Play It Safe

This spring was a volatile one for Wall Street. The S&P 500 Index fell off a cliff in late February, dropping 3.5 percent in a day. Yet in April, the most-watched index, the Dow Jones industrial average, skipped over the 13,000 mark for the first time in its history. And in early May, the S&P 500 Index climbed above the 1,500 barrier for the first time in seven years.

Volatility's not all bad. It generates positive returns as well as negative ones. Still, a topsy-turvy period like we've just experienced provides a reminder that a little diversification goes a long way--and not just across different types of stocks, but between asset classes, too. The bottom line: Even for long-term investors, it's a good idea to keep stable, conservative holdings in your portfolio.

Jack Bogle, the patron saint of index investing due to his extended tour at Vanguard funds, has written that a person should consider keeping a relatively consistent percentage of his or her portfolio in bonds. He suggests using your age minus 10. So if you're 36, you want roughly 74 percent in stocks and 26 percent in bonds, according to Bogle's math. That moves you toward slightly more conservative holdings as you age, while keeping some of your portfolio in stocks until you're at least 110.

But, with apologies to Jack, I suggest a modified version: maybe your age minus 20 through your 20s and 30s, your age minus 15 in your 40s, and your age minus 10 from your 50s onward. This captures many of the advantages of the Bogle system but allows you to be more aggressive in your younger years.

As for Bogle's index theory, I'm generally a fan of his approach. And the Vanguard Total Bond Market Index is, in fact, easy and relatively cheap (0.2 percent expense ratio). It gets you everything except munis and junk bonds, which you could always add yourself if you really wanted to.

So why bother with boring old bonds? When some things are dropping, it can be a comfort to know that others are rising. After all, it's all about the volatility.

Scott Bernard Nelson is a newspaper editor and freelance writer in Portland, Oregon.

This article was originally published in the July 2007 print edition of Entrepreneur with the headline: Play It Safe.