Your retirement, your responsibility: how to build and manage your mutual fund portfolio.

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WHEN IT COMES TO YOUR FINANCIAL future, here's the deal: You're on your own. Pensions are going the way of the petticoat, Social Security is looking more rickety by the day. Our healthcare system is being held together by chewing gum and chicken wire. In today's environment, you must be a realist and admit that you're going to have to create your family's financial security all by your lonesome.

In a way, this realization can be pretty empowering. But the freedom to design your own future means you're going to have to become a much more sophisticated investor. You can't just leave it to your pension manager, and you certainly can't trust the government to fill Social Security's coffers.

"These days, you have to take care of yourself," says Janice Overton, a financial planner with Total Retirement Consultants in Nashville, Tennessee. "For most investors, mutual funds are one of the best ways to build wealth. Unless you have the money to pick a wide selection of individual stocks, mutual funds are the best way to diversify."

You don't have to tell Lee Blue. The Houstonian, a senior project manager in the healthcare industry, hasn't done anything earth-shattering in building his portfolio. He and his wife, Stephanie, 44, an elementary school teacher--self-professed "DINKs," a couple with double income and no kids--have simply been putting away cash into mutual funds for years. Nothing fancy, just a selection of Fidelity offerings he compiled, now standing at five funds, spread across his 401(k) and IRA. Blue, 43, looks for funds with solid historical performance and low fees and owns a blend of different market niches like small-cap and large-cap companies, along with a 12% smattering of bonds. A couple of his biggest holdings: Fidelity Equity Income II (FEQTX), up 7.6% through the end of June, and Fidelity Value (FDVLX), up 11.4% over the same time period. Both have an expense ratio of 0.66%.

The result of his slow-and-steady fund philosophy? Blue and his wife may not yet be Bill and Melinda Gates, but with their combined annual income of $195,000, they've already amassed a war chest of more than $800,000 in mutual funds, almost all in tax-deferred retirement accounts, with another $225,000 in CDs. "Mutual funds have helped give us a real sense of security," says Blue, who started his investment journey back in his early 20s. "So much so that now we're planning to get out and retire early, maybe in our early 50s. I'd like to do some teaching about business or computers, which I've always dreamed about. And my wife's a musician, so she'll be able to travel and play different venues around the world." Adds Stephanie: "I was taught to save at an early age. As a musician, I was able to play to make money and I was taught to give 10% to the church and save the rest." So get a plan, stick with it, start early, and use mutual funds to reach your goals.

But whether you're a beginner driving down this road to financial security, or a longtime veteran on this journey, you're still going to need a map. That's why we talked to a mix of financial planners, mutual fund experts, and real-life investors to compile the best tips in assembling, managing, and analyzing your portfolio.

JOB ONE: HOW TO GET STARTED

So where to begin? Just like patients who each get a different prescription, your fund strategy must be tailored to you.

But if you're fairly new to the fund game, there are a few basic ways to get your financial foot in the door, say experts. Index funds are your probable jumping-off point. "They're broadly diversified, they're cheap, and you don't have to worry about whether the person running the fund is brilliant or terrible," says Todd Trubey, a senior fund analyst at Chicago-based research firm Morningstar. That's because index funds own shares of every company that's represented in a particular index, with the aim of matching the performance of that slice of the market. And because there isn't a pricey team of stock pickers at work, management costs tend to be very low. For example, buying into Vanguard Total Stock Market (VTSMX)--which tracks the MSCI U.S. Broad Market Index--buys you every listed company in the U.S., charges a rock-bottom expense ratio of 0.19%, and has a five-year annualized return of 13.3%.

And because there are index funds for every imaginable market niche, getting proper diversification is easy. "For new investors, I like to recommend a total-market index fund, a fixed-income (bonds) index fund, an international index fund, and a real estate investment trust (REIT) index fund," says Kim Need, principal at Chevy Chase, Maryland-based Allison Brentwood Financial Planning. "That covers the whole spectrum of diversification."

Of course, you can shave costs even more by opting for exchange-traded funds, an increasingly popular option that, like an index fund, tracks a market index but can be traded intra-day like a stock. Witness that Vanguard's ETF version of its total stock market offering--Total Stock Market ETF (VTI)--takes even less of your money for operational expenses, just 0.07%, and sports a five-year annualized return of 13.4%.

Whatever funds you choose to get you started, make sure they're no-load. That means your investment management firm isn't taking a sales commission--known as a load--tight off the top or out of the back end. Instead, the firm is investing every dollar you give it, which is as it should be. "[Do-it-yourselfers should] never buy a load fund on their own," cautions Morningstar's Trubey.

