Balancing Portfolio Risk And Reward: Asset Allocation for New Graduates

Editor’s Note: This article is a part of a series on investing advice for recent college graduates, drawing on expertise from financial professionals, university faculty and of course, InvestorPlace’s very own analysts and writers. Read more “Money Moves for Recent Grads” here and check out Top Grad Stocks 2021 for our best stocks to buy for new graduates.

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New graduates just starting to invest probably have a lot of questions about the stock market. Where do you start? What should you invest in, and how much?

These are questions your parents probably asked themselves at the start of their careers. But in 2021, as the world begins to recover from the novel coronavirus pandemic, young investors are entering a market that feels more volatile than ever. The rush of Reddit-fueled short squeezes and 1,000% gains in cryptocurrencies this year has given investors young and old serious FOMO, and even tempted some into trying to “diamond hand” their way to wealth.

Certainly that has worked for some, but while it’s better to be lucky than smart, you can only control one of those things. Yet that doesn’t mean you need to be scared of risky investments. In fact, young investors have the potential to bank huge gains in their portfolios early on, with a little portfolio management and an eye on asset allocation.

Time Is On Your Side

For 20-somethings, investing early in life is important. And if you’re reading this article, you know that leaving your money in a savings account isn’t the answer. Over time, inflation will outpace your savings’ interest rates, yielding a negative return on investment. Luckily, there’s good news to counter the bad.

The first piece of good news is that time is on your side. If you’re investing for more than 20 years, you can not only be more aggressive in your investment strategy, you can ride out the ups and downs of the stock market. The more you invest in now, the better off you’ll be later.

The second piece of good news is that you don’t need a financial advisor. Investing in your 20s is very different from saving for retirement. Because young investors have a longer time frame for investing, they can be more aggressive about how they allocate their investments. This difference is a good reason for taking a hands-on approach to asset allocation than a more balanced fund allows.

Young investors typically have a relatively small portfolio size, so they should focus more on increasing the rate at which they can save and invest, as opposed to choosing the best advisor or mutual fund. At this early age, increasing savings, making some good early long-term stock picks, and minimizing fees will take your money a lot further than a possible extra percent or two in return.

Of course, investing in any individual stock or bond leaves you vulnerable to the risk that the particular investment will decline in value, Diversifying your investments will reduce this risk and give you the opportunity to make money with one asset class while another declines.

Rising Inflation Means A More Aggressive Equity Portfolio

Inflation has been double the rate of general inflation over the past decade. Current yields tend to be a good indicator of future bond returns and the iShares Core U.S. Aggregate Bond ETF (NYSE:AGG), which serves as a broad bond market benchmark, is currently yielding 2.06%. At the same time, the April increase in The Consumer Price Index was the sharpest since September 2008. That means young investors looking to grow their wealth will have to adopt more aggressive asset allocations plans.

The first step is to define an asset allocation strategy to ensure your portfolio is both diversified and aggressive enough to meet your savings needs without unnecessary risk. Think of asset allocation as a grocery shopping basket: you’ll want to throw in a mix of various asset categories. These assets are index funds, mutual funds, bonds, cryptocurrency and of course, equities.

Not only are the categories important, so is the weighting. For young investors, this weighting will differ from older folks nearing retirement. The is to create an ideal mix of investments that gives you the greatest potential for long-term gains at a tolerable risk-level.

Source: InvestorPlace (Dream Stafford/Vivian Medithi)

Equities (50%): Focus on Technology, Growth and Innovation

As an aggressive investor, putting 50% of your investment into stocks (domestic AND international) is a good way to capitalize on economic and technology shifts at home while also investing in younger economies growing faster than the U.S. Investing directly in stocks gives you exposure to a growing economy, disruptive technologies/innovations and long term secular trends. The long-term returns on equities tend to be better than returns from cash or fixed-income investments. By diversifying your equity investment across different sectors, you’ll get exposure to both cyclical trends and secular long-term trends. Another benefit: you’ll lose less if a particular sector tanks.

