these are more likely to ebb and flow with the economy. For instance, you might find the company that makes the latest "it" gadget or luxury item in your growth fund mix. Common labels for this category include mid-cap, equity or growth funds.
• Aggressive growth: Think of this category as the wild child of your portfolio. When these funds are up, they’re up. And when they’re down, they’re down. Aggressive growth funds usually invest in smaller companies. So small-cap funds are going to qualify—or even a mid-cap fund that invests in small- to mid-sized companies. But size isn’t the only consideration. Geography can also play a role. Aggressive growth could sometimes mean large companies that are based in emerging market.
• International: International funds are great because they spread your risk beyond your home soil and invest in big overseas companies you know and love like Trader Joes, Firestone and Gerber. You may see these referred to as foreign or overseas funds. Just don’t get them confused with world or global funds, which group all world countries together.

How Do You Pick Mutual Funds?

Mutual funds are like people: The only way to separate the good ones from the not-so-great ones is to get to know them. But unlike people, you can find all the important information about a mutual fund on its printed prospectus or online profile. Here are a few important features you’ll need to review as you select funds to invest in:

• Objective: This is a summary of the fund’s goal and the types of investments it will make to achieve that goal. Remember the four categories: growth, growth and income, aggressive growth, and international.
• Performance (Rate of Return): You want a history of strong returns for any fund you choose to invest in. I am looking for a fund with around a 10% average annual return. Focus on long-term returns, 15+ years or longer if possible. You can find a funds inception date on their fact-sheet. You’re looking for a fund that consistently outperforms most funds in its category.
• Cost: Closely related to performance. You are looking for great rate of return and low fees. Something I refer to as net return. Rate of return – fees = net return. Keep in mind the fund’s expense ratio. A ratio higher than 1% is considered expensive. For example, a rate of return for a fund is 10% and the fees are 1%, your net return = 9%.
• Portfolio: What your investments look like when you put them all together. Once you review a funds fact-sheet, you may see the same companies inside both. If the companies inside are very similar, then I would choose the better one by comparing the other features listed here. No need to purchase both if they have the same companies.
• Turnover Ratio: Turnover refers to how often investments are bought and sold within the fund. I am looking for a low turnover ratio of 50% or less. Anything more than 50% will incur fees that I don’t want to be passed on to me.
• Fund Manager Experience: You want an experienced manager calling the shots for your mutual fund—someone with at least five to 10 years of experience. Keep in mind, though, that many managers mentor their successors for several years. So, a fund with a new manager can be worth considering if the fund has consistently performed well.

Hands--on exercise

Let’s turn to a real-life example: Vanguard options in Australia.

Below are the options in 2020 for what you can purchase at Vanguard AU:

Vanguard High Yield Australian Shares Fund VAN0017AU
Vanguard Index Australian Property Securities Fund VAN0012AU
Vanguard Index Australian Shares Fund VAN0010AU
Vanguard Index Diversified Bond Fund VAN0101AU
Vanguard Index Hedged International Shares Fund VAN0107AU
Vanguard Index International Shares Fund VAN0011AU
Vanguard Investor Cash Plus Fund VAN0100AU
Vanguard LifeStrategy Balanced Fund VAN0124AU
Vanguard LifeStrategy Conservative Fund VAN0013AU
Vanguard LifeStrategy Growth Fund VAN0014AU
Vanguard LifeStrategy High Growth Fund VAN0015AU

The minimum initial investment for each of these funds is $5,000. All future investments can be any amount you chose ie $100/week going forward.

If you want to buy a new fund, then you must have the initial $5,000 again.

Based on my 4 category suggestions above, how many of the above funds can you eliminate?

Question: What funds are left when you cross those off the list?

Answer: Vanguard High Yield Australian Shares Fund VAN0017AU
Vanguard Index Australian Shares Fund VAN0010AU
Vanguard Index Hedged International Shares Fund VAN0107AU
Vanguard Index International Shares Fund VAN0011AU
Vanguard LifeStrategy Balanced Fund VAN0124AU
Vanguard LifeStrategy Growth Fund VAN0014AU
Vanguard LifeStrategy High Growth Fund VAN0015AU

Now that you have narrowed the list to 7 different funds you get to look more into the details of each fund.

Things to look for: performance, inception date, total fund holdings, portfolio turnover rate, and their top 10 holdings with %’s.

I will talk about each of these and what I recommend looking for. All of these answers can be found in the Factsheet PDF that is located on the Vanguard Australia website.

Question: What is the performance (long-term track record) of each fund?
Meaning how well this fund has performed over time. I am looking for a fund that has an average annual return of 10%.

Question: What is the inception date?
This is closely related to the long-term track record question. You are looking for a fund that has been under management 15+ years. This is not always possible but if you find a fund that has only been open for 3 years, then you are less sure they will do great over the long-term. I personally own a fund that was opened in the 1950’s.

Question: How many companies are inside this one fund? (Total fund holdings)
This represents how many companies a fund is invested in. I am looking for an average of 80-200 different companies. Sometimes this is going to be less and sometimes more. The reason for looking into this is the level of diversification that you have. You don’t want a fund with only 10 companies inside as that becomes too risky, especially if they are all in the same sector (i.e. property). If you have 5,000 different companies in a fund, then your money could be spread too thin.

Question: What is the portfolio turnover rate?
Meaning how often they buy and sell the companies they have in the fund. The higher the turnover rate, the more fees you pay, possibly more taxes, and statistically speaking the less money you make.

Question: What are the top 10 company holdings and their percentages?
This represents the “big” players or “big” money-makers they are using to grow this fund. An example could be a mutual fund with 200 different companies; Amazon, Visa, Microsoft, Apple and Facebook being some of the top 10 and they combine for 17% of the total holdings. In this example, the remaining 83% of holdings with be the 190 other companies. This question could come in play if you are concerned with the companies you invest in matching your values. For example, wanting a more ethical choice.

Additional notes: I like to use https://www.morningstar.com/ for an even more in depth analysis of any fund on the market.

Final question: What funds would you invest in from the 7 on the list?

This is a trick question because it is personal. What I would choose to purchase, may vary a little to what you would purchase and that’s okay. In my humble opinion, any of the 7 would work well. Keep in mind, I wouldn’t buy all 7 but that’s your choice if you do.

You also will notice some companies that overlap in the 7 funds from Vanguard so you may only buy 2 or 3 different funds. The companies that you have invested inside your other retirement accounts may play a role in your choices here too.

Depending on your current net worth, you could choose to buy only one fund until you reach a dollar amount. For example, you will only buy one fund until it reaches $50,000 and then buy your next fund until that one reaches $50,000 and so on.