MASTER CLASS: GETTING TO THE NEXT LEVEL

More sophisticated investors will likely want to take their game up a notch. Instead of index funds, you might want to try your hand at picking actively managed funds, which could outpace the returns of the general market. (However, keep in mind that historically, most index funds actually beat their stock-picking peers).

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Ensure proper diversification in your fund menu, That likely means a mix of a large-cap domestic equity fund (meaning it's comprised of companies worth more than $10 billion); a small-or mid-cap domestic equity fund; a diversified international fund; a core bond fund; and perhaps a dash of emerging-markets equities and real estate investment trusts (REITs), for a little extra flavor, That kind of broad-based portfolio is more likely to cushion any sudden falls in a particular region or sector. While investors who hold diversified portfolios weren't immune from this summer's highly volatile stock market, not having all of their money in equities likely helped them sleep a bit more soundly, "I don't watch the market every day because I'm a consistent investor for the long term," says Lee.

So how do you pick the right fund for you? The standard path for investors is to call up a fund's star rating at Morningstar.com. A four- or five-star rating means it has provided the best balance of risk and return within its category: three stars means it's an average performer; and one or two stars indicates that it's been a dog. While that reveals past performance, not future, it's still a great gauge of whether a fund is generally on the right track. "Don't look just at its one-year return," cautions financial planner Reed. "I look for four- or five-star funds, at their three- or five-year return, and nothing with more than a 1% expense ratio," While a fund's star rating can be used to help focus your search, by no means should it be the sole criterion for investing.

Other hallmarks of a worthy fund include low turnover (how often the manager buys and sells securities, which tends to eat up returns), solid tax efficiency, and lengthy manager tenure, factors that helped us compile our list of 100 top funds (see "The Money-wise 100," this issue). For each fund category, we screened for turnover rates that were less than the category average. Generally, a high turnover rate is more than 100%, while a low turnover rate would be less than 30%, According to Morningstar, the average annual turnover rate for domestic stock funds is about 85%.

With respect to management: "I look for managers who have been there five years or more," says Overton, "who have performed well in both bull and bear markets in comparison to other managers in their category, and who have shown a consistent investment strategy."

Once you've stepped up your investing and are choosing actively managed funds, then it's time to pay more attention to management fees, Expect higher expense ratios than with index funds, because plenty of research goes into stock picking, and superstar fund managers tend to command hefty salaries. But if expense ratios get too high, be aware that the tiny percentage is going to chew away at your retirement assets. As a general rule, says Trubey, anything above 1.25% should raise red flags, "I have a hard time paying any more than that," he says. "And if a fund charges 1.5% and up, you need a really great reason to invest."

You should also make sure you're not doubling up on your investments by choosing mutual funds that have similar companies peppered throughout their holdings. A simple way to check up on that: Morningstar's Instant X-Ray tool, which lets you input all your funds and churn out an immediate analysis that includes an overlap report. "Investors think the more funds they have, the more diversified they are," says Reed. "But there can be a whole lot of redundancy in mutual funds."

BALANCING ACT: KEEPING THE FUND NIX RIGHT

Now you've made your fund picks, but you're not done--not by any stretch. How often should you keep tabs on your portfolio First, resist the temptation to toy with your holdings too much. Remember that your finish line is likely decades off, so what the market does on any given day or week doesn't matter a whole lot. So as you see reports of dramatic triple-digit swings in the Dow Jones industrial average, certainly take note. But don't lose sight of your long-term perspective. Plus, if you're obsessively selling or buying funds, transaction fees and capital-gains taxes are going to eat away at your returns. For the long term, buy and hold should be your default philosophy.

That said, your portfolio is eventually going to get out of whack, and it pays to check in on it. Maybe one sector or asset class is outperforming all the others, and all of a sudden you're way too heavy in a particular area. So sit down occasionally and figure out if your portfolio needs rebalancing, says Trubey. Compare your current percentages with the investment game plan that you've drawn up, and if things are wildly off, then it's time to trim back on some investments or add to others.

For instance, if your target percentage of foreign stocks is 20%, and its share in your portfolio has risen to 22%, don't panic. But if it has shot up to 30%, then it could be time to act. Don't necessarily sell, since that carries tax and transaction-fee implications, but tweak your portfolio by slowing or stopping your contributions to international funds for a while, and shift that extra cash elsewhere. "Every year is a good rule of thumb for rebalancing," says Trubey. Don't wait more than 18 to 24 months.

