How would I invest $20,000 today if I had to start over

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

Investing is personal. No wonder, we would all take different approaches and strategies. You should consider factors such as your personal financial situation, your investment time horizon, and your general appetite for risk and volatility.

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

Image source: Getty Images.

Categorize your investment ideas

The sheer size of the stock market can be intimidating. This means that the first thing I would do is divide my investment ideas into broad categories.

I would focus on four main areas:

1. Broad market funds
2. Proven winners
3. Stable ingredients
4. Companies with high options

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

Broad market funds

In the long run, S&P 500 has given a return of over 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 Vanguard 500 Index Fund ETF (FLIGHT -1.12%)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’re one of the most important factors to consider when researching ETFs and mutual funds.

If I invest today, I would allocate 20% of the amount 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 -0.59%) (GOOGL -0.64%), Nvidia (NVDA -2.44%), Apple (AAPL -1.39%) AND Microsoft (MSFT -1.23%) are all examples of such companies.

Because these businesses have years and even decades of absolute dominance in their respective markets, not nearly as much research is involved when choosing 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 more.

While long-term growth is somewhat limited by their large market capitalizations, these companies provide a healthy growth foundation for the portfolio with little long-term risk.

I would allocate 7.5% of the $20,000 to each of these four tech giants.

Stable ingredients

Some of my favorite stocks are boring companies that just keep moving year after year. Look no further than Costco (COST -1.00%), McCormick (MKC -0.68%), Home depot (HD -0.66%), Coca-Cola (Wh -0.34%)AND ball (TOP -0.49%).

All these “boring” businesses have:

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

But what I really like about these stocks is that they are mixed machines. Each has delivered a compound annual growth rate (CAGR) of at least 10% over the long term.

Data source: Calculations by author.

While they may not be the most exciting businesses to own, you’ll be glad you bought them decades from now when the magic of compound growth begins to take hold.

I would allocate 6% of the total to each of these high quality ingredients.

Companies with high options

Finally, I would invest 20% of the $20,000 equally in five high-option growth stocks: Free market (MELI -1.61%), Duolingo (LOVE -0.97%), Trade desk (TTD -0.91%), Axon Enterprises (AXON -1.61%)AND KnowBe4 (KNBE -0.10%).

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

In other words, by investing a small amount in companies with a wide potential for results, you can turn a small initial investment into large profits.

All five of these growing companies are using technology to disrupt mass addressable markets.

Because these firms are in hyper-growth mode, I’m less concerned about today’s 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 big risk for new growth companies, but that risk is significantly reduced when the company generates a surplus of cash like any 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 previously mentioned stocks.

Average dollar cost to protect against a collision

If I were to invest $20,000 today, here’s how it would break down:

To mitigate the risk of another market crash, I would probably dollar average 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 invested the entire amount at once.

Finally, while the allocation to VOO gives this portfolio a high degree of diversification, I would add additional positions over time, aiming to own at least 25 individual stocks.

Your strategy may look different, but I believe the above investments provide a solid foundation for what we hope will be an impressive market portfolio over the long term.