The Only 7 Investments You Need

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5. A High-Quality Bond Fund

First choice: Vanguard Total Bond Market Index (VBMFX)

As much as you need stocks, "precious few people can really stomach an all-stock portfolio," says William Bernstein, author of "The Four Pillars of Investing." Equities are essential for long-term growth, but you hardly need reminding in today's market they're not that reliable in the short run.

Bonds will never run the table in performance, at least not when high-quality corporates are yielding around 5.5%, as they are today. So think of the fixed-income funds in our simple portfolio as ballast to make your nest egg more stable. Over the past five years, a portfolio consisting of 80% blue-chip stocks and 20% bonds delivered nearly 90% of the returns of an all-stock portfolio, but with just four-fifths of the risk.

Focus on high-quality bonds, which tend to zig when stocks zag; they've returned nearly 7% a year since 1998, beating stocks in a tough market. As you get closer to retirement, you'll also appreciate the reliable income these bonds pay out.

Today you can own the fixed-income universe in one fund, Vanguard Total Bond Market. Since bond funds return less than stock funds, low annual fees are crucial, and in this one they total just 0.19% vs. 1.02% for the average fund. That advantage makes Vanguard's index fund very tough to beat.

Alternatives: Vanguard Total Bond Market ETF (BND) and Harbor Bond (HABDX)

6. An Inflation-Protected Bond Fund

First choice: Vanguard Inflation-Protected Securities Fund (VIPSX)

For the better part of two decades, inflation has been the polio of the American economy: a terrifying danger, to be sure, but one you could confidently say was eradicated. No longer. Since last fall, consumer prices have been more than 4% higher than the year before - a rate we have not seen in nearly 20 years.

Why worry if you have an ample dose of stocks? Because as you get older, you'll gradually reduce your equity stake while boosting your bond allocation, to reflect your greater income needs and the fact that you can't afford to take as much short-term risk as you once could. But inflation eats away more than half of the return of a conventional bond.

Enter funds made up of inflation-protected bonds. These portfolios invest in Treasury Inflation-Protected Securities, or TIPS, which not only pay a predetermined yield but also adjust the value of the bond's principal to preserve purchasing power.

Among TIPS funds, Vanguard Inflation-Protected Securities has several things going for it, including lower costs and better management than you would get if you assembled your own TIPS portfolio. While the fund returned 6.6% over the past five years, you shouldn't expect it to make a pile of dough. Its job is to protect the money you already have.

Alternatives: iShares Lehman TIPS Bond (TIP) and T. Rowe Price Infl.-Protected Bond (PRIPX)

7. A Money-Market Fund

First choice: Fidelity Cash Reserves (FDRXX)

A money-market fund is essentially a cash account. And as we've said in the past, cash is not an investment - it's a place to stash your emergency fund or safeguard money you'll need to spend right away. In fact, over the past decade, the 100 largest money funds returned just 3.6% a year on average, barely keeping pace with the long-term rate of inflation.

So why, then, include it in the only seven investments you need? As an investor, there are times when you'll need to have some cash to manage your portfolio. What if you wanted to take advantage of a buying opportunity in the stock market, for instance? Without some money that's easy to get at, you'd have to sell some stock or bond holdings, possibly triggering taxes.

As you get older, you'll also need an account to safely park the income thrown off by your stocks and bonds. While they don't carry FDIC insurance, money funds are a solid choice. They're about as safe as a bank account, since they aim to maintain principal value. Yet they're more liquid than CDs.

When choosing a money fund, think service and fees. Among the largest funds, Fidelity Cash Reserves has the highest current yield at 2.85% (thanks to modest fees). And Fidelity will let you link a high-yielding checking account to the fund.

Alternatives: Schwab Value Advantage Money (SWVXX) and Vanguard Prime Money Market (VMMXX)

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