The Right Focus Can Improve Your 2012 Returns

Focus on diversifying your stock and bond holdings instead of picking winners.

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Many investors will focus on the wrong ball when making investment decisions for the New Year. For these investors, the light at the end of the tunnel could be a freight train.

The international and domestic stock markets were negative or flat in 2011. The S&P 500 Index had a paltry return of 2.11 percent, which made it a standout performer among major markets. There were some big winners in the stocks making up the Dow Jones Industrial Average. McDonald’s gained 34 percent, Pfizer was up 28.6 percent, and IBM gained 27.3 percent.

[See The 10 Best Places to Retire in 2012.]

Brokers are on their phones calling their clients with recommendations for next year’s winners. They are also dispensing their views about where the market is headed in 2012.

Here’s my advice: Don’t listen to them. They have no more ability to pick winning stocks than a chimpanzee tossing a dart at a board. If they really knew where the market was headed, they would have predicted the biggest recession since the Great Depression and the ensuing rapid recovery.

Instead of engaging in the discredited notions of stock picking and market timing, you should be eschewing all individual stocks and bonds and limiting your investments to a globally diversified portfolio of low management fee stock and bond index funds in an asset allocation (the division of your portfolio between stocks and bonds) appropriate for you.

While you may understand the importance of globally diversifying your stock holdings, doing the same with your bonds is just as important. Few investors appreciate that almost 75 percent of the global government bond market is composed of non-U.S. bonds. While average returns of U.S. and non-U.S. bonds may not differ significantly, there can be meaningful differences in annual performance. By adding non-U.S. bonds to your portfolio (assuming the currency risk is hedged), you can reduce overall volatility, which is one of the primary benefits of diversification.

[See top-rated funds by category ranked by U.S. News Mutual Fund Score.]

It used to be quite difficult for investors to obtain international diversification of the bond portion of their portfolio in a cost effective manner. That’s about to change. Vanguard recently announced the Vanguard Total International Bond Index Fund, which will be available early this year. The fund will have a low expense ratio of 0.4 percent for the investor share class. Vanguard recommends an allocation to international bonds ranging from 20 percent to 40 percent for the bond portion of your portfolio.

Another option for those seeking international bond diversification is SPDR Barclays Capital Short Term Fund (BWZ). This fund tracks the Barclays Capital 1-3 year Global Treasury ex-U.S. Capped Index, which consists of fixed rate, investment grade debt issued by foreign governments of investment grade countries. It has an expense ratio of only 0.36 percent.

[See The Best and Worst Sources of Financial Advice.]

The next time your broker calls and wants to discuss how the international monetary crisis could affect your investments, stop him in his tracts. Tell him you want to focus on broadly diversifying both the stock and bond portion of your investments. Ask him to recommend an international bond index fund or exchange-traded fund. Don’t be surprised by the stunned silence at the other end of the line.

Dan Solin is a senior vice president of Index Funds Advisors. He is the New York Times bestselling author of The Smartest Investment Book You'll Ever Read, The Smartest 401(k) Book You'll Ever Read, The Smartest Retirement Book You'll Ever Read, and The Smartest Portfolio You'll Ever Own. His new book, The Smartest Money Book You'll Ever Read, was published on December 27, 2011.

The views set forth in this blog are the opinions of the author alone and may not represent the views of any firm or entity with whom he is affiliated. The data, information, and content on this blog are for information, education, and non-commercial purposes only. Returns from index funds do not represent the performance of any investment advisory firm. The information on this blog does not involve the rendering of personalized investment advice and is limited to the dissemination of opinions on investing. No reader should construe these opinions as an offer of advisory services. Readers who require investment advice should retain the services of a competent investment professional. The information on this blog is not an offer to buy or sell, or a solicitation of any offer to buy or sell any securities or class of securities mentioned herein. Furthermore, the information on this blog should not be construed as an offer of advisory services. Please note that the author does not recommend specific securities nor is he responsible for comments made by persons posting on this blog.