What's Preventing a Diversified Portfolio?

For the past 6 years, there has been strong investorsentiment that bond interest rates are going up.So far, investor sentiment has been dead wrong,at least for bonds maturing 5 years out and longer—interest rates have gone down. For investors who havebeen awash in cash during this time, fixated on higherinterest rates instead of their long-term game plan, theprice of waiting has proven to be a costly mistake.

Let's quickly review the three Coffeehouse Investorprinciples, created 6 years ago in the midst of a red hotstock market:

• Don't put all your eggs in one basket (ie, a singleasset class).
• Capture the entire return of each asset classthrough low-cost index funds.
• Develop a long-term financial plan.

Before you determine how to allocate assets amongstocks, bonds, real estate, and cash, it is essential thata long-term financial plan is established, so that youcan determine the minimum amount of risk needed toreach our financial goals.

Index Fund Allocation

I have long focused on a seven-index-fund portfolio,with a 40% allocation to an intermediate-termbond index fund and the remainder divided evenlyamong large cap, value, small cap, small value, international,and real estate investment trust index funds.This is just one example of a sophisticated approach tobuilding wealth, ignoring Wall Street, and getting onwith your life. It doesn't mean that this portfolio is theright one for you. It is quite possible that your portfolio,especially your bond allocation, will be significantlydifferent from the one advocated in this article.

Although I am a strong advocate of owning indexfunds when investing in the stock market, that doesn'tmean I am a strong advocate of stock market investing.In fact, my view on the stock market is to minimizeone's exposure to it, especially for investors whoare nearing retirement or have retired and will nothave the earning capacity to dollar-cost average intothe stock market during steep market declines.

You might say, "Well, what about keeping up withinflation?" I'm one step ahead of you because I've alreadyfactored inflation into my long-term projections.

Freedom from Stocks

Why bonds and why now? Even though I am only45 years old and plan on working at least another 40years (why retire when you love your work?), it isimportant for me to own bonds right now. First andforemost, it creates a discipline that will serve me wellthe rest of my life. Ultimately, I want to be at a placeat retirement where I have very little allocated to thestock market. This means I can enjoy my retirementyears absent the worry that a steep stock marketdecline will negatively impact my lifestyle.

I want to own bonds right now because someday (itmight be 3 years from now, it might be 30 years) Iexpect the entire stock market will plummet 30% to40%, which will be a tough hit on my emotions, notto mention my portfolio. A healthy bond allocationwill not only cushion that blow but will allow me torebalance and reallocate more of my fixed-income (ie,bond) allocation into the stock market at lower levels,just as Coffeehouse Investors did in late 2002 after thesteep stock market decline.

I confess, I'm a bond market junkie, and bondsshould be a key piece in a diversified portfolio.

Bill Schultheis is the author of The Coffeehouse Investor: How to

Build Wealth, Ignore Wall Street and Get On With Your Life

(Longstreet Press; 1999). He is also an investment advisor with

Pacific Asset Management in Kirkland,Wash. He welcomes questions

or comments at 425-820-1769 or billschultheis@pacificasset.net. For more information, visit www.coffeehouseinvestor.com.