Best way to invest $1,000 right now

By Harry Domash

So you want to start investing, but you have only $1,000?

Don't even think about individual stocks. Even great stock pickers come up with their shares of duds. You need to own at least 10 stocks to keep one clunker from sinking your portfolio returns. You can't do that with $1,000.

Your best approach is to put that $1,000 into an old-fashioned managed mutual fund. Yes, I know, traditional mutual funds won't give you much to talk about in the locker room. They are nowhere near as fashionable as the new kids on the block, exchange-traded funds, or ETFs. But mutual funds are better suited to your needs.

Most ETFs track indexes that reflect the action of a particular market segment, such as biotechnology or energy stocks. So to make money with ETFs, you have to successfully predict which industries or market sectors are going to outperform over your investment horizon -- say, the next 12 months. That's a tall order even for an experienced investor.

It makes more sense to hire a qualified mutual fund manager. Pros have better access to information, and many have teams of analysts to help with the task.

Picking the best manager

Of course, not all mutual funds are created equal. Many underperform. The trick is to find a fund manager with a long track record of beating the market.

But high returns by themselves won't cut it. Here's why:

Even the best funds have good years and bad years. Say you put your $1,000 into a volatile fund and that fund hits a dry spell. You watch your $1,000 shrink to $900, then to $800 and so on. If you're like most investors, you'll bail out before the fund turns around. Thus a track record of low volatility is just as important as overall returns.

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Here's a strategy I devised using Morningstar's free fund screener to spot funds that have that magic combination of market-beating returns and low volatility, and welcome small investors.

With a few modifications, you can use other online tools, of course.

Start by selecting "domestic stock" from the "fund group" drop-down menu. If you prefer to focus on international funds, select "international stock" instead.

Screening parameter: Fund group = domestic stock.

Suitable for small investors?

Next we'll limit the field to funds that accept small investors.

Because the bookkeeping and customer-support costs are basically the same regardless of account size, many funds establish relatively high minimum opening balances to avoid dealing with small investors. This screening parameter rules out funds that won't accept $1,000 initial investments (after that, you can usually add to your holdings in smaller increments). If you have more to invest, select a value from the drop-down menu that suits your needs.

Screening parameter: Minimum initial purchase less than or equal to $1,000.

Don't pay loads

Many fund operators rely on financial advisers and stockbrokers to market their funds. They collect fees, called loads, to compensate advisers or brokers for recommending their funds. Front loads are paid when you purchase a fund, while deferred loads are paid when you sell. Most load funds charge one or the other, not both.

Loads are simply marketing expenses. The money doesn't go to hiring smarter analysts or to buying better computers. The loads reduce your returns, and there is no point in paying them if you're picking funds on your own.

Screening parameter: Load funds = no-load funds only.

Go with the best stock pickers

Some fund managers are better stock pickers than others. Although this is a controversial topic, I've found that, assuming the same manager is at ­the helm, a fund with a strong historical track record is likely to outperform funds that have lagged the market, at least over the next year or so.

Of course, a manager who has consistently outperformed through all sorts of market conditions is a better bet than a newcomer who might have had a good year simply because he or she got lucky and picked a few good stocks.

To find those long-term outperformers, I require that passing funds must have recorded average annual returns at least equal to the Standard & Poor's 500 Index ($INX) over the past one, three and five years.

Screening parameter: 1-year return greater than or equal to S&P 500.

Screening parameter: 3-year return greater than or equal to S&P 500.

Screening parameter: 5-year return greater than or equal to S&P 500.

Continued: It's about more than returns

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