But what do you do if you're just getting started and have only a few hundred, a thousand or maybe a few thousand dollars to launch your assault on the capital markets? Fear not! The range of low-cost mutual funds and other instruments available to you has exploded in recent years, and I'm going to give you a step-by-step guide to building a smart, secure and properly diversified portfolio. This strategy works for building a portfolio with any amount of money, and it's great for those starting small.

Investing on a shoestring

So let's say you get a $100 tax refund and want to start investing. The simplest course is to open an individual retirement account at any of the big discount brokers and commit to investing $50 or $100 a month in a mutual fund. The hard part is deciding which of more than 8,000 funds is worthy of your money and will be adequately diversified. I have nothing to recommend for this approach, because I haven't yet found any no-load funds that include significant allocations to commodities and real estate. Nor do many fund managers follow the kind of consistent discipline that Gibson's data would support.

The alternative -- and the course I recommend and follow personally -- is building your own portfolio with exchange-traded funds, or ETFs. These are instruments that trade like stocks and mimic the behavior of a variety of different types of assets (stocks, bonds, real estate or commodities) and are typically designed to track an index, such as the S & P 500, iShares MSCI EAFE Index (EFA) or Russell 2000 Index ($RUT.X).

In order to make this approach work for the small-dollar investor, it's vital to keep transaction costs as low as possible. I've found only two brokers that have no minimum account size and charge only a small commission for each security purchased: ShareBuilder, at $4 per trade, and Zecco, at $4.50. It's worth noting that ShareBuilder charges $9.95 to sell shares, while Zecco sticks with its $4.50 pricing for all trades. (And once your account value reaches $25,000 -- and it will get there if you stick with it -- Zecco will give you 10 free trades a month.)

In order to minimize your trading costs, you'll want to rotate your initial purchases among the following ETFs, which invest broadly in each of five major asset classes:

  • Rydex S&P Equal Weight (RSP), which invests equal sums in the stocks of the 500 companies in the S & P 500.
  • Vanguard FTSE All World ex-US (VEU), which tracks an index of more than 2,200 companies in 46 countries outside the United States.
  • Vanguard Total Bond Market (BND), which tracks the price and yield performance of the total U.S. market for corporate and government bonds.
  • Vanguard REIT Index (VNQ), which tracks an index that represents about two-thirds of the value of the U.S. real-estate investment trust market.
  • PowerShares Deutsche Bank Commodity (DBC), an index of futures contracts for the 14 most heavily traded commodities in the world, including energy, metals and agricultural products.

If you're able to invest only $100 a month, it would be wise to make a single quarterly purchase of $300, rather than monthly purchases, so that your trading costs take only about 1.3% of your investment dollars, rather than 4%.

Regardless of how you do it, though, it won't take long to build a portfolio that will ride out the market's ups and downs a lot more smoothly than most.

Rebalance yearly

As time goes on, you'll find that some of your investments have grown in value while others have lost money or stayed about the same.

For this simplified example, let's suppose that by the end of the first year you've invested a total of $1,000, putting $200 in each ETF. To keep things simple, let's say your U.S. stock holdings have increased 30% in value, while your foreign stocks have declined 5%. There, on the bottom line, is a $50 profit! Your portfolio is now worth $1,050 and looks like this:

 
Exchange-traded fundValue after 1 year% of portfolio
Rydex S&P Equal Weight (RSP)$26025%
Vanguard FTSE All World ex-US (VEU)$19018%
Vanguard Total Bond Market (BND)$20019%
Vanguard REIT Index (VNQ)$20019%
PowerShares Deutsche Bank Commodity (DBC)$20019%
Total value$1,050100%

But now you've got more than your target of 20% in U.S. stocks and less than 20% in the other asset classes. To restore your portfolio to its target percentages, you'll need to sell $40 worth of RSP and buy more of the ETFs that have performed less well to bring them up to 20%, or $210 each. (This isn't as dumb as it seems at first blush: It disciplines you to buy more when prices for an asset class are low.)

A typical real-world allocation would be something like the one I use: 20% U.S. stocks, 22% non-U.S. stocks, 30% bonds, 17% real estate and 11% commodities. A younger investor with a higher risk tolerance might want to reduce the bond component to 10%, while a retired person with lower risk tolerance might want to raise the bond allocation as high as 50%. Bonds tend to reduce the overall volatility of a portfolio and mitigate risk, which is especially important for retirees.

Once you've established your target allocations, stick to them. Succumbing to the temptation to guess what the next hot asset class will be is your surest ticket to mediocre returns. And keep investing through the down markets, especially, because that's when your discipline will pay off with higher returns down the road.