Survive the Market: Your Two-Fund Solution

May 12, 2009 — -- This week, I'm going to keep it simple.

I'm going to suggest a simple way to invest that provides broad diversification, an opportunity to participate in market upswings and a buffer against downturns at a minimal cost.

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Sound too good to be true? Of course, it is. But the strategy I have in mind is a sensible way to get started with a long-term plan for investing after the most brutal period any of us could have imagined.

It's what I'll call the Two-Fund Solution, a simple yet elegant way to construct a portfolio that can overcome the forces of procrastination and indecision. It is not intended to be a finished product but rather a solid building block for the future.

As the name implies, the Two-Fund Solution involves the purchase of two broadly based mutual funds. The intent is to make it as easy as possible to implement.

The first is an index fund designed to track the overall U.S. stock market. Such funds usually are called total stock market funds. My favorite is the Vanguard Total Stock Market Index Fund, but there are similar funds available from Fidelity, Charles Schwab and T. Rowe Price among others.

A total stock market fund will allow you to capture the long-term rewards of stocks in a low-cost, tax-efficient manner that provides broad diversification across all segments of the market from large caps to small caps.

The second fund is one that tracks the overall U.S. bond market. Again, these kinds of funds are usually called total bond market funds. I like the Vanguard Total Bond Market Index Fund, but other mutual fund families offer good choices, as well.

Again, a total bond market fund exposes you to all segments of the bond market and eliminates the need to guess when is the best time to invest in particular portions of the bond market.

Together, the total bond and total stock funds allow you to establish a solid foundation that either you can build upon or allow to stand on their own for years to come.