The Smarter Investor

The news is flooded with doom-and-gloom scenarios coming out of the crisis in Japan. The devastation and loss of life are tragic and our prayers go out to everyone affected in the region. As a member of the financial community, this type of situation typically means that people begin frantically asking for our predictions and theories about how it will affect the economy. Unfortunately, it's impossible to predict what will happen. Just like it was impossible to predict what was going to happen the day prior to the bottoming out of the S&P 500 two years ago. In order to understand the complete lack of predictability we are faced with, let's take a look back over the past two years.

We recently reached the two-year mark since the market low of March 9, 2009 when the S&P 500 hit a low of about 676. To put this low into perspective, one should note that investors have to look back to 1996 to find a time when the market last registered that index level.

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Everyone knows that a well-diversified portfolio should contain bonds. Bonds typically provide stability and keep portfolios safe, especially when the market is tanking. But sometimes, that last statement couldn't be further from the truth.

Here are three reasons why you should be leery of the current bond market:

[See The 100 Best Mutual Funds for the Long Term.]

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Rebalancing your portfolio is one of the keys to successful investing over time. Rebalancing means adjusting your holdings—that is, buying and selling certain stocks, funds, or other securities—to maintain your established asset allocation. For example, let's say your asset allocation is 60 percent stocks and 40 percent bonds. If stock prices go up for a few months, your allocation to them might rise to 70 percent. That means you have to sell some stocks to get back to your desired level. It's important to maintain your asset allocation because it keeps your tolerance for risk at the most comfortable level.

For most investors, rebalancing twice a year is sufficient to make sure their asset allocation isn't getting out of whack. Mark the dates you want to rebalance on a calendar you check the most. That way you won't forget.

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

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In the mid 1990s, exchange-traded funds came riding down Wall Street like Clint Eastwood in an old spaghetti western—fearless and ready to take on the bandits who had been terrorizing the townsfolk. For years prior to the arrival of ETFs, average investors were held hostage by obscene fees while mutual fund robbers brashly collected their booty, threw back some expensive whiskey, and then shamelessly shot up the town.

In 1989 the first ETF—Index Participation Shares—came to the rescue. This S&P 500 proxy traded on the American Stock Exchange but was quickly gunned down by the Chicago Mercantile Exchange who quickly perceived the threat. It wasn't until 1993 that the real gunslinger rode into town and changed the order of the fund industry forever.

[See What Style of Index Investing Is Right for You?]

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