A Broker Nightmare? An Educated Investor

I'm sure you've heard the talking heads telling investors "diversification failed" and "buy and hold doesn't work." But here's a scenario you won't hear from them, or from your broker. Say you invested $10,000 at the peak of the market on Oct. 1, 2007, putting 60% in a globally diversified portfolio of low-cost index stock funds and 40% in a low-cost, short term-bond fund that tracked the Barclays Capital U.S. Aggregate index. Your timing couldn't have been worse. The Dow closed at a record 14,087.%%DynaPub-Enhancement class="enhancement contentType-HTML Content fragmentId-1 payloadId-61603 alignment-right size-small"%% Let's say when the market tanked, you didn't panic. In fact, you did nothing. Your holdings are the same today. Your $10,000 would now be worth about $9,000. Actual returns would vary depending on the index funds selected.

Consider Resetting Investment Goals

Now compare those results with your portfolio returns. I bet the portfolio returns don't compare favorably.

Many investors are now doing year-end planning. Their brokers are typically engaging them in discussions about "best stock picks for 2010," which fund managers are likely to outperform in the future and whether the markets will take off or tank.

Here's the question they should be asking: What are your investment goals? Forget all the talk about stocks having superior returns over the long term. 2008 taught us some painful lessons about the bilateral direction of the stock market. For retirees and those planning for retirement, consider resetting your goal to simply keep pace with inflation. If that's your goal, you may be able to accomplish it with relatively little risk.

Don't Forget 2008

A globally diversified portfolio of 85% bond index funds and only 15% stock-index funds had annualized returns of about 4% for the decade ending in 2008 -- and that was one of the worst decades in stock market history. In 2008, this portfolio lost only 2.62%.

Compare these returns to a riskier portfolio of 60% stocks and 40% bonds, invested the same way. It had annualized returns of 4.75% for the same time period. But in 2008, this portfolio lost 23.03%!

A sum of $10,000 invested in the more conservative portfolio was worth $14,895 at the end of the decade compared to $15,914 in the riskier portfolio. Keep in mind that, while the conservative portfolio exceeded the historical rate of inflation of 3.3%, it might not provide sufficient returns to permit investors to enjoy a higher standard of living over time.

Be Wary Of the 'Market-Beating' Broker

Every investor has to understand their goals and determine whether the increased downside risk of a more aggressive exposure is worth the upside. Instead of conversations with your broker focusing on market predictions, stock picking, market timing, and manager picking, this is the kind of data every investor should know.

It won't happen. Why? Because an educated investor would not use a "market-beating" broker or adviser.
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