How to invest: What You Need to Know to Get Started

Is it time to get in the game?

If you have been sitting on the sidelines since the financial crisis and the stock-market crash, maybe you're feeling a little bolder now.

The economy is looking better. The worst of the layoffs seem to have passed. And the stock market has certainly roared back -- the Dow Jones Industrial Average is up 67% from its crisis low point.

While there's no guarantee that trends will continue, the nascent economic rebound is giving people more confidence, as workers and as investors.

One clear lesson of the recession: You need to borrow less, spend less and save a lot more. For the vast majority of people, that means investing in mutual funds in an individual retirement account or workplace 401(k) retirement plan. (Is your employer matching retirement plan contributions? Many stopped during the crisis.)

If your investing acumen has dulled through the downturn or if you have put off saving for future rainy days because you've been too busy living through them, you might need a Mutual Funds 101 refresher course.

Investing in funds doesn't have to be complicated and expensive. Many fund companies have easy-to-use electronic tools to help investors design an appropriate portfolio and select mutual funds.

Many 401(k) plans also offer advice, as well as all-in-one funds for those who would rather set and forget their investments.

Here's a start:

Q: What are your goals?

Jon Ellenbogen, a financial adviser with Wells Fargo Advisors in Washington, starts the investment process by asking clients how they plan to use the money. That's because a down payment for a house or a rainy-day fund should be invested in something with little risk, while retirement savings typically need a lot of exposure to stocks for their potentially greater returns over time.

The "primary driver" of how you invest should be your time horizon, agrees Stuart Ritter, a financial adviser at T. Rowe Price Group.

A young person decades from retirement should invest in funds focused more heavily in stocks (many experts say 100%), gradually increasing the portion of more stable investments over time.

In contrast, someone five years from retirement should have 60% in stocks, 30% in bonds and 10% in money markets or certificates of deposit, says Mr. Ritter.

If the goal is retirement, Mr. Ritter says a good rule of thumb is to save 15% of your salary, including the company match if one is available.

Q: Why invest through funds?

Funds enable small investors to pool their money with other investors to get a broader range of stocks or bonds than most people can buy themselves. The funds typically can provide the average person greater diversification, professional management and more convenience than investing in individual stocks or bonds.

Diversification is key, to earning decent returns while limiting risk. Many funds specialize in a particular type of security; but you can combine those funds -- or buy all-in-one funds -- to have broad exposure to stocks and bonds of numerous types.

Q: What types of funds are there?

Most funds concentrate on a particular type of security. Among stock funds, for instance, there are funds that invest in companies of a particular size and style -- "growth" funds, for instance, focus on sexier, fast-expanding companies (think Google) while "value" funds feature workhorses that churn out income (think General Mills).

There also are funds that focus on specific sectors of the economy, like gold stocks or European shares. Bond funds invest in bonds of varying maturities and from different types of issuers -- for instance, intermediate-term corporate bonds.

Most funds have managers who try to beat a benchmark. There also are "index" funds that don't try to pick winners but instead simply mimic the holdings of an indicator, such as the Standard & Poor's 500-stock index.

Over the long haul -- like a lifetime of investing -- few, if any, managed funds will beat out the index funds that invest in the same type of securities. Still, many investors like to try to identify funds they believe might come out on top. And over shorter time horizons, managed funds can, and often do, outpace the market.

For diversification, you want a portfolio of funds that give you exposure to companies of different sizes and types in this country and around the globe, as well as to bonds and cash.

Q: Isn't there an easier way?

Yes, indeed. Various types of funds cover a wide swath of the investing landscape -- or even offer an all-in-one solution.

For instance, there are funds indexed to the total U.S. stock market or bond market and global stock funds that buy shares world-wide. "Balanced" and "allocation" funds typically hold a broad mix of stocks and bonds, and sometimes other securities as well.

One of the easiest solutions, particularly for novice investors, is "target-date" funds geared to a particular year you might retire. The funds give you a mix of stocks, bonds and other exposure, and the mix shifts from an aggressive stock-heavy portfolio to a more conservative bond-focused portfolio as the target date approaches.

"It does a lot of heavy lifting for you," says Mr. Ritter of T. Rowe Price. "Most people don't want to be or don't have time to be engaged in the process."

Many of the target-date funds took a beating when the market plunged, but they've also seen a nice recovery (see the target-date funds chart).

There also are all-in-one portfolios geared to investors with risk profiles from "conservative" to "aggressive."

Q: What if I am only investing at work?

Target-date and target-risk funds are the default investments in many company retirement plans. Many plans also offer an assortment of narrower stock and bond funds.

Other funds commonly included in 401(k) plans are "stable-value" funds -- portfolios that are similar to but not actual mutual funds.

They typically invest in a mix of bonds, coupled with a financial guarantee from a bank or other financial company that is intended to protect your investment from declining in value.