by Archie M. Richards, Jr.
April 30, 2007

The American Institute for Economic Research (AIER), a group I much admire, now believes that a U.S. recession is likely. Leading economic indicators stand at levels that preceded prior recessions. "A contraction of general business activity," AIER says, "is more probable than continued expansion."

A recession is an economic downturn significant enough, based on employment data and other indicators, to be declared a recession by the National Bureau of Economic Research (NBER).

AIER's prediction does not mean that stocks should be sold. The prediction may be wrong. I don't expect the recession to continue for long, nor do I expect stock prices to fall far. Indeed, they fell last February, perhaps in anticipation of a recession. By year end, the market should be higher than it is now.

There's a lag between an economic trend and the time the government issues statistics about it. In some years, NBER doesn't identify a recession until the economy has again turned up. Hang in there.

Norman has a problem. He has made a hobby of his investments, causing difficulties.

He holds 20 no-load mutual funds. To explain why, he writes, "I study various funds prospectuses and get excited about some of them. I try to diversify to different types of stocks. But sometimes I find three funds of the same type and buy them all because I can't decide which is best. Maybe I need a new reading hobby."

You got it right, Norman. When you can't decide between three similar investments, pick one by flipping a coin.

As you suspect, having many mutual funds of the same type is phony diversification. All of them would own about the same stocks, moving up and down roughly together.

Readers who hold load funds (the ones sold by brokers) should be aware that some brokers talk a good line about diversification. But their real purpose is to increase their income. Load funds have "break points," meaning that the more invested in the fund, the lower the percentage of commissions. Usually the first breakpoint is $25,000. By keeping the investments in each fund below this number, the broker's income is maximized.

For genuine (SET ITAL) double (END ITAL) diversity, a person must hold different classes of stocks - different types of investments whose price trends don't correlate.

For each class, use an index fund or ETF, each of which holds virtually all of the stocks of a particular group. This enables annual rebalancing. With 20 funds, rebalancing is impossible.

But rebalancing is essential. You're shaving off some of the investment classes that have performed unusually well and buying those that are weak. In effect, you're selling high and buying low.

For his IRA, Norman wants to adopt the allocation of investments recommended in archierichards.com. He plans to sell his mutual funds and acquire the exchange-traded funds I recommend.

Norman's IRA is held by a large mutual fund family - we'll call it Jones. The IRA holds mutual funds from companies other than Jones. The trouble is, Jones charges $70 for each purchase or sale of all non-Jones funds. When selling his mutual funds to acquire ETFs, Norman is stuck with paying these costs.

Norman's hobby led him to acquire too many mutual funds. After he acquires the 9 ETFs I recommend, he may have another problem: He may not be able to leave the portfolio alone. With investing his hobby, he'll want to fiddle with it.

It's not that my recommendations are perfect; surely they aren't. But you're better off to adopt an investment program that's pretty good and (SET ITAL) let it alone. (END ITAL) Let the market do the work. The more you try to perfect an investment approach, the worse the results will be. The more investment decisions you make, the more likely you'll be wrong.

If Norman can't find another hobby, he should take 5 percent of his portfolio and trade it for all it's worth. Except for rebalancing, he should let the rest of it alone.