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If you’re one of the millions eligible to receive at least $10,000 in student loan forgiveness, it’s never too early to begin thinking about what you could do with the money you’ll save — such as invest (surprise, surprise). Instead of just viewing it as debt wiped away, you should view it as money you can now use to make more money.
The amount you have forgiven won’t just appear in your bank account, but you can put a plan in place to use the money you would’ve otherwise been paying on the loans. And you don’t have to try for a home-run investment. Instead, I would focus on four types of index funds that could be the foundation of a solid, well-diversified portfolio.
Of the major benchmarks in the stock market, the S&P 500 is by far the most followed. Tracking the largest 500 U.S. companies by market cap, the S&P 500 can be a one-stop shop for many investors. An S&P 500 index fund has three things that almost any investor would want: blue chip stocks, dividends, and long-term stability.
The iShares Core S&P 500 ETF (IVV 3.06%), for example, contains large-cap stocks covering all the 11 major sectors, and with a 0.03% expense ratio, it’s very low cost.
Because of the size and influence of the companies within the S&P 500, it’s often used to gauge how the broader stock market and economy are performing. There will undoubtedly be bumps along the way, but with an S&P 500 index fund, investors can feel more confident in its long-term return potential.
Just as there’s a risk/reward trade-off between different types of investments (such as stocks versus bonds), there’s a similar risk/reward trade-off within stocks themselves. Larger, more established companies are generally more stable because of their resources, but they also tend to have less room for high growth.
Conversely, small-cap stocks — generally defined as businesses with a market cap between $300 million to $2 billion — are more prone to volatility, yet there’s room for hypergrowth. Mid-cap stocks are the sweet spot in between. They’re just small enough to have high growth potential, yet they’re large enough to have more money and resources at their disposal.
Both the Vanguard Small-Cap ETF (VB 4.07%) and Vanguard Mid-Cap ETF (VO 3.62%) are good index funds to look into. They’re low cost (0.05% and 0.04% expense ratios, respectively), and they’re both diversified enough to lessen some of the risks that usually come with smaller-cap companies. The Vanguard Small-Cap ETF holds 1,516 stocks, and the Vanguard Mid-Cap ETF holds 363.
Part of having true diversification in your portfolio is making sure you’re not only investing in U.S. companies. There are many great international companies, and you’d be doing yourself a disservice as an investor to ignore them. Generally, you should aim to have around 20% of your portfolio in international stocks.
International markets are broken down into developed markets and emerging markets. Developed markets are seen as having more mature financial systems and economies. Economies in emerging markets may not be as developed, but there’s usually more room for growth because of it.
As an investor, it’s good to get exposure to both, but instead of focusing on them individually, I would invest in a total international index fund. The Vanguard Total International ETF (VXUS 3.55%), for example, contains 7,837 stocks in both developed and emerging markets. The breakdown is:
To get a bit of stability while also leaving a chance for higher returns, here’s how I’d divide the money saved:
How you divide it largely depends on your personal situation and risk tolerance. If you’re closer to retirement, you may not want as much exposure to smaller-cap companies because of their risk. But if you’re decades away, you may be comfortable with it for the chance of higher returns. The most important part is to do what’s comfortable for you.
It may also help to use dollar-cost averaging, which involves making set investments at set intervals, regardless of how stocks are performing. This will keep you consistent and avoid you possibly trying to wait for the “perfect” time to invest. If you’ll be saving $200 monthly, for instance, here’s how you could break it down:
The most important thing is to remain consistent and stick to your schedule no matter what. It’s a great strategy for long-term investors.
Stefon Walters has positions in Vanguard Mid-Cap ETF, Vanguard Small-Cap ETF, and Vanguard Total International Stock ETF. The Motley Fool has positions in and recommends Vanguard Mid-Cap ETF, Vanguard Small-Cap ETF, and Vanguard Total International Stock ETF. The Motley Fool has a disclosure policy.
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