Here are the important sectors to invest in, with weighting recommendations for your equity portfolio:

  • Technology (30%): Spanning both large-cap tech titans and small-cap growth stocks, young investors shouldn’t miss out on the chance to invest early on in secular long-term trends. Key themes include Cloud computing, software, semiconductors, IoT (Internet of Things), electric vehicles, solar technology and 5G. Some of our favorite ideas include Palo Alto Networks (NYSE:PANW) in 5G and cybersecurity, Splunk Software (NASDAQ:SPLK) in IoT, Li Auto (NASDAQ:LI) in electric vehicles, MP Materials (NYSE:MP) in battery technology, and Enphase Energy (NASDAQ:ENPH) in solar energy.
  • Healthcare (20%):The intersection of rising healthcare costs and an aging global population make for a potent combination that shouldn’t be overlooked by young investors. While healthcare stocks aren’t the first to take off when the economy charges higher, valuations are generally inexpensive right now. Investing here offers exposure to global growth and stocks with high dividend-yields. Key sub-segments to look at include pharmaceuticals, biotech, health technology companies, medical device manufacturers, health insurance companies and healthcare IT.  Favorite names include AbbVie (NYSE:ABBV) and Zomedica (NASDAQ:ZOM) in biopharmaceuticals and Intuitive Surgical (NASDAQ:ISRG), a leader in robotic-assisted surgeries. Pharmaceuticals and companies focused on physician-administered therapies and vaccines are also good places to look.
  • Consumer Discretionary (10%): These stocks include durable goods, high-end apparel, entertainment and leisure activities. They tend to lead a stock market recovery, since consumers have more disposable income to spend when the economy is growing. Names to consider are those that track consumer spending trends, like e-commerce giants Ebay (NASDAQ:EBAY) and Etsy (NASDAQ:ETSY) and EV supplier Tesla (NASDAQ:TSLA). There are also some new trends to play here, like cannabis stock Cronos Group (NASDAQ:CRON) and video streaming supplier Roku (NASDAQ:ROKU).
  • Communications Services (10%): This sector, which comprises roughly 10% of the S&P 500, includes media, internet, satellite and phone services companies that span the range from stable dividend payers to more volatile growth names. With remote work, streaming, and gaming becoming a standard part of everyday life, the providers of this critical infrastructure are long-term growth investments. 5G technology is also a key catalyst for growth in the sector. Names to consider here include Verizon (NYSE:VZ), the largest wireless carrier in the U.S., American Tower (NYSE:AMT), the largest cell tower operator, and Comcast (NASDAQ:CMCSA), the largest pay-TV and home internet service provider.
  • Financials (8%): This segment includes investment banks and brokerage firms as well as emerging fintech stocks. The social investing movement has also opened up new business models in lending and online banking. Favorite names here are disruptive fintechs, including digital payment players Square (NYSE:SQ), Affirm (NASDAQ:AFRM), and Paypal (NASDAQ:PYPL). Also look at traditional credit card networks like Mastercard (NYSE:MA), which are poised for near-term recovery as international travel resumes.
  • Consumer Staples (5%): These non-cyclical stocks, which comprise roughly 70% of the GNP (Gross National Product), include food and beverages, household goods and hygiene products. They are also impervious to business cycles and offer a more defensive strategy in a contracting economy. As we look to a post-pandemic economy, the best names to choose short-term may not be these “stay at home” names that sell household necessities. But there are some good long term plays, like Costco Wholesale (NASDAQ:COST), whose bare-bones wholesaling approach has defied the retail downtrend. Other names to consider are those with strong brand portfolios, like Nestle (OTCMKTS:NSRGY), and Energizer Holdings (NYSE:ENR). Cosmetic companies like Estee Lauder (NYSE:EL) are also good long-term plays, benefiting from an increase in makeup sales.
  • REITs (5%): REITs (Real Estate Investment Trusts) own or manage income-producing commercial real estate. These provide diversification and lower risk as a counterbalance to other equity investments, as well as high-yield dividends, paying out 90% of taxable income to shareholders. With COVID-19 having impacted many of these landlords’ tenants, plenty of these names are currently trading at bargain prices. some good places to start include e-commerce warehouse REITs, healthcare REITs and telecom REITs. Some recession-proof REITs to consider include data center supplier Equinix (NASDAQ:EQIX), food industry REIT Americold Realty Trust (NASDAQ:COLD) and Life Storage (NYSE:LSI) in self-storage.
  • Industrials (5%): Machinery, manufacturing, construction, defense and aerospace are poised for growth as more industrial development is brought back into the U.S. Some of the fastest growers in this space include Ingersoll Rand (NYSE:IR), which manufactures flow control equipment, Amerco (NASDAQ:UHAL), a diversified holding company which owns U-Haul, and Middleby (NASDAQ:MIDD) in cooking and food prep equipment.
  • Energy (5%): Rising demand plus rising prices equals continued investment in transportation, exploration and production. Integrated oil and gas companies provide value and dividends, pipeline operators and MLPs (Master Limited Partnerships) offer steady income payments, and more disruptive oil and gas explorers can deliver big returns for those willing to take on the risk. Magellan Midstream Partners (NYSE:MMP) and Enviva Partners LP (NYSE:EVA) are trading at yields above 10%. Alternative energy and biofuels are also important growth areas. Examples here include Clean Energy Fuels (NASDAQ:CLNE), First Solar (NASDAQ:FSLR), and Enphase Energy.
  • Materials (2%): These cyclical stocks include precious metals, oil, wood and raw chemicals and offer broad-based exposure to a growing economy. Examples of recession-proof names with strong balance sheets and diversified portfolios include International Paper (NYSE:IP) in packaging, pulp and paper, and LyondellBasell (NYSE:LYB) in plastics and chemicals.

