For many investors who are just starting to save for retirement or who have smaller nest eggs to work with, finding the right mix of investments can be a special challenge. Many mutual funds have substantial investment minimums making it difficult, if not impossible, for someone with a few thousand dollars to construct a fully diversified portfolio. So what can you do to get the investing ball rolling when you don't have a lot of cash to work with?
Making do with less
There are a couple of things you can do to work around the mutual fund minimums that may prevent you from creating your ideal portfolio. First of all, you might want to consider buying a few exchange-traded funds. ETFs can give you inexpensive, broad access to wide sections of the market in one stop. For example, Vanguard Total Stock Market ETF (NYSE: VTI) attempts to track the entire domestic stock market, while Vanguard Emerging Markets Stock ETF (NYSE: VWO) is one of the best emerging markets ETFs around. Since ETFs have no minimum initial purchase constraints, you can more easily create a diversified portfolio than you can with higher-minimum mutual funds.
There are also several fund families that offer lower hurdles for investors with less cash on hand. The Homestead family of funds only requires a $500 initial investment for each of their seven funds. They offer a small-cap, international, short-term bond, large growth, and large value fund, among others. One of my favorites here is Homestead Value (HOVLX), which has been managed by the same investment team for more than two decades. The focus here is on large-cap names that management sees as undervalued in the market. Right now, the team sees pharmaceutical names as a prime area of opportunity. Many drugmakers, including Bristol-Myers Squibb (NYSE: BMY) and Pfizer (NYSE: PFE), have drugs coming off of patent and thinner product pipelines, which has pushed down share prices from their late 1990s highs. However, management is betting on an industry revival and renewed innovation from the health care sector, which accounts for roughly 23% of fund assets.
First things first
However, these steps outlined above may not be realistic for some investors. You may be in an employer-sponsored retirement plan with limited investment choices and no ability to buy exchange-traded funds. In such a case, you may need to build your asset allocation bit by bit, asset class by asset class.
If you only have money to devote to one or two funds, make your first purchase a large-cap mutual fund or index fund. This will give you access to one of the largest and most important sectors of the market. And given that small caps have absolutely trounced large caps over the past decade and are now considerably more expensive, I'm betting that large-cap names will come back into vogue sometime in the near future. That means this is one area of the market you don't want to miss out on.
Once you've got your large-cap allocation, you might want to consider buying an international equity fund next. You'll want a fund that focuses primarily on developed markets, but you do need a decent dash of emerging markets thrown in as well. If you can buy a fund like Dodge & Cox International Stock (DODFX) that invests in both developed and emerging stocks, that's probably your best bet. However, if your options are limited, at least make sure you get broad exposure to the developed world and then plan on adding in an emerging markets fund as soon as you can down the road.
Beyond that, you may want to consider a small-cap fund next. While I think small caps are much less attractively priced right now and they no longer have the wind at their backs, they still have terrific long-term appeal. And since you are investing for the long-run, you need a small-cap allocation. After all, a smaller mining firm like Allied Nevada Gold (NYSE: ANV), with its $2.3 billion market cap and promising results from its 2010 Hycroft exploration program, has a lot more room to grow than larger competitor Newmont Mining (NYSE: NEM). Small caps won't always lead the pack, but they should be an important part of any investor's long-run plan.
Next steps
Once you've got the bare bones minimum down in your asset allocation, make sure you continue to branch out and further diversify your portfolio as soon as you can afford it. Make sure you've got exposure to mid-caps, developed and emerging foreign stocks, growth and value-oriented funds, and even fixed income. You can build a pretty fully diversified portfolio with as few as 5 or 6 funds depending on your choices, but for most investors who go with actively managed funds, you'll probably need closer to 10 or 12 funds to adequately cover all your bases.
Ultimately, you shouldn't feel bad if you don't have tens of thousands of dollars to invest right now. The important thing is that you contribute what you can, make smart fund choices now, and build your asset allocation over time. So get started today!
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