by Archie M. Richards, Jr., CFP^®
November 15, 2004

In his book "Investor Therapy," Dr. Richard Geist describes the characteristics needed to invest successfully in individual, small growth stocks. I presented those characteristics in my column dated 9/20/04 (see archierichards.com). But the talents Dr. Geist calls for are so broad and so profound that not many people possess them. Certainly I don't. I therefore describe here an investment style more appropriate for mere mortals:

Use index funds or exchange-traded funds (ETFs). Both hold securities that are included in a particular index. For example, Morgan Stanley has created an index of small-cap value stocks (small U.S. companies that have low prices in relation to the company's earnings and book value). The index is a hypothetical portfolio designed to parallel the performance of this particular kind of stock. As the stocks collectively rise or fall, the index goes higher or lower by the same percentage.

The Vanguard Small-Cap Value Index Fund buys and holds the very same stocks selected by Morgan Stanley for its index. As the index goes, so goes the Vanguard fund.

With no need for stock research, the fund's operating costs are low - only 0.27 percent a year. And since Morgan Stanley changes its selections infrequently, Vanguard does little buying and selling, keeping transaction costs and taxes low. All of Vanguard index funds have low costs.

I suggest nine index funds, providing double diversity. At one level, each fund holds hundreds of stocks. At the second level, holding nine of them provide exposure to many types of securities.

I recommend 30 percent in U.S. stocks (4 funds), 30 percent in foreign stocks (3 funds), 20 percent in real estate investment trusts (REITs) and 20 percent in long-term bonds. Here's the specific portfolio, all Vanguard index funds:

When one investment segment, such as stocks, is falling in value, others, like the REITs and the bonds, may be rising. The volatility of the whole is less than the average volatility of each component. This reduces anxiety and makes it easier to ride through unpleasant periods without selling. Yet the growth of the entire portfolio will be almost as good as that of the best performing group.

Vanguard funds (800-523-7731) require a starting minimum of $3,000. For IRAs, $1,000. To maintain the percentages shown above, a non-IRA portfolio must total $60,000. (The lowest percentage recommended above is 5 percent. 5 percent of $60,000 is Vanguard's minimum of $3,000.)

In an IRA, $20,000 would be the minimum total. If you're starting out with lesser amounts, you'd have to reduce the diversity and buy fewer funds.

Rebalance every year and a day. (To avoid high-taxed short-term gains, be sure to wait the extra day.) If a fund has gained more than 30 percent above the original percentage, sell enough to bring it back to the original. For example, if a fund that was originally 10 percent of the portfolio becomes 13.1 percent or more, sell enough to bring it back to 10 percent. If no fund has changed by more than 30 percent, leave them all alone.

Add the proceeds to the funds that are weakest. Broad investment sectors represented by indexes may stay weak for years, but they eventually rebound and they never fall to zero.

Rebalancing doesn't require judgment. It's an automatic method for selling high and buying low. Generally, the fewer investment judgments we make, the better. Except for rebalancing, just keep on holding (unless of course you need the money).

Remember, bear markets aren't your fault. If the business news becomes unbearable, switch off the tube. Do whatever you must to ride through difficult periods without selling.

You don't have to be a genius to be an investment success. Take advantage of double-diversity, rebalance annually, and hold. The wealth created by the people of the world will carry your portfolio higher. Give time for them to do the work.