The Boring Old Trick That Makes You Money

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Want to know how to boost your portfolio's performance in challenging markets? I've got a couple things you'll want to hear about: asset allocation and diversification.

Yawn. Wake me up when it's over, will you?

Look, I know it sounds boring, but it's important stuff. Different asset classes -- not just stocks and bonds, but different types of stocks and different industries -- behave differently at different times. By spreading your investments across different kinds of assets, you can --

Oh jeez. You're not going to stop, are you?

-- reduce volatility and improve performance over time. No, I'm not going to stop. Listen up, this is actually pretty important.

I hate this stuff. Why can't you write articles like this one? The guy hunted up a whole bunch of stocks selling for less than book value, like Energy Conversion Devices (Nasdaq: ENER)? Or this one, where they cut through all that balance-sheet baloney and find the metrics that matter on stocks like Garmin (Nasdaq: GRMN)? Or even this one, where the guy drills down into Ford (NYSE: F) and looks at what it'll really be worth if it pulls off a recovery. That's all stuff I can use. But here you are blathering on about asset allocation. Who cares?

Dude, I wrote the Ford article.

Oh.

And I'm writing this one because I think it's important. Diversification is something you can use, too, and my sense is that a lot of people still don't get it. Now that the markets are looking choppy again, I think it's important to remind folks about this, because diversification is a key to lowering your stock portfolio's overall volatility without killing your potential for returns.

So people over 50 need some bonds with their stocks, but not too many. Okay, done. Now write about something interesting, like TomTom's new GPS app for Apple's (Nasdaq: AAPL) iPhone. Is it cool or what?

Actually, I think $99 is way too expensive for an app. For $30, I'd buy it. $50, I'd think about it. $99? I'll pass, because I bet it'll be under $50 in a few months once the buzz fades and reality sets in.

Happy? Now will you be quiet while I talk about this stuff?

Fine, just get it over with.

Asset allocation and diversification aren't just about stocks and bonds, although that's often what people mean when they say "asset allocation." But diversification within each asset class is also really important. A lot of people who have big stock portfolios, maybe in a rollover IRA, tend to buy the stocks that look interesting to them without thinking about the larger picture. Like -- what are those stocks you bought last spring?

Well, I got ExxonMobil (NYSE: XOM), because I knew oil prices couldn't stay low forever, and I got Contango Oil & Gas (AMEX: MCF), because it's a very well-run little company, and I got Pride International (NYSE: PDE), which does drilling for oil and gas companies, and --

Stop. That's a great example. You've got three companies that are all linked, to some extent, to the energy industry. Think about that. Those are three great companies, but even if it seems likely that oil will get more expensive over the long haul, do you really want to bet that much of your portfolio on it?

Huh. I never thought of it that way.

Some experts say that how you choose to divide up your portfolio by industry and asset class has an even bigger impact on your returns over time than your choice of individual stocks within those classes.

Wait. Stockpicking is everything!

Stockpicking is really important. But what I'm saying is, so is choosing where to look for those stocks. You've got a lot of energy stocks. Maybe if you look at the market as a whole, it makes sense to overweight energy and underweight something else, like banks. But I don't get the sense that you did that.

But look at my oil stocks. There's a small cap, a mid cap, and a large cap. Isn't that diversified?

Sort of. I mean, that counts to some extent -- Contango is likely to be more volatile than ExxonMobil because of its market cap. But you're still heavily exposed to one factor -- energy prices. It's better to make money by having exposure to lots of different factors, unless you're really confident in your thesis.

I'm really confident that oil is going to get expensive.

I hear that. But what if it trades in a tight range for the next five years while some other sectors take off? You can still overweight energy, but instead of an energy large cap, maybe replace ExxonMobil with a large-cap pharmaceutical stock like Novo Nordisk (NYSE: NVO) or something. That way, you start to get diversified across market cap and industry, and you've still got great stocks with lots of potential.

I've never heard of Novo Nordisk.

They're diabetes specialists. You keep eating those doughnuts, you might get real familiar with them.

Okay, I guess I need to learn more about this asset allocation and diversification stuff. Where do I start?

There's a great set of introductory articles in the Fool's Rule Your Retirement service, together with some excellent model portfolios to help you get your 401(k) sorted out. Log in and hit the "Resources" tab, then check out "Model Portfolios" and "Asset Focus."

So I've got to pay to see them?

Nah. Grab a free trial and you're good for 30 days, which is plenty of time to get rolling on this. Just click here to get started.