I’d focus my investments on four specific categories that I believe will set a portfolio up for long-term outperformance.

If I handed you $20,000 to start a portfolio from scratch, how would you invest that money?

Investing is personal. Unsurprisingly, we would all take different approaches and strategies. You’d have to consider factors such as your personal financial situation, your investment time horizon, and your overall stomach for risk and volatility.

While I can’t tell you how you should invest $20,000 today, here’s how I would do it.

Categorize your investment ideas
The sheer size of the stock market can be daunting. This means the first thing I’d do is divide my investment ideas into broad categories.

I would focus on four main areas:

  1. Broad market funds
  2. Proven winners
  3. Consistent compounders
  4. High-optionality companies

I’ll extrapolate each of these categories, but keep in mind, as the manager of your own portfolio, you can focus on whatever areas you think offer the greatest risk-adjusted potential.

Broad market funds
Over the long term, the S&P 500 has delivered a return in excess of 10% (when dividends are reinvested). While I believe beating the market is possible, I would allocate a significant portion of my portfolio to the benchmark via a low-cost, market-tracking exchange-traded fund (ETF). This creates a solid foundation for my investments and provides instant diversification.

My personal favorite is the Vanguard 500 Index Fund ETF (VOO), which tracks the S&P 500 and has an expense ratio of just 0.03%.

Expense ratios are the fees you pay to own a fund, and they are one of the most important factors to consider when researching ETFs and mutual funds.

If investing today, I’d allocate 20% of the sum to a low-cost S&P 500 ETF.

Proven winners
There are some businesses that have been such consistent winners over the years, it’s almost impossible not to include them in a diversified basket of stocks.

Alphabet (GOOG) (GOOGL), Nvidia (NVDA), Apple (AAPL) and Microsoft (MSFT) are all examples of such companies.

Because these businesses have years and even decades of absolute dominance in their respective markets, there’s not nearly as much research involved when picking them.

All of these companies have extremely strong balance sheets with very little debt. They are also growing their top lines by at least 15% and boast net profit margins of 20% or greater.

While the long-term upside is somewhat limited by their enormous market capitalizations, these companies offer a bedrock of healthy growth to the portfolio, with little long-term risk.

I’d allocate 7.5% of the $20,000 to each of these four tech behemoths.

Consistent compounders
Some of my favorite stocks are boring companies that just keep chugging along year after year. Look no further than Costco (COST), McCormick (MKC), Home Depot (HD), Coca Cola (KO), and Ball (BALL).

These “boring” businesses all have:

  • Leadership in their industries
  • Wide moats in the form of strong brand recognition
  • They make products that their customers will likely buy regardless of the economic environment.

But what I really love about these stocks is they’re compounding machines. Each has delivered a compound annual growth rate (CAGR) of at least 10% over the long term.

While they might not be the most exciting businesses to own, you’ll be glad you bought them after a few decades when the magic of compounding growth starts to kick in.

I’d allocate 6% of the lump sum to each of these high-quality compounders.

High-optionality companies
Finally, I’d invest 20% of the $20,000 evenly across five high-optionality growth stocks: MercadoLibre (MELI), Duolingo (DUO), The Trade Desk (TTD), Axon Enterprises (AXON), and KnowBe4 (KNBE).

The investment firm NZS Capital defines optionality as “a large potential payoff resulting from a relatively small investment.”

In other words, by investing a small amount into companies with a wide potential of outcomes, you can turn a small initial investment into outsized gains.

All five of these growth companies are using technology to disrupt massive addressable markets.

Because these firms are in hypergrowth mode, I’m less concerned with present-day profitability and more focused on cash flow. As such, I selected these five, in part, because they are all free cash-flow positive.

Bankruptcy is a large risk with young growth companies, but that risk is reduced significantly when the company is generating a surplus of cash like each of these five.

While high-growth businesses can be really exciting to own, it’s important to limit your initial allocation, as they carry significantly higher risk than the stocks previously mentioned.

Dollar-cost average to hedge against a crash
If I were investing $20,000 today, here’s how it would break down:

To mitigate risk of another market crash, I would probably dollar-cost average into these positions, investing $5,000 each month for four months. That way, if the market crashes tomorrow, my cost basis for these positions will be much lower than if I’d invested the entire sum all at once.

Lastly, while the allocation to VOO gives this portfolio a high degree of diversification, over time I would add additional positions, with the goal of owning at least 25 individual stocks.

Your strategy might look different, but I believe the investments above provide a solid foundation to what will hopefully be a market-beating portfolio over the long term.

— Mark Blank

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Source: The Motley Fool