Arguably the hardest step in investing is the first step. Investors who are just starting out face a sometimes bewildering array of choices, a deluge of advice and the dread that if they make a mistake, they will lose everything.

It does not have to be that difficult, though. By following a few general guidelines, investors can make their initial forays into the market. Consider sample, or model, portfolio allocations. These give investors a rough outline of how to apportion their money, however much money they may have.

IN PICTURES: Learn To Invest In 10 Steps

Large What?
Terms like "large cap" and "value" are vague, but they also tend to mean what you think they should mean. Wal-Mart (NYSE:WMT), for instance, is a very large company that has a P/E below the market average and a higher-than-average dividend yield. Not surprisingly, it is considered a large-cap value stock. On the other hand, Apple (Nasdaq:AAPL) is even larger but is growing faster and has richer multiples - making it a large-cap growth stock.

For the sake of simplicity, we are looking only at stocks and bonds here. Other investment categories like hard assets (commodities and precious metals) and real estate certainly have a proper place in personal finance, but those go beyond the scope of this piece.

Model #1 - The Risk-Seeking Approach
A risk-seeking investor is typically one with a long investment horizons (decades) and a willingness to trade volatility and uncertainty for higher overall returns. A risk-seeking approach is going to prioritize growth over value, smaller market capitalization over larger, and will lean more towards international diversification. Fixed income is not likely to be a major part of the portfolio, apart perhaps from international bond and/or lower-rated corporate bonds.

5% - Large-cap value 20% - Large-cap growth
10% - Mid-cap value 25% - Mid-cap growth
15% - Small-cap value 20% - Small-cap growth
5% - Fixed-income

Foreign / domestic - 50% / 50%

This allocation may actually seem too conservative for very aggressive investors, but beginners should probably get a little experience under their belts before really ratcheting up their risk threshold. Why include any value allocation at all for risk-seeking investors? Well, with the exception of the 1990s, value-oriented investment approaches actually out-perform growth-oriented strategies. Still, it is generally true that growth is what fuels returns and this portfolio is designed for those who want growth.

Model #2 - The Risk-Tolerant Approach

10% - Large-cap value 15% - Large-cap growth
15% - Mid-cap value 20% - Mid-cap growth
15% - Small-cap value 15% - Small-cap growth
10% - Fixed income

Foreign / domestic - 35% / 65%

As you can see, this is a much more balanced approach than the first portfolio. This approach surrenders some of the growth opportunities of the more aggressive approach in exchange for a bit more conservatism and predictability.

Model #3 - The Risk-Limiting Approach

25% - Large-cap value 10% - Large-cap growth
20% - Mid-cap value 10% - Mid-cap growth
15% - Small-cap value 5% - Small-cap growth
15% - Fixed income

Foreign / domestic - 25% / 75%

This portfolio is better suited for an investor who believes "slow and steady" wins the race, as well as investors who do not want so much month-to-month or year-to-year volatility in their results. Still, there should be more than enough growth in this sort of allocation to outpace inflation. (For more, check out Fight Back Against Inflation.)

Security Selection - How Do I Choose?
Given this sea of numbers, how should a beginning investor turn those allocation percentages into actual candidates? A lot of that depends upon the time you have to devote to the work and your confidence in your own abilities to pick individual stocks.

Stocks and Mutual Funds
It takes a few hours to properly research a single stock. In that same time, you can thoroughly research a mutual fund, and you can search for them by broad characteristics like "large-cap growth". Moreover, an individual mutual fund is not going to be nearly as volatile or risky as any single one of its holdings. In other words, pick the wrong stock and you could have a 20% loss in one week, but you are unlikely to see such a sharp decline in a fund. Of course, the reverse is true as well - if you can "out-pick" a fund manager, you will outperform.

Exchange Traded Funds
Going a step further, you can find sector-specific ETFs (or mutual funds) that meet those allocation guidelines. For instance, the S&P Biotech SPDR (NYSE:XBI) would certainly fulfill some of the "growth" allocation in a portfolio, while the iShares NYSE 100 Index (NYSE:NY) probably fits the bill for large-cap value seekers. There is more risk here (say, if the entire biotech sector sells off), but more potential for return as well. (To learn more, see How To Use ETFs In Your Portfolio.)

