NEW YORK (CNN/Money) -
I'm a college student who's managed to save $10,000 and would now like to invest that money for a good return. I'm willing to risk it all because no one ever succeeded without giving it all.
-- Tyler Smith, Sea Girt, New Jersey
If I were a professor giving you a grade in Personal Finance 101, I would give you an A+.
You've shown you have the discipline to save money and that you're ready to make the transition from saving to investing. Believe me, those are two concepts that many people never master at any point in their lives.
But now you're moving on to advanced course work: investing the ten grand you've managed to save. You've certainly got the right idea that you should be willing to take some risks with this money in pursuit of competitive returns.
But, somehow, phrases like "I'm willing to risk it all" and "no one ever succeeded without giving it all" conjure up for me the image of someone who's maybe a little too gung-ho.
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Yes, you're young, which means you can probably afford to take some risks. But that doesn't mean you should be putting your ten large in tech stocks or some other sector of the market that's been sizzling lately.
The key to successful investing is to take prudent risks, risks which have a good shot at boosting your return without jeopardizing your savings too much. Otherwise, you're not investing, but speculating. And aside from earning you a failing grade in Investing 101, speculating may result in your $10,000 stash dwindling in value rather than growing.
Here's what I suggest.
First of all, at your age I think the chances are pretty good that you might have to tap into your stash over the next few years for one reason or another. Perhaps you'll need to buy yourself a decent wardrobe when you begin interviewing for jobs. Or maybe you'll need some cash to sign an apartment lease and furnish your new digs after leaving campus.
In any case, you should estimate how much of your ten grand you might need for short-term expenses and possible emergencies and set aside that amount in something really secure like a money-market fund or, possibly, a short-term bond fund. This way, if you need cash quickly, you won't have to cash in other investments at what could be an inopportune time.
Now, with the money that you'll be investing for the long-term, you should be looking to build a portfolio that will allow your stash to grow.
That means a portfolio invested mostly in stock funds, since history shows that over the long term, equities provide the highest returns. That said, I believe even a young risk-taker like yourself should have at least a small position in bond funds as well, if only as a small hedge against the possibility that the future for stocks isn't as glorious as the past.
The exact percentage of stocks vs. bonds can vary depending on how much you're willing to tolerate your portfolio's value bouncing around in the short-term. But someone like you might go as much as 80 or 90 percent stocks. (For more guidance on this, click here.)
You also want to be sure to diversify your holdings among different types of stocks -- large and small, growth and value. For someone investing the amount of cash you're investing -- which is pretty small in Wall Street terms -- the easiest way to get that diversity is to invest in index funds.
In fact, you can make things really easy on yourself by buying a stock index fund that tracks a broad index like the Wilshire 5000, which in essence gives you the entire U.S. stock market in a single fund.
As for bonds, normally I'd recommend diversifying among various types of bonds as well (government, corporate, high-yield), but since you'll be putting such a small amount in bonds I think you can get by with a broadly diversified government or high-quality corporate bond fund -- or you can go with a bond index fund as well.
When you buy your funds, choose to have all dividends and capital gains reinvested in the funds. That way, you're plowing back your returns into your portfolio so you can enjoy the benefits of compounding, or earning gains on gains.
And don't make the mistake that many investors do of constantly moving their money around in hopes of capitalizing on the latest hot sectors. You should track your funds' returns vs. peers (which you can do by going to the Morningstar Web site and you can even dump a fund if it drastically underperforms for a significant period -- say, a year or longer. But beyond that, you don't want to tinker with your portfolio too much.
A final reading assignment
Before you actually begin investing, however, I want you to complete this assignment: Go to our Money 101 section and check out the following lessons:
Basics of InvestingInvesting In StocksInvesting in Mutual FundsInvesting in Bondsand Asset Allocation.
If you understand the material and can pass the 10-question test that comes at the end of each lesson, I think you'll be well prepared to begin investing real money in the real world. Class dismissed.
Walter Updegrave is a senior editor at MONEY Magazine and is the author of "Investing for the Financially Challenged." He also answers viewers' questions on CNNfn's Money & Markets at 4:40 PM on Monday afternoons.
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