Forbes.com
Money Builder The $5,000 Portfolio David K. Randall, 04.14.09, 6:00 PM ET One of the biggest misconceptions about investing is that it takes a lot of money to get started. Thanks to mutual funds and exchange-traded funds, you can start building a solid portfolio for as little as $5,000. Before you get ahead of yourself, remember: Every investment holds some element of risk. For money you're going to need in the next year or two, stick to bank accounts. After all, the last thing you want is for your ability to pay your rent to drop along with the stock market. But if you've saved up $5,000 or so you won't need in the near future, investing in stocks, bonds and funds is a proven way to build your personal wealth over the long term. There's no right single answer to what your investment portfolio should look like, but it should give you the opportunity to grow your money without taking on too much risk. The way to do that is to diversify what you own. That means owning a mix of investments: some that pay off over the long term and some that provide more steady returns. Say you're 30 years old and about to start building a securities portfolio for the first time. Most financial advisers will recommend putting the bulk of your assets in stocks. True, nobody can predict whether the stock market will rise and fall over the next few months or years, but over the long haul, every $1 invested in stocks at the beginning of a year has, on average, turned into $1.06 by year's end. The down side: It's a rough ride. Some years, your money will grow a lot more than 6%; other years, you'll suffer big losses. The important thing is to keep the faith and commit yourself to holding on to whatever you purchase for at least three to five years, but preferably a lot longer. What should you buy? A good first step is to put $3,000 of your $5,000 in an index fund like the Vanguard Total Stock Market Fund (you'll find it by searching for VTSMX on Forbes.com). The fund, which charges a management fee of just 0.15%, known as an expense ratio, is a good choice compared with funds that charge fees as much as 5% of the money you invest. The Vanguard fund has a minimum investment of $3,000 and encompasses 3,386 stocks, making it a great way to diversify. By purchasing this fund, you'll own shares in practically every publicly held company in the U.S. Sure, some of them might fail. But you'll also be buying the up-and-comers that nobody knows about yet--probably even the next Google. Owning such a broad index will protect you from the ups and downs of individual companies and increase the odds that your investment will grow over the long run. Does individual stock-picking sound more exciting? Probably, but consider the drawbacks: First, you can make a bad bet and spend $20 per share on a company that may soon be worth $1. Second, the act of buying and selling repeatedly makes you a cash cow for brokerage companies, which charge fees ranging from $8 to $20 for each trade you make. You'll need to pick a steady stream of winners just to break even--and even professional money mangers have a hard time doing that. When you buy the Vanguard fund, or an equivalent from another low-cost vendor like Fidelity Investments or T. Rowe Price, you'll be offered the option to reinvest your dividends. Do it. Currently, your $3,000 will buy you about 148 shares in the fund for $20.27 each. The next time it pays dividends, you'll receive about 15 cents for each share you own. If the price doesn't change much between now and then, your 15 cents per share will net you $24 each quarter, or 1.2 new shares. Reinvesting simply means your dividends will automatically be used to purchase new shares. With $2,000 left to spend in your $5,000 portfolio, look for a safe, steady investment. Set aside $1,500 for bonds that will pay out reliable returns. Sure, bonds don't have the high reward potential stocks do, but they will give your portfolio a firm foundation with less risk. Unfortunately, many bond index funds require a $3,000 minimum investment, so you won't have enough money right now to purchase one. One alternative is an exchange-traded fund (ETF) that holds bonds. Two good choices are the iShares Barclays Aggregate Bond Index (AGG), which charges 0.20% a year in expenses, and Vanguard's Total Bond Market (BND), which charges a fee of 0.09% per year. Buying shares in an ETF will cost you about $15 per transaction in fees, depending on your broker. In return, you'll get monthly payments for each share you own. Consider holding bonds and bond funds inside tax-sheltered accounts like a 401(k) or IRA, as the dividends your bonds pay will trigger tax liability if held outside these types of accounts. There are some bond mutual funds that have a lower minimum investment, but have slightly higher expense ratios than ETFs. Compared with paying commission fees to buy an ETF, you may come out ahead by choosing funds like JPMorgan's Core Bond Fund (PGBOX), Pimco's Total Return Bond Fund (PTTDX), or the Schwab Total Bond Market Fund (SWLBX). Each has a minimum investment of $1,000 or less and reasonable expense fees. You now have about $485 left. Resist the urge to blow it on a speculative stock. Instead, put it into a few dozen shares of an international stock ETF like the Vanguard Total World Stock (VT), the iShares MSCI AWI Index Fund (ACWI), or the SPDR MSCI ACWI ex US (CWI). Each of these funds buys stocks in companies around the world. The advantage here is that you spread out your risk even further, without needing expert knowledge of a particular sector or country. With the basics covered, you're on your way to a prosperous future. Questions or comments? E-mail drand...@forbes.com.
