Don't avoid investment risk. Control it.
If you want a portfolio that does more than just hold it's own, you're going to need to take on investment risk. Here are tools to help you control investment risk.
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It's not enough to buy these stocks and bonds: You have to rebalance them periodically, say, two or four times a year. At the end of the period, if your stocks go up in value, you switch some of the money to bonds to get back to your original stock-bond split. And if your large-company stocks outperform your international holdings, move money to get back to your original allocation. This discipline forces investors to buy stocks when they're low and sell them when they're high.Skip to next paragraph
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This classic approach to investing, known as modern portfolio theory, has many detractors. Diversification didn't work during the 2008 panic since almost all stocks fell sharply. And those long-term steady returns from stocks turn out to be the average of two highly different periods, says Ed Easterling, author of "Probable Outcomes" and founder of Crestmont Holdings, an investment management and research firm in Oregon.
If you invested when stocks were undervalued, such as the early '80s, your portfolio did much better than the 10 percent or so annual average. If you invested when stocks were overvalued, it took years and sometimes decades to approach that return.
But the bigger danger may be letting the fear of risk keep you from investing in stocks at all. With a diversified stock and bond portfolio – rebalanced once a year and with the stock portion allocated among mutual funds invested in small and large US companies, overseas firms in developed and emerging markets, US real estate, and commodities – you would have done fairly well since 2000, Roy calculates. It didn't matter whether you were aggressive (85 percent in stocks) or conservative (37 percent in stocks), your returns would have averaged anywhere from 5 percent to 6.1 percent a year, according to Roy's calculations, far better than the 0.5 percent from the S&P and with less risk.
So $100,000, invested in the aggressive portfolio in 2000, would be worth $180,000 by the end of 2011; the conservative portfolio, $203,500.
Not bad for a lost decade.