Chapter 6. Your Ideal Portfolio

A workman who wants to do his work well must first sharpen his tools.

Confucius

Investors willing to give up chasing recent performance and trying to pick tomorrow's hottest managers can fall back on about 80 years of performance data. In this chapter we show how that data can be used to put together a world-class portfolio of low-cost mutual funds investing in asset classes that are likely to continue to outperform the Standard& Poor's 500 Index.

We recommend an investment program that is boringly predictable instead of dazzling and exciting. We call it n "Your Ideal Portfolio," and we'll show you in this and the following chapters how to put it together. My goal, in a nutshell, is to give investors a piece of the action along with peace of mind. What investors need most is a strategy with enough power in good times to generate positive returns, coupled with enough protection in bad times to keep those investors from bailing out in discouragement.

This chapter looks in detail at the nature of diversification, noting the difference between real diversification and mere window dressing. The latter, unfortunately, is much too common in 401(k) plans and in many mutual funds.

As a point of reference, we look at how the pension funds of large U.S. companies have traditionally invested most of their money. We measure this model in terms of its risk and returns. This model is typically allocated 60 percent to stocks and 40 percent to bonds. Its returns are strong ...

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