The second group consists of investors who believe they can outsmart the market. They’ve stayed on the sidelines, planning to buy in and make their fortunes when the markets break down a second time. But they may never get their chance.

Both strategies are flawed. And both ignore the single strategy that investors need to employ to profit in the later stages of a recovery rally.

The first group of investors – the indexers – have a unique problem. Broad-based investments such as indices are really only favored in the early stages of any recovery rally, when there’s plenty of easy money to be made.

These investors either don’t know – or choose to ignore – the reality that long rallies tend to change character: Broad-based choices are super when the rising tide is lifting all boats early in the game. But then the game itself changes.

Early on, index investors reap the lion’s share of the market-rally profits. But as rallies mature and capital continues to flow, successful investing becomes more of a stock-picker’s game. This means that specific stocks – not the indices – become vastly higher probability bets.

There are many reasons why this shift occurs, but it really comes down to two key factors: Where the money is going, and where the money is flowing.

This means there’s plenty of fuel to keep the rally alive both here and abroad, and we’re not alone in our opinion.

Beware of the “Golden Period”

Jack Ablin, who helps oversee $60 billion as chief investment officer for Harris Private Bank (NYSE: BMO), says there is still  “an enormous stockpile of liquidity on the sidelines [and] the reinvestment of [that] cash could help fuel the market.”

Unfortunately, this is well-known to investors, which actually makes it a problem. As hedge-fund manager Kyle Bass noted: “We are today in the midst of what economists often refer to as the ‘Golden’ period, where everything feels good and the long-term effects of deficit spending and money printing have not yet been realized.”

This is something I’ve talked about time and again during investor presentations all around the world. People who are already numb from having been pummeled on the way down, have once again become intoxicated with the rally over the 12 – 18 months that such advances typically last. They see a chance to recoup all their losses and be made whole. This makes them more prone to poor timing decisions, or poor investments choices.

Another problem with long rallies like the one we’re experiencing now is that you have be “in” from the get-go or you won’t “go” at all.  Today’s algorithmic trading simply doesn’t allow for the kinds of market pullbacks and corrections we used to see as recently as 10 years ago. I know – I’ve written several of these trading programs. Today, if you’re not in when the money starts moving, you might as well hang it up.

At the same time, you just can’t sit and wait until things get better, either. If you do, you are likely to miss most of the gains.

And don’t bother trying to “time” the market. That’s a recipe for disaster, as reflected by numerous Dalbar studies. The Dalbar data repeatedly demonstrates that investors who try to time the markets not only fail miserably in the near term, over a period of years they tend to fall dramatically behind the market averages.

How much behind? Try 40%-60%, depending on what data period is examined.

Winning Markets – Big and Small

That brings me back to today’s key point. In the early stages of a rally, it’s best to invest using broad, sweeping choices like index funds or exchange-traded funds (ETFs), which are tied to the major indices. Believe it or not, picking the “right” stocks is essentially irrelevant. Sure you always want to have some zoomers in your portfolio, but when the rally really begins, it’s far more important to have broad-based stock-market exposure. It’s a shotgun approach. And it works.

Over the past 118 years, there have been 19 bear-market events in the Dow Jones Industrial Average. The average bear-market drop was 37%. The rally into the next year generated an average gain of 40% from the market bottom – with 70% of the gains coming within the first half of the rally’s duration.

That’s why, for example, I’ve repeatedly told Money Morning readers, as well as subscribers to our affiliated publications, to employ such broad choices as the Vanguard Wellington (Nasdaq: VWELX) or the SPDR S&P 500 ETF (NYSE: SPY).

Today, with the Standard & Poor’s 500 Index having zoomed 57% from its March 9 low, the rebound is 1.5 times bigger than the typical post-recessionary rally.

That means the best choices are now the companies that are backed by trillions of dollars in stimulus spending and that operate in growth markets that support real earnings, real cash flow and real purchasing power.

That makes a lot of sense if you think about it. Fully 78% of the world’s total economic activity now takes place outside U .S. borders, which means that if you really want to “follow the money,” you’ve got to look in areas that you might traditionally have considered as “off limits.” In fact, you may find that you are looking at companies whose names you can’t easily pronounce. But many of those companies not only have double- or even triple-digit growth, they are still viewed as compelling values – because of the torrid growth rates of the markets they sell to.

Take Iceland. After its financial travails, the country once again has positive gross domestic product (GDP) growth. It’s unemployment rate of 7.7% is not only dropping, it’s now well below the U.S. jobless rate of 9.8%.

Iceland was the first nation to have its currency destroyed and its finances and political government replaced.  It embraced its pain, and focused on doing what was necessary to fix its issues. Now its exports are booming, and its outlook is much better than it was just a few months ago.

Iceland has turned into an example of growth following a situation that most people thought was unfixable. From September 2008 to August 2009 – a period in which most economies were shrinking –the Icelandic economy actually expanded 2.4%. For global investors, economic growth – in the face of some of the toughest economic issues in generations – is the Holy Grail in surviving an economic crisis.

