No. of Recommendations: 0
I'm approaching retirement and have spent untold hours working on the asset allocation question. Most "experts" advise us to diversify our holdings and rebalance periodically to maintain that mix of assets. What they don't tell us is the appropriate way to diversify. Most often you're told to have a mix of an S&P500 Index Fund, some Mid/Small Cap exposure and some International to boot. Then add a bunch of bonds until you're not scared to go to sleep at night.

Unfortunately the above doesn't really diversify, it just lowers volatility. Said another way, the returns on all the stock investments above are highly correlated, meaning that they move in the same direction. The only difference is how fast they move. What you need to do to get true diversification is to find some assets that are either not correlated or are negatively correlated with stocks. These could be commodities, REITs, utilities, etc. Interestingly, you can also get there by a careful selection of individual stocks, but only if you're comfortable with doing the homework on those.

There's a new book out by Ben Stein & Phil DeMuth that explains all this in an easy-to-follow way. It also references some software that can facilitate the process. I just read the book and tested the software and would recommend both highly.

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