Think what $10,000 can buy. A couple of decent family holidays, a second-hand car, or a takeaway coffee every day for eight years. It’s a lot of money (and potentially a lot of caffeine).
When it comes to sharemarket investing, though, $10,000 isn’t a huge sum. In fact, it’s probably about the minimum you need to start a share portfolio. Even then you’re likely to break some important rules, such as having adequate diversification.
Putting together a share portfolio is an important topic. Whatever your portfolio size, it’s worth reading our special report titled Building and Managing your Portfolio.
- Write an investment plan to keep you on track
- Stick to lower risk stocks until you have more experience
- Three stocks is probably adequate until you have more cash
If you have a small amount to invest, though, this Investor’s College will help you meet your specific challenges head on. As ever, consult someone licensed to provide personal advice if you need help with your situation.
Let’s talk about you
When it comes to portfolios, one size won’t fit all. Yours will reflect who you are and what you want. So let’s profile what you – our investor with $10,000 – might look like.
|Set up a direct debit from your pay into a high-interest savings account that’s dedicated to accumulating investment funds. If the cash is quarantined from your transaction account, you won’t be tempted to spend it.|
First, you’ve accumulated $10,000, so you’re a saver (well done). Your saving habit will come in handy, because $10,000 is only the beginning. Expect to add more cash to your portfolio over time as you save more of your income.
Second, you’re probably young (under 40, say). Goals such as pursuing education, buying a home or starting a family can make saving large amounts difficult until you reach mid-life.
Third, you’ve decided you won’t need access to your $10,000 for five years or more. Funds allocated to the sharemarket must stay invested long-term to ride out the volatility inherent in this asset class. If you’ll need access to your funds within a year or two, stick with a bank account.
Fourth, you’re enthusiastic and eager to get started but new to sharemarket investing. You understand that you’re inexperienced and it will take time to build your investment capital.
So what’s the next step?
Time to buy your first stock, right? Well not so fast. With decades of investing ahead, there’s no rush. Boring as it may seem, you should start by writing an investment plan. One page should do it.
Outline your time horizon (decades if you’re young), total return expectations (the long-term average of 10% might be a good guide), income expectations (are dividends important?) and how much invested capital you’d like to have in five years (including additional savings). Be realistic.
|Potential loss (%)||Type of companies you could consider|
|Up to 25%||Listed investment companies|
|Up to 30%||Low-risk blue chips e.g. Woolworths|
|Up to 50%||Higher-risk blue chips|
|Up to 80%||Profitable small companies|
|Up to 100%||Biotechs, mineral explorers etc.|
Most importantly, think about your risk tolerance. Inexperienced investors tend to overestimate both their stock-picking ability and their ability to cope with market falls.
In your investment plan write down the percentage loss you could tolerate on any individual stock, and your portfolio as a whole. This will help guide what stocks you select (see Table 1), and may help you keep things in context if things turn nasty.
You’re keen to buy a stock, we can tell. Before you do, consider the following:
- Take time to educate yourself about company valuation. There’s nothing wrong with taking a year or more to read books and study investing before pushing the ‘buy’ button for the first time;
- Never buy a stock unless it’s undervalued. Intelligent Investor Share Advisor’s recommended buy list will help here, but make sure you understand why the stock you’re interested in is undervalued. If you’re not sure, spend more time studying the business;
- Only buy a stock if it’s consistent with your investment plan. If your investment plan says you’ll stick to stocks paying dividends, simply ignore those that don’t.
Whatever you think your risk tolerance is, your first few stocks should probably be at the ‘low risk’ end of the spectrum. Even ‘low risk’ stocks can fall 20%-30% in a market downturn (and sometimes more).
There’s nothing wrong with buying listed investment companies, which are naturally diversified, or blue-chip companies such as Woolworths (assuming they offer some value of course). Think about your first few stocks as part of your investing education rather than a quick way to double your money.
|A starting $10,000 portfolio should probably look more like|
|Woolworths ($3,400)||AWE ($6,000)|
|ASX ($3,300)||Silver Lake Resources ($2,000)|
|Washington H Soul Pattinson ($3,300)||Kingsrose Mining ($2,000)|
|* Example only, using current buy recommendations|
Tempting though it may be to jump into something more exciting, resist the urge until you’ve been investing for a few years. Many newbies end up losing money in ‘hot’ stocks that old-timers instinctively know to avoid.
There’s one very good reason to avoid risk initially. With a $10,000 portfolio it’s impossible to diversify adequately. While you should aim to have 10-15 stocks eventually, it’s too many for now.
The reason? Brokerage is a surprisingly insidious cost. To avoid brokerage taking too big a bite out of your total return, you should aim to keep it below about 1% per trade. With most online brokers charging $20-$30 per trade, $10,000 will get you about three stocks using that rule of thumb. If you allocate your capital equally, each stock will represent 33% of your portfolio.
Portfolio weightings this high aren’t usually sensible, but you have little choice with a small portfolio. So avoid risky stocks until you’re more appropriately diversified. It only takes one company collapse to wipe out a third of your $10,000 initial capital at this stage.
Time’s on your side
Building a well diversified portfolio takes years. Impatience and overconfidence can lead to mistakes, so take your time and stick to your investment plan.
Keep saving and your investment capital will grow quickly. As your experience grows, add other stocks to your portfolio to improve diversification. Just never forget that a stock should be undervalued to earn a place in your portfolio.
Then sit back and let time work its magic. Your portfolio may never be ‘finished’ but boy, it’s going to be exciting watching it grow.