Tourism is flourishing in Iceland, as international citizens flock to that country’s shores to enjoy having a strong currency to spend.

Icelandic vocalist Bjork, 32, a former fashion model wearing silver snakeskin leggings, black boots and blond ponytail, recently told a journalist that “business is growing.” Thanks to the utsala – “SALE” – signs that were everywhere, “tourists are buying a lot these days, and even Icelanders are buying more at home.’

Granted, shopping for designer duds in Iceland with a snake-skinned model may not be your notion of a conservative-economic recovery play, but don’t miss the real point here: What Bjork was shrewdly observing was that consumers in her part of the world are no longer panicking. They’re back from the brink of almost-total collapse and have now come to terms with their nation’s economic recovery.
This demonstrates just why investors need to be looking at markets where there is real growth – from the smallest economies like Iceland, to some of the largest – such as China.

Speaking of which, with a population of 1.3 billion, a personal savings rate of 35%, and a government that isn’t suffering from a fiscal hangover, it’s no wonder the world’s leading companies are beating a path to the Red Dragon’s doorstep.

In China, the government’s focus is growth, and banks are looking for projects to invest in.  Those in positions of power and authority understand the need for balancing savings, growth and long-term investments. China’s stimulus plan focuses on infrastructure development, which will generate long-term growth, while the United States had had to use its balance sheet to prop up “zombie banks” – just to keep things from getting worse than they already are.

If this sounds a bit complex, the reality is that it’s actually quite basic. Limiting yourself to index investments at this stage of the market cycle is not your best bet. We’re now at the stage where the world’s stock markets have already delivered the broad, indiscriminate gains that benefit index-investors to more specific opportunities that require more-careful analysis and some specialization. Follow that game plan and you’ll be a long-term winner.

Source: The Two Investing Mistakes to Avoid at all Costs

And in his first installment of a new series, he shows you exactly how you can do that with low-minimum mutual funds.

Just this week, a friend told me that he wanted to jump-start his long-neglected saving-and-investing efforts, but was worried it wouldn’t be possible on his current household budget.

I’d be willing to bet that a lot of folks are asking that very same question right now.

I mean, let’s face it: Everyone knows how important it is to save money. But in the middle of what may well be the worst U.S. financial crisis since the Great Depression, finding the cash to create an emergency fund – or to invest in a mutual fund that requires a $10,000 initial outlay – can appear so daunting that many investors decide to not even bother.

Don’t that same mistake.

There’s an option: Mutual funds with a low initial investment threshold. We all know, for example, that Vanguard Wellington (VWELX) is a great fund – indeed, it’s a favorite of Money Morning Investment Director Keith Fitz-Gerald – but here in the depths of a financial crisis, not everyone has the $10,000 in cash needed to become a new shareholder.

The upshot: Unfortunately, a lot of folks stop right there, and don’t bother to jump-start their saving-and-investing program.

Don’t that same mistake.

When a Small Start is a Good Start

One way around is to seek mutual funds that allow investors to start with either a very small initial investment – or with no initial investment at all (provided you’re willing to let the fund company take $50 or $100 a month directly out of your checking or savings account).

This approach has a couple of advantages, Money Morning’s Fitz-Gerald says:

• First, it induces you to keep investing, even in a bad market, which history shows is a key element of better long-term results.
• Second, by taking advantage of the electronic-investing option many fund companies offer, you’re investing consistently – for instance, investing the same amount of money on the same day each month.
• Third, for the ultra-cautious the lower investment thresholds can serve as a de facto risk-management tool, since it means that you’re putting less money at risk in the market at a time when the market is uncertain (although, at the same time, you’re still investing).

“It’s a way to insure that you continue to invest, even when the markets stink,” Fitz-Gerald says. “If you are gun-shy, and don’t really want to put a lot of cash at risk, this is a good way to continue your forward-investing momentum, to continue even when the markets aren’t optimum.”
Where do you look for funds like this?

One good place to start your search is with Morningstar, the noted financial-products researcher. For some help, we turned to Morningstar.com’s handy mutual fund screener. And here’s what we did. We looked for funds with an initial purchase of $500 or less. Not wanting big chunks of our capital to for sales commissions, we set the “load” status to “No-Load Funds Only.” And we opted for low-expense offerings, meaning we screened for funds featuring expense ratios of 1.00% or less.

Wanting to cull this further – and to hopefully end up with the “best-in-breed” funds – we limited our search to funds that were rated as “five-star” products by Morningstar. Lastly, since we’re looking chiefly as equity funds in this exercise, we ran one screen for domestic stock funds and another for international stock funds.

We ended up with 23 funds in the domestic-stock category and 16 funds in the international stock category.

What this demonstrates is “that there are quality funds out there,” even for investors who have smaller amounts to invest, Fitz-Gerald says.

