The first thing to master is the 'style box', or the Morningstar style box. This is a graphical representation of a fund's 'style' as defined by Morningstar.com.

On the vertical axis is market capitalization, or "market cap". For funds, a "large cap" fund would be made up stocks of the largest companies (ATT, Exxon, GE), while a "small cap" fund is made up of stocks of smaller companies (Market Leader, TeeKay Tankers). In the middle is of course "mid cap" like BorgWarner and Joy Global.

On the horizontal access is "value" vs. "growth". In general, a "value" stock is priced lower than its intrinsic value. It might be a newcomer, or it might be beaten down by bad news or bad market conditions. Growth stocks tend to be more mature, and in many cases pay dividends.

"Hitting the four corners of the style box" is something I try to do both in domestic equities and foreign holdings. Investing in the S&P500 in a low cost index fund isn't a bad strategy, but it heavily skews your investing to "large blend". The more dynamic action in the market (more risk, more rewards) tends to be in the smaller cap and value corner.

By splitting the domestic equities into four distinct corners like these domestic equity ETFs:

• iShares Russell 1000 Growth Index (IWF)
• iShares Russell 1000 Value Index (IWD)
• iShares Russell 2000 Growth Index Fund (IWO)
• iShares Russell 2000 Value Index Fund (IWN)

A more refined view of the Morningstar style box includes a centroid (the weighted average of domestic holdings) and a "cloud" that represents the zone of 75% of the funds holdings. Attached is the centroid / zone view for IWC as of this writing:

IWC is tightly focused on micro-caps, and the graphic shows that pretty readily.

Proper asset allocation and diversification really comes into its own when coupled with proper rebalancing.

Index of investing articles