Picking Stocks
Individual stock selection is also always an option. This takes the most time and the most effort, but it allows you to invest in more or less exactly the sorts of companies you want to own. It may take a bit more work here to distinguish growth from value or foreign from domestic - Procter & Gamble (NYSE:PG) gets a lot of its revenue from overseas; it is not a 100% U.S. company even if it is headquartered in Cincinnati - but there is no need for absolute precision here.

Investors do not have to go 100% in any direction. Especially for beginners, it may make more sense to buy one or two individual stocks and then round out the portfolio with ETFs and mutual funds. As you become more comfortable with individual stock analysis and selection, you can gradually replace more and more of the holdings with individual stocks. By the same token, you may find that you are better at selecting managers or ETF concepts than individual companies.

The Bottom Line
In any case, the most important step of all is to begin investing. We have laid out some starting options for you here, but they are just that - options. The right mix of risk and reward or growth and stability is a very personal decision and there is no "right" answer. (For more tips, check out Rebalance Your Portfolio To Stay On Track.)

Catch up on your financial news; read Water Cooler Finance: Who Is The Next Buffett?

Related Articles
  1. Active Trading Fundamentals

    How Hedge Funds Front-Run Index Funds to Profit

    Understand what front running is, and learn how hedge funds use this investing strategy to profit from the anticipated stock buys of index funds.
  2. Mutual Funds & ETFs

    Top 5 Chinese Mutual Funds

    Learn about some of the most popular and best performing mutual funds that offer investors exposure to the important emerging market economy of China.
  3. Mutual Funds & ETFs

    ETF Analysis: Schwab US Large-Cap

    Discover how the Schwab U.S. Large-Cap exchange-traded fund is managed, the index it tracks and the investors for which it is most appropriate.
  4. Mutual Funds & ETFs

    ETN Analysis: Rogers Intl Commodity Energy Total Return

    Learn more about the Rogers International Commodity Total Return, which is an exchange-traded note that tracks a broad index of commodity futures.
  5. Investing Basics

    Explaining Unrealized Gain

    An unrealized gain occurs when the current price of a security exceeds the price an investor paid for the security.
  6. Investing Basics

    What is a Settlement Date?

    A settlement date is the day a security trade must be settled.
  7. Investing Basics

    Explaining Risk-Adjusted Return

    Risk-adjusted return is a measurement of risk for an investment or portfolio.
  8. Investing

    Five Things to Consider Now for Your 401(k)

    If you can’t stand still, when it comes to checking your 401 (k) balance, focus on these 5 steps to help channel your worries in a more productive manner.
  9. Economics

    Understanding Organic Growth

    Organic growth is the increase in a company’s revenue and value due to internal operations.
  10. Investing Basics

    Calculating the Margin of Safety

    Buying below the margin of safety minimizes the risk to the investor.
RELATED TERMS
  1. Equity

    The value of an asset less the value of all liabilities on that ...
  2. Principal-Agent Problem

    The principal-agent problem develops when a principal creates ...
  3. Exchange-Traded Fund (ETF)

    A security that tracks an index, a commodity or a basket of assets ...
  4. Profit Margin

    A category of ratios measuring profitability calculated as net ...
  5. Quarter - Q1, Q2, Q3, Q4

    A three-month period on a financial calendar that acts as a basis ...
  6. Series 6

    A securities license entitling the holder to register as a limited ...
RELATED FAQS
  1. What is the formula for calculating compound annual growth rate (CAGR) in Excel?

    The compound annual growth rate, or CAGR for short, measures the return on an investment over a certain period of time. Below ... Read Full Answer >>
  2. What is a stock split? Why do stocks split?

    All publicly-traded companies have a set number of shares that are outstanding on the stock market. A stock split is a decision ... Read Full Answer >>
  3. Is my IRA/Roth IRA FDIC-Insured?

    The Federal Deposit Insurance Corporation, or FDIC, is a government-run agency that provides protection against losses if ... Read Full Answer >>
  4. Is there a difference between financial spread betting and arbitrage?

    Financial spread betting is a type of speculation that involves a highly leveraged derivative product, whereas arbitrage ... Read Full Answer >>
  5. How do I place an order to buy or sell shares?

    It is easy to get started buying and selling stocks, especially with the advancements in online trading since the turn of ... Read Full Answer >>
  6. When does the fixed charge coverage ratio suggest that a company should stop borrowing ...

    Since the fixed charge coverage ratio indicates the number of times a company is capable of making its fixed charge payments ... Read Full Answer >>

You May Also Like

Trading Center
×

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!