Morningstar’s mutual fund screening program – which is free – allows for investors to include other parameters, too, including those for risk, returns, portfolio turnover, and management tenure. We were attempting to keep it simple to show what’s possible, and also figured you’d want to do some of your own research to find funds that match your personal financial needs. The program can also screen for bond funds. One task it does not perform is to identify which of the funds are close to new investors.

Go Global or Get Left Behind

The Money Morning graphic shows the results of our search for International stock funds – and for a good reason. As regular readers of Money Morning know, we believe a global investing strategy is key to any investor’s long-term success. Unfortunately, too many investors de-emphasize the international or global elements of their portfolio, believing that domestic investments are less risky.

There are many different kinds of risk, however – including the risk of getting left behind. Long-term, most of the growth that’s expected in the decades to come will be outside U.S. borders.

If you want proof, just ask the World Bank.

• Today, the United States and Asia each account for 28% of the worldwide economy. Combined, that’s a total of 56%.
• Twenty-five years from now, America’s share of the global economic pie will have slipped to 24%. But Asia’s will have soared to 55%.

In short, in slightly more than two decades, Asia will be twice the economic powerhouse that the United States is today.
It’s true that a number of overseas markets have been problem-plagued in recent months. But that’s just a short-term problem. And as the World Bank statistics demonstrate, the long-term outlook for growth outside the U.S. borders is exceptionally strong.

By focusing only on U.S. stocks, you’ll be looking at only a quarter of the world’s investment opportunities. You’ll miss out on some of the world’s fastest-growing markets. And you’ll get left behind.

The greatest growth will come from China, India and the newly capitalist economies of Eastern and Southern Asia. There may be some other growth areas, such as resource-rich Latin America.

Famed Wharton Business School Professor Jeremy Siegel recently pronounced that the long-held conventional wisdom on international investing should be thrown out the window. For decades, we’ve heard over and over how international investments should comprise 5%, 10% or at most 15% of our portfolio’s total value. Any more than that is foolhardy and risky, we were programmed to believe.

According to Siegel, however, the truly foolhardy act is to limit our international exposure that much. In other words, the biggest risk U.S. investors now face isn’t just the possibility of losses incurred when some foreign market plunges. The real risk now is the possibility that U.S. investors face – getting left behind financially because of all the growth that’s expected to be generated beyond U.S. borders.

Investment advisors who stick with the old asset-allocation model are actually doing their clients a huge disservice, Siegel says.

Siegel now believes that international investments should comprise about 40% of your total holdings. Most individual investors know Siegel for his best-selling book, Stocks for the Long Run: The Definitive Guide to Financial Market Returns and Long-Term Investment Strategies. The book first came out in 1994, and is considered one of a handful of “must-read’ titles in investing finance. The new edition, which appeared in November 2007, includes a long addition addressing the international arena, and how investors must adapt their strategies to the new realities of globalization.

The nation’s wealthy already really understand what’s at stake and are already profiting from these trends – and in a big way. According to a 2007 study by the Spectrem Group, 40% of affluent U.S. households are continuing to invest internationally, while a full one-third are actually planning to invest more. Their chief country of choice when it comes to investing abroad: China.

Other Options

For cash-challenged investors who want to capitalize on China’s growth, there is a solid option – the China Region Opportunities Fund (USCOX), which is operated by the San Antonio, Texas-based U.S. Global Investors Inc. (GROW). As it does with most of its funds, U.S. Global offers interested China fund investors its trademarked “ABC Investment Plan,” which permits investors to make a $100 initial investment and subsequent monthly investments of $30 a month, so long as the new shareholder consents to an automated electronic transfer. You can even tell the company which day of the month you want the money to be invested.

A number of other companies offer similar programs, which are known in the industry as “automated investment plans,” or AIPs. One other company known for operating quality funds is the Baltimore-based T. Rowe Price Group Inc. (TROW), a firm I covered during my time as a business journalist. With most of its funds, the minimum initial investment is waived as long as you agree to have at least $50 a month per fund automatically transferred from your checking account and invested. That arrangement must be maintained until you reach the specified minimums to avoid any extraneous fees.

(One point worthy of note: When my wife and I bought our house nearly nine years ago, the down payment came from two T. Rowe Price funds that I’d built up over a couple of years solely through AIP investments).

Here’s a list of T. Rowe Price funds of all types that are ranked four and five stars by Morningstar.

One final note about low-initial investment funds: This is a great way to get you started back on the savings pathway. At some point, however, you’ll likely want to either add funds or boost your regular investment total to start amassing capital.

“One thing that investors too often don’t understand: You never want to stop investing altogether,” says Money Morning’s Fitz-Gerald. “Even if it’s only a couple of bucks here and there. History shows that those who continue to invest through thick and thin are those who generate the best returns.”

At least, however, this strategy is a great way to get you started back on the savings pathway. At some point, however, you’ll likely want to either add funds or boost your regular investment total to start amassing capital.

Source: Mutual Funds With Low Minimums Can Put Investors Back on the Winning Path

Editor’s Note: This is the first installment of a new series that will explore sound strategies for investing during the ongoing financial crisis.