Once you've determined the right asset allocation, you need to divide your capital between the appropriate asset classes. On a basic level, this is not difficult: equities are equities and bonds are bonds.
But you can further break down the different asset classes into subclasses, which also have different risks and potential returns.
For example, an investor might divide the equity portion between different sectors and market capitalizations, and between domestic and foreign stocks.
The bond portion might be allocated between those that are short-term and long-term, government debt versus corporate debt and so forth.
There are several ways you can go about choosing the assets and securities to fulfill your asset allocation strategy (remember to analyze the quality and potential of each investment you buy – not all bonds and stocks are the same):
Stock Picking – Choose stocks that satisfy the level of risk you want to carry in the equity portion of your portfolio – sector, market cap and stock type are factors to consider.
Analyze the companies using stock screeners to shortlist potential picks, then carry out more in-depth analysis on each potential purchase to determine its opportunities and risks going forward.
This is the most work-intensive means of adding securities to your portfolio and requires you to regularly monitor price changes in your holdings and stay current on company and industry news.
Bond Picking – When choosing bonds, there are several factors to consider including the coupon, maturity, the bond type and rating, as well as the general interest-rate environment.
Mutual Funds – Mutual funds are available for a wide range of asset classes and allow you to hold stocks and bonds that are professionally researched and picked by fund managers.
Of course, fund managers charge a fee for their services, which will detract from your returns. Index funds present another choice; they tend to have lower fees because they mirror an established index and are thus passively managed.
Exchange-Traded Funds (ETFs) – If you prefer not to invest with mutual funds, ETFs can be a viable alternative. ETFs are essentially mutual funds that trade like stocks.
They're similar to mutual funds in that they represent a large basket of stocks – usually grouped by sector, capitalization, country and the like. But they differ in that they're not actively managed, but instead track a chosen index or other basket of stocks.
Because they're passively managed, ETFs offer cost savings over mutual funds while providing diversification. ETFs also cover a wide range of asset classes and can be useful for rounding out your portfolio.