Keep on top of your portfolio, and you could end up like Anthony Grissett. Grissett, the owner/operator of five McDonald's franchises in Arlington, Texas, is only 49 and says he's already financially able to retire. And though he and his wife, Arminda, have a trusted financial planner, he enjoys the challenge of picking mutual funds himself. Two of his picks carry Morning-star's five-star rating: Excelsior Value & Restructuring (UMBIX), which ranks at the top of the large-value fund category with a five-year annualized return of 18.7%, and Janus Twenty (JAVLX), which offered investors a five-year annualized return of 16.4% but is closed to new investors.

As a whole, Grissett's portfolio carries a heavy weighting in real estate because he likes its relative stability. He also maintains a larger cash position than most investors because in his buisness, opportunities can arise quickly and he needs to abe able to act.

But when it comes to mutual funds, Grissett is such a believer that he has already opened Roth IRAs for his three kids-Austin, 17, Alena, 15, and Alex, 9--to teach them about investing and the importance of starting early. "I think investing is pretty simple, actually," laughs Grissett. "Put aside 10% of your money for God, 10% for yourself, and learn how to identify mutual funds with a great track record. Consistently do that, and you just can't lose."

Sites to Behold

Vowing to brush up on your mutual fund knowledge is one thing. But which Websites will actually make you a better investor and help put your plans into action? We asked our financial planners and fund experts for a few of their favorite haunts on the Web. Without further ado:

* Morningstar (www.morningstar.com) The go-to site for fund information. Much of its content is free to the public, but premium membership gets you access to all analyst picks and reports. Best feature: the Instant X-Ray tool that gives you an analysis of your varied holdings.

* Google Finance (www.google.com/finance) Easily navigable roundup of market movements, financial news, videos, and stock and sector breakdowns.

* BigCharts (http://bigcharts.marketwatch.com) It's predictably strong on its visual tools for evaluating a security's volatility. Neat function: historical quotes, which let you research and chart closing prices from the past.

* Yahoo! Finance Mutual Funds Center (http://finance. yahoo.com/funds) Terrific introductory info on how to choose a mutual fund. It details how to gauge fees and expenses, how to analyze funds and evaluate performance, and how to screen for top picks.

* RiskGrades (www.riskgrades.com) Free site that helps you assess the risks of your individual securities or your overall portfolio, with a customized report from its Risk Analyzer function.

* Financial Industry Regulatory Authority (www.finra.org) The NASD regulates securities firms, and its site furnishes valuable consumer info like fraud alerts. Best of all, its BrokerCheck service lets you research the background of potential securities firms and brokers--a must.

7 Common Mistakes to Avoid

1 Sitting on the sidelines: The stock market can be intimidating to new investors but don't let anxiety over making a mistake paralyze you, The sooner you're in the market, the more you'll benefit from compounding--earning interest on interest. If your company matches contributions to employee 401(k) plans, though you should try to maxim-size your contributions, at a minimum you should have enough income withheld to obtain the match,

2 Lacking a plan: As much as you don't want your money to be tied up in too few investments, you also don't want your money to De spread across too many. It's a mistake to think that each additional stock or fund in your portfolio will somehow lessen your overall risk,

3 Not thinking long term: This summer's uncertainty over how the subprime lending crisis is going to play out led some investors to panic. But making any changes to your investments based on a Short-term slump--or spike--in the market may be detrimental. As an investor, remember tomorrow's another day,

4 Failing to review expenses: There are thousands of mutual funds so you don't want to chase the performance of the hot fund of the moment and leave it at that When looking at a fund, be sure to scrutinize whether there's a sales charge and how its expense ratio compares to funds with a comparable performance record.

5 Ignoring management changes: Part of the appeal of mutual funds is the investing expertise that their managers bring to the table. But fund managers come and go, Be sure to take a look at an y fund literature you receive and keep an eye out for manager changes or changes in the investing sty e that might not fit with your overall goals.

6 Being passive. You'll want to review your portfolio at least once a year and determine if you need to make any changes to your asset allocation. i.e., mix of stocks. bonds, and other instruments, Also, be sure to scrutinize the holdings of your entire mutual fund portfolio to avoid an unintended duplication in your investments.

7 Taking en too much: Don't be afraid to ask for help when it comes to investing, While everyone should have at least a general understanding of their investment options, it clearly takes a time commitment to manage a portfolio effectively. One investment that could produce a meaningful return is hiring a financial planner, if even just for a periodic consultation.--Trevor Delaney

Blue Portfolio Analysis

46.4%   Domestic Stocks
26.8%   Cash
15.3%   Foreign Stocks
11.5%   Bonds

Grissett Portfolio Analysis

48.0%   Real Estate
32.0%   Stocks
19.7%   Cash
0.3%   Bonds