I’ve previously written that low-cost, passively managed mutual funds out-perform high-fee, actively managed funds over the long-term.  So the first step in selecting the right investments is avoiding high-fee products.  But there’s much more to it.

The real key to attractive returns with acceptable risk is in how you combine these funds — getting the proportions right.

Here’s a simple example.  Over the past 10 years, a low-cost fund tracking the US stock market went up, on average, 3.9% per year.  But a 50/50 combination of two funds – the US stock market fund and a fund tracking all non-US stocks – did better: 5.4% per year.  If we add in funds tracking other important sectors – emerging markets, bonds and real estate  – the return over the past ten years would have been over 7% annually.  Over 10 years, you would have doubled your money, compared to only a 50% increase with US stocks.  And by diversifying, you would have reduced your risk.  The past is no guarantee of the future.  However, history teaches us that, on average, a diversified portfolio will generate attractive long-term returns with lower risk.

“Asset allocation” – the process of deciding which types of investments to select, and what weighting each should have — is far more important than picking individual stocks or funds.  A value-added adviser will spend their time determining the right mix, and matching that to a client’s risk tolerance and financial goals.  How much to put into international? Emerging markets? Commodities?  Real estate?  Short, intermediate and long-term bonds?  Over time, the adviser will continue to monitor those weightings as a client’s situation, and the world, changes.

In investing, it’s all in the mix.