Ben Stein How Not to Ruin Your Life

It’s impossible to think of this past summer and the current fall without thinking of storms.

Hurricane Katrina, the biggest disaster to hit New Orleans in at least 75 years, and Hurricane Rita, which caused probably the worst traffic jam in U.S. history, preoccupied the nation and the world.

But a truism kept occurring to me all through the storms: Those who prepared got off relatively cheap. Those who had an evacuation plan, plenty of canned food, flashlights, medicines, and batteries got away from the storm or weathered it while others struggled.

The hurricane that's coming now is called retirement. It's a storm that's been forecast over and over and it's bearing down on 78 million baby boomers. For most of them, the preparations have been pitifully small.

We have a basic idea of what should be included in a hurricane disaster kit, but do we know what to have in our portfolio of investments for retirement? This column is going to start forthwith a heavy deluge of advice about what should be in that portfolio.

First, the portfolio should be different for different age groups. If you’re in your 70s, you should have a portfolio that is far more conservative than someone in their 20s who can afford to ride out ups and downs in stock prices. Even if you’re middle aged, you’ll want to have some fixed income (usually bonds) that can be counted on to pay out a regular stream of coupons whether the stock market goes north or south.

But just this one time, let's assume you have only notched maybe 30 or so years on the calendar. You’re pretty much a beginning investor. Your biggest earnings years lie ahead and so do your biggest spending years as you pay for your kids' educations and your bigger homes.

At age 30 or so, you might well want a portfolio of almost all common stocks. These tend to give the biggest long-term rewards, although there have been long periods when they have languished, as in the Great Depression and some time afterwards. But in the past 50 years their returns have been superb. While those perfect, balmy days are probably past, common stocks' returns will beat anything else even if they are only half as good as they have been in the past.

Now, let’s get down to specifics.

Maybe about 30 percent of the total you have to invest should go to so-called “spiders,” a low cost, highly tax efficient index of everything in the S&P 500 made up of the 500 largest industrial firms in America. An index is an unmanaged fund of stocks chosen by certain fixed characteristics. In the case above, the characteristic is large capitalization.

Then you might have about 10 percent in so-called “diamonds,” an index that covers the Dow Jones 30 Industrials made up of 30 of the largest firms in America. Because they have fewer volatile technology firms, diamonds tend to fluctuate less than spiders.

Then, since research clearly shows that small-capitalization stocks do better over very long periods than the S&P 500 but with a bit more volatility, 15 percent in an index of small-cap stocks. The two often used are the IWN, which is the Russell 2000 Small Cap Value, and the VBR, the Vanguard Viper which has similar characteristics but some say offers more stability in its holdings. Whichever index you choose, remember small-cap stocks are for holding for very long periods.

Then you might want to have 15 percent in the EFA, which is an index fund of European, Australian, and Far Eastern stocks, usually of very large capitalization. These offer a chance to get in on foreign growth.

I’d also suggest about 10 percent in the EEM, which is a popular index of stocks in developing nations such as Brazil, India, China, Thailand, and others. These stocks have been red hot lately as the developing world explodes with growth, but they usually offer a choppy ride. Results such as those of the past few years are not to be anticipated again for a time, but when they come, they come like thunder. 

Then, since many experts believe high commodities prices are here to stay, you might want an index that collects commodities related stocks. Here, I’d recommend that you put about 5 percent of your holdings into each of the IGE, the Goldman Sachs commodities fund, and 5 percent in the EWC, the Canadian iShares, an index of Canadian large-cap companies weighted about 25 percent in commodities. Canada is a very large exporter of oil, will be a bigger one in the future, and is loaded with commodities of all kinds. It is also a play on the strengthening of the Canadian dollar, which seems to me an inevitability considering the power of their exports in commodities.

I might put the rest in the ICF, which is the index that tracks real estate investment trusts (or REITs). Its future is not going to be as good as its recent past, which has been stellar. But it pays a good dividend and will go up as the real estate boom slows and as tenancy of office buildings grows -- both of which may well be in the cards.

The keys here are diversification, exposure to all parts of the market, and allowing long term trends -- growth in the developing world, fall of the dollar, endless demand for energy commodities -- work for you. 

Obviously, you should have at least six months' expenses in cash for emergencies, too.

We’ll get to fine-tuning and different portfolios for different ages in future columns, but this is a good start.