Step Two - Choosing Investments

On Friday, we looked at the American Association of Individual Investors (AAII) asset allocation models. This was followed by yesterday's post on the Schwab asset allocation models.

The process of picking an asset allocation model is the first step in the investment process.

So by "hook or crook", as they say, we've arrived at an asset allocation model. Now is the time to take Step 2 in the process: choosing investments.

The model we've selected lists various asset classes and gives a targeted percentage to invest in each asset class. For example, the Schwab "Moderate" asset allocation model shows 10% targeted to "small cap equity."

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(Source: Charles Schwab).

Basically there are three ways to satisfy this specification: buy a small cap stock fund, select individual small cap stocks, or use a combination of the two. A good place to start when selecting a fund is at the iShares site and, in particular, their "core solutions":

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(Source: iShares)

As shown, there are 6 funds to choose from, including small cap growth and small cap equity. I would suggest the broadest fund - IWM, which is indexed to the Russell 2000. Another source of funds to consider is with the broker. Competition has led many brokers to offer their own commission-free, low-cost indexed funds. If you are using Schwab, Fidelity, or a similar broker, check out their commission-free offerings.

If you like to pick individual stocks, one place to start is by examining the holdings of a small cap stock exchange traded fund. You can find the top holdings by going to Yahoo! Finance, putting in the fund symbol, and then clicking "holdings" on the left hand side:

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(Source: Yahoo! Finance)

The final step in the 3-step process is to monitor your investments. We'll look at how this can be done tomorrow.

Some books that can help the beginning investor in the asset allocation process are: