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Is Your Portfolio Safe?

Unless your returns are outpacing Warren Buffett's, you're probably a bit concerned about the future of your invested capital right now.

But what if I put the above question another way: Is your portfolio diversified? According to a recent poll by Bankrate, 45% of Americans aren't sure.

It's a crucial question to know the answer to, because as stock market scholar Roger Ibbotson affirmed in a recent Rule Your Retirement interview, "Your asset allocation pretty much explains all of your [portfolio's] performance."

So with a diversified portfolio singularly determining whether you'll have a worry-free retirement, the stakes are high.

An ancient teaching's new guise
The idea of spreading one's savings across a variety of opportunities is not a new one. As the oft-quoted axiom of yore puts it, "Let every man divide his money into three parts, and invest a third in land, a third in business, and a third let him keep in reserve." Those words come from the Talmud -- the written collection of oral rabbinic interpretations of Mosaic Law.

Today, the topic of diversifying funds relates more to finding one's ideal ratio of stocks to bonds, but the wisdom is still present.

Why is this a good thing, you ask?

Simple. It keeps the riskiness of your portfolio -- and your emotions -- in check.

Are you saying I'm too emotional?
An asset-allocation plan not only keeps your money secure but also keeps you sane during times when the stock market is not so hot.

Let's face it, if your portfolio lost half its value in one day, your first response might not be self-mutilation, but your emotions would likely lead you to make some irrational decisions, such as selling when these stocks are down.

Only a smart asset allocation plan can prevent panic.

No mutiny on this bounty
If decreased risk and less stress are not enough to convince you of the merits of possessing an asset allocation plan, look at this chart showing the returns of several asset classes over the past 30 years:

Large-Cap Stocks

Small-Cap Stocks

REITs

International Stocks

Intermediate Bonds

Annualized return 1976-2006

12.8%

17.5%

16.5%

12.5%

8.2%

Large- and small-cap and bond data from Ibbotson Associates; REIT data from the NAREIT Index; international data from the EAFE Index.

So, say you spent the past 30 years invested in an S&P 500 index. Your money would have been spread among powerhouse stocks that whole time; today, that list includes AT&T (NYSE: T  ) , Citigroup (NYSE: C  ) , Procter & Gamble (NYSE: PG  ) , Chevron (NYSE: CVX  ) , American International Group (NYSE: AIG  ) , and Pfizer (NYSE: PFE  ) .

But if that were the case, you'd have missed out on the more impressive gains present in the world of small caps and real estate.

So if you're not the world's best stock picker, it makes the most sense to have your money divvied up among a variety of companies and asset classes, so that when some take one step back, there are others taking a few steps forward.

Yet the greatest hazard is to risk nothing
To learn more about implementing an appropriate asset-allocation plan for yourself, as well as to take a look at some model portfolio allocations, click here to browse through the wisdom of my Foolish colleague, Robert Brokamp, in his Rule Your Retirement service, free for the next 30 days. There's no obligation to subscribe.

This article was first published Nov. 19, 2007. It has been updated.

Fool analyst Adam J. Wiederman is not too emotional, but he's reportedly been seen crying during a chick flick. He owns no shares of any company mentioned above. Pfizer is an Inside Value recommendation. The Fool's disclosure policy is, for the record, diversified.


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