If you are literally starting from scratch—you have no other forms of savings—the process is more difficult. While you should have your ultimate allocation goal in mind, the fact of the matter is that when you are starting from scratch, you will not be able to implement your full investment program at once. Instead, you will have to build toward it.
First, you should make sure that you have enough savings to meet your basic liquidity needs—you do not want to be in the position of being forced to withdraw funds from your investment program to meet emergencies or other cash needs. Once you have established a cash reserve, you can start to build your plan.
Here are two approaches.
A Balanced Start:
Under this basic approach, you would start your investment program by investing in a balanced or asset allocation fund that divides its assets in a relatively set range between stocks, bonds, and cash. Additional investments can be made to the fund until you have saved enough to begin investing in funds in more specific market segments.
| Advantages | Disadvantages |
| Immediate diversification in the major asset categories with one minimum initial investment. |
Cannot control the allocation—and many younger investors seek heavier commitments to stocks than is typical of balanced funds
Likely to outgrow the balanced fund—in other words, you will want to switch from the balanced fund to several different funds according to your asset allocation plan. If your balanced fund is taxable savings, you will have to pay taxes on any gains when you switch. |
If you use this approach, make sure that you fully understand your chosen fund's investment approach, because the names can be confusing. Some funds that call themselves "asset allocation funds" try to time the various market segments by changing their asset mix depending on their outlook. These types of funds should be avoided.
Other funds that call themselves "asset allocation" funds have a relatively fixed allocation to the major market segments; funds that refer to themselves as "balanced" also tend to have fixed allocations. These are the funds you should stick with, since they will ensure exposure to the three major market segments at all times. However, check to be sure that the fund you have selected is committed to the major market segments in which you want to be invested.
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