All cashed up and ready to grow

NEW YORK (Money) -- Question: I'm 24 years old and have about $65,000 in an Internet savings account and about $25,000 in mutual funds. Do you think I should dump everything I have in savings into mutual funds for maximum growth? -Nick, New York

Answer: I find that in most financial situations - not to mention other aspects of life - "digital decisions" usually aren't very good ones. What do I mean by digital decisions? I mean ones that see the alternatives in black and white and allow for no shades of gray, like choosing to put all of your money in stocks and none in bonds (or vice versa) or converting your entire your IRA or 401(k) balance to a Roth.

So while I think that you're right that at your age you've probably got too much tied up in a savings account and that you should be thinking of investments that can provide better long-term growth potential, I think there's a better way to go about it.

So before you "dump everything" (or anything for that matter), I suggest you ask yourself the following three questions, and then let your answers guide you in re-jiggering your investments.

Even the most growth-oriented investors need at least some cash on hand in a savings account, money-market fund or short-term CDs. Otherwise, if you need some dough to get you through a bout of unemployment or to fund unanticipated expenses, you might have to sell off investments at an inopportune time.

Most pros generally recommend that you keep three to six months' worth of living expenses in a money fund or savings account as a cushion for emergencies. I think that advice is sound, but you should also consider whether you might have other needs in the near future that would require a larger reserve.

Are you planning to buy a car or make a down payment on a house anytime within the next few years? If that's likely - or if you think you might have to make other large payments that you can't fund out of your paycheck - then you'll want to factor these extra needs into your estimate of what size cash cushion you require.

You can then keep that estimate - $15,000, $20,000, whatever it is - in your savings account. Your answers to the next two questions will help you figure out how to invest the rest.

I agree that younger investors should generally be focused on making their money grow over the long-term. But when I hear someone say they want "maximum growth," I begin to worry.

Why? Well, frankly it's one of those phrases that people toss off with great confidence when the markets are doing well and cruising to new highs. But shooting for maximum growth also means having to periodically go through some gut-wrenching downturns. We haven't had a really severe meltdown for more than five years. You were only 19 and probably don't remember it.

But even if you do, it's quite another thing to experience one, to see your portfolio's value decline by 50 percent in a matter of months. Suddenly, even the most ardent growth seekers, people who say they have nerves of steel when it comes to risk, begin to second guess themselves - and often end up selling at the bottom and locking in losses. So you want to be realistic in how you create a mutual fund portfolio.

Some people say that it's fine for someone your age to stick 100 percent of his money in stocks. After all, history shows that stocks provide the highest returns and the most growth over long periods of time. And at your age you've got plenty of time to recover from market slides.

But the "let it all ride on the stock market" approach is too digital for me. Maybe at heart, I'm just more of an analog guy, but I think even young investors need to hedge their bets a little bit. Maybe stocks won't do as well as they did in the past. Maybe stocks will hold up fine over the long term, but you won't hold up so well during a big market meltdown if all your money is in stocks. Having a bit in bonds may make it easier for you to weather difficult periods in the market, and make it more likely you'll hold onto the rest of your stock fund portfolio.

In any case, I think it's prudent to keep a bit in bonds, say, at least 10 percent - more if you get anxious when your portfolio's value takes a dip. For guidance on how to split your money between stocks and bonds, check out our Asset Allocator tool.

There's no shortage of mutual funds out there that will take your money. You have more than 6,500 choices (more if you count different share classes of the same funds). The trick is finding ones that are likely to deliver superior, or at least solid, gains over the long-term.

I'll be the first to admit it's virtually impossible to pick the "best" funds. Indeed, that's not even much of a standard since what's best for one person may not be best for another. But there are several ways you can increase your chances of choosing funds that give you a decent shot at above-average gains.

The first is to be disciplined and systematic about the way you choose funds. You can start by looking for funds with low fees, then move on to ones with solid performance over a variety of time periods and then check to make sure those gains are in line with the risks the fund takes. You can do this sort of research at our Fund Screener tool.

But you probably need to delve deeper still. You want to be sure the manager now at the helm is the one responsible for the performance you're so impressed with. And you want a fund that treats its shareholders fairly as well. By checking around at sites that cover mutual funds - Morningstar's site, the funds section of our site, for example - you can suss out funds that possess these qualities. But you've got to be willing to put a bit of work into it.

If you prefer an easier route, you can start your search at a pre-screened list of funds. Normally, I'm wary of doing that, but in this case I happen to have some inside knowledge of how one such list was created that makes me confident of its recommendations. I'm talking about MONEY Magazine's Money 70 list, which provides a roster of funds in virtually every category you need to build a diversified portfolio. I'm not saying you should pluck funds from the list willy nilly. But it's an excellent place to start with a list of candidates on which you can do some more research.

If you want to make things even easier on yourself, you can do one of two things. You can stick to the index funds on the MONEY 70. Since these funds invest in and then track well-known market benchmarks, you know exactly what you're getting, and you don't have to worry about a manager screwing up or leaving to go to another fund. You'll also get incredibly low fees to boot.

Or you can invest in one of the target-date retirement funds. You just pick the fund with a date that roughly matches the year you plan to retire, and you get a diversified portfolio of stocks and bonds appropriate for someone your age. As you age, the fund's mix shifts more into bonds, so that the fund's value becomes less volatile as you near retirement, which makes sense since you probably prefer to avoid big hits to the value of your investments later in life. (For more on how these funds work, click here.)

So get out of that digital mind set you're in and start thinking in a more nuanced way about your finances. That may mean taking a bit more time before making a move. But, hey, better to spend some time thinking things through and looking for potential pitfalls and problems ahead of time than charging ahead and spending the time regretting a hasty decision afterwards.