Index and Mutual Funds: Diversified exposure to ride out volatility

  • Mutual Funds (20%): Mutual funds are managed portfolios that give investors reduced-risk exposure to a diversified set of market sectors. Young investors should choose funds weighted toward small-cap growth stocks. At this early stage of investing, bond-based mutual funds are too defensive and low-growth in nature. Investors should be on the lookout for low costs (sales commissions) and low expense ratios. Some of the best performing mutual funds this year include Bridgeway Ultra-Small Company Market Fund (NASDAQ:BRSIX) and DFA US Small Cap Value I (NASDAQ:DFSVX).
  • Index Funds (5%): Early in their careers, new grads don’t need the safety of passive index funds when they have a long-time frame for investing. There are newer, more specific ETFs that track particular sectors that young investors may find attractive, such as electric vehicles, space, and alternative energy. Examples include the Global X Cloud Computing ETF (NASDAQ:CLOU), SPDR S&P Software & Services ETF (NYSE:XSW), Global X Cybersecurity ETF (NASDAQ:BUG) and iShares Global Clean Energy ETF (NASDAQ:ICLN).

Bonds (5%): A strong defense isn’t important right now

Bonds tend to be less volatile than stocks, and when held to maturity can offer more stable returns. For young investors, recommended exposure is low given a long time-frame for investing. That said, building a small early position offers some insulation against the volatility of the stock market. The corporate bond market is seeing a new wave of supply, with Amazon (NASDAQ:AMZN) and T-Mobile (NASDAQ:TMUS) recently issuing debt.

Cryptocurrency (20%): Because it’s here to stay

With mainstream support for cryptocurrencies rapidly escalating, young investors shouldn’t overlook this space. Now totaling over 7,000 publicly traded cryptocurrencies with a consolidated market capitalization of around $1.9 trillion, crypto has the potential to become a scarce asset that increases in value as fiat currencies depreciate. It could also gain extensive use as a digital form of cash, with the potential to become the first truly global currency. Already, digital payment platforms Square and PayPal, which also owns transfer app Venmo, allow customers to use cryptos. Favorite names include the number one and two by market cap — Bitcoin (CCC:BTC-USD) and Ethereum (CCC:ETH-USD). But, considering the run-up in these names, investors should also consider other emerging names with strong retail support, including Dogecoin (CCC:DOGE-USD), Ripple (CCC:XRP-USD) and blockchain platform Cardano (CCC:ADA-USD). My InvestorPlace colleague Tezcan Gecgil believes Litecoin (CCC:LTC-USD) will be the big altcoin winner. Many of these cryptocurrencies are trading below $2. That means for $2,000 you can buy up to 1,000 coins or tokens.

Disclosure: On the date of publication, Joanna Makris held long positions in TSLA, DOGE-USD, AMZN, MMP, EQIX, MA, PANW, SPLK, BTC-USD, PYPL and ETSY. She did not have (either directly or indirectly) positions in any of the other securities mentioned in this article.

Joanna Makris is a Market Analyst at A strategic thinker and fundamental public equity investor, Joanna leverages over 20 years of experience on Wall Street covering various segments of the Technology, Media, and Telecom sectors at several global investment banks, including Mizuho Securities and Canaccord Genuity. 

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