by Archie M. Richards, Jr., CFP^®
May 22, 2006

Mark writes "To take advantage of my company's 100-percent matching, I contribute 6 percent of my salary to a 401(k) plan. But I still have some disposable income to invest. I'm just a beginner. What do you suggest?

You're on your way to wealth, Mark. Way to go.

In this site, you might find the Suggested Portfolios and Selected Columns helpful. But if all that is too daunting, forget it. Here's why:

Many people don't view changes in their portfolio in terms of (SET ITAL) percentages (END ITAL) gained or lost. Unfortunately, they view the changes in terms of (SET ITAL) dollars (END ITAL) gained or lost. If the total portfolio is large, the dollar changes are substantial and the emotional reactions are intense. When stock prices rise, people feel optimistic and want to buy more. When the prices fall, they feel pessimistic and want to get out.

Buying high and selling low is not exactly the way to go. (Poet Laureate of the money world - that's me.)

My recommendations include nine mutual funds whose price trends differ from one another. The lack of correlation limits volatility, which keeps people from becoming over-optimistic and buying more when prices go up big. More importantly, it keeps people from selling in panic when prices go down big.

You don't say how much you plan to invest, Mark. If it's just a few thousand, limiting the volatility may be unnecessary, because the dollar changes would be modest and perhaps not stressful.

With $3,000 (Vanguard's minimum in non-IRA accounts), buy the Total Stock Market Index Fund. With at least $6,000, put half into the Total (SET ITAL) International (END ITAL) Stock Market Index Fund. As the funds grow, broaden the diversity.

With less than $3,000, deal with a broker to acquire one of the stock funds of my favorite family of load mutual funds - American Funds.

Herb writes, "I told my financial advisor that you recommend 60 percent stocks, 20 percent real estate investment trusts (REITs), and 20 percent bonds. He counts REITs as stocks and feels that your portfolio is, in effect, 80 percent stocks and 20 percent bonds. He considers this too aggressive and suggests a more conservative 60 percent stocks / 40 percent bonds.

REITs may technically be stocks, Herb, but they don't act like other stocks. Here's evidence:

• From 1998 to 2000, stocks went up big, while REITs went down.
• During the killer years from 2000 to 2003, stocks went down big. REITs went up modestly.
• From 2003 to the present, stocks went up modestly. REITs went up big.

In every period, REITs acted differently from stocks. That's exactly what you want: asset classes whose price trends don't match one another. This limits the volatility of the whole.

In effect, my allocations represent a 60/40 split, just as your advisor recommends. But my diversification includes more than just bonds. The broader the diversity, the better.

Vernon writes, "What have been the historical returns for the asset-allocation portfolio you recommend?"

That's a bigger undertaking than you may think, Vernon. Here's why:

• The analysis would have to show the exact number of shares acquired of each of the nine funds because of the reinvestments of dividends and capital gains.

• Rebalancing every year-and-a-day would be troublesome, especially since I call for rebalancing only when the portfolio percentages have changed by at least 30 percent from the intended percentages. (The spreadsheets in my Suggested Portfolios handle this.)

• The record would have to reflect the modest change in allocations I made in 2005, as described in my 11/28/05 column.

All of this would have to be tracked every year for each fund, with a summary for the entire portfolio - no small task. Vanguard could handle the job, but I'm not about to ask them (or pay them) to do it.

I can tell you this: Readers who have followed my suggestions and told me about the results are pleased. No complaints yet!