OK, so let’s say old Aunt Lizzie has died (the aunt who you don’t remember seeing since you were five, and just remember that she had a lot of cats) and she has left you $100,000. You aren’t sure why she left you the money, but now you have a bunch of cash and want to try your hand at investing.
Let’s assume further that you already have an emergency fund (cash) of 3-6 months worth of expenses, a retirement account set up that is full of mutual funds and the like, you don’t have credit card debt, you have the house on a fixed 30 year or — even better –15 year loan, and you have the kid’s college account set up and ready to go. If any of these are not the case, take care of these first – you aren’t ready to start investing in stocks.
So the question is, how do you invest all of this money, starting from a such a large sum?
Well, if you read any of my recent posts, you’ll know that I don’t think the market is particularly attractive right now, and probably will be heading down for a while. I could be wrong, however, and all of that federal funds money may finally start the lending flowing and we could see 20,000 on the Dow in a year. What the market will do over the next few years will also not matter a whole lot in 10-20 years. There is therefore no reason to wait, but there also is no reason to jump in with both feet.
First of all I would determine how much of the $100k I was wanting to preserve and not put substantially at risk, and how much I was wanting to grow more rapidly with a bit off added risk. Personally, I might decide that I wanted to preserve $40,000-$50,000 of it through diversification. (Others who are more risk averse might want to put $70,000-$80,000 in mutual funds. If you really don’t want to mess around with individual stocks, you would be just fine putting it all into mutual funds.) This I would put in 2-3 index funds. Here one might see declines of 20-30% on some years, but this will be rare, and with time this money should grow at an average rate of about 10-15% per year, doubling each 5-7 years. Here I would put some in now, wait a few months, and put in more, taking about 6 months to a year to become fully invested.
With the rest I’m looking to take a bit more risk for the chance at larger returns through investing in individual stocks. I know that any one stock could collapse, but it could also grow by thousands of percent. By buying a few carefully picked stocks I’m hoping to get at least one that grows for years and beats the overall market.
Anytime a large sum is to be invested, even if the market doesn’t look so unstable as it does now, it is always wise to wade in slowly. I would start by picking 2-3 stocks that have good long-term prospects (see the stock picking category of the blog). Buy a few hundred shares of each of these — about equal dollar amounts. Then watch them for a while, hoping that they will drop a bit and you can buy more shares for a bit less. Add to positions that do.
Once you have the initial positions, set up, wait about three months. Check on the positions then and see if the companies still have the fundamentals you thought they did. If they do, invest more in the 1-2 stocks that have lagged the others – buy low. Continue to do this, adding a few hundred shares every three months, until you have about 500-1000 shares of each. You may have $30-$80,000 of the money invested by this time, with $10-$30k in each stock. If this is too much for you to lose, choose six stocks instead, making each position $5-$15k. If this is still too rich, choose 10. If you are still too worried, individual stock investing is not for you. Buy three or four nice ETFs or index mutual funds and sleep easy at night.
At this point, start to look for another good stock in which to invest the remaining funds if money remains. As the positions grow, sell off some shares if any of the positions become too big for you to lose – bad things happen some times. Put some of this money in other individual stocks or add to existing position. Diversify the rest to preserve the capital you’ve gained. If any of the companies lose the qualities for which you bought them, sell them off and put the money into something else. Also, see if you can save some money from your occupation and continue to add stocks to your portfolio.
Hopefully Aunt Lizzie’s gift will lead to a large portfolio of stocks and be worth many times the original gift 20 years into the future. If this happens, maybe take $100,000 and give it to a grandchild. Put it in an index fund or ETF when they are twenty and you will have paid for their retirement. Do it when they are two, and you will have created a multi-millionaire.
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Disclaimer: This blog is not meant to give financial planning advice, it gives information on a specific investment strategy and picking stocks. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.