Survive the Market: Your Two-Fund Solution

For the nervous investor, a logical first step might be to dedicate half of your savings to the Two-Fund Solution and keep the remaining assets in cash. Then, evenly divide the noncash half between the total stock market fund and the total bond market fund.

If you're a little more aggressive, you might keep a quarter of your savings in cash and then split the rest between the total stock market and total bond market funds.

In either case, you can move more cash into each fund as you become more comfortable with this strategy.

Going Global: The Three-Fund Solution

You might also consider a move to a Three-Fund Solution, adding to the mix a total international stock market fund. For a conservative investor, an appropriate mix might be 50 percent total bond market, 35 percent total U.S. stock market and 15 percent total international stock market.

The international fund can be added at the beginning, or somewhere along the line, depending on how easy you want to make it.

Keep in mind, the Two-Fund Solution (and the Three-Fund version) is not without risk. In the past year, just about any portfolio other than one invested entirely in cash lost money. But a heavy allocation to a total bond market fund would have mitigated losses.

For instance, suppose you invested $50,000 each in the Vanguard Total Stock Market Index Fund and the Vanguard Total Bond Market Fund at the beginning of 2008. At the end of last week, such a portfolio would have been worth $86,143, assuming your reinvested your dividends, according to Morningstar.com.

That amounts to a 14-percent decline in your initial $100,000 investment. But such a loss pales in comparison to a 37-percent drop in the Standard & Poor's 500 Index, a benchmark for U.S. large cap stocks.

On the flip side, a large allocation to a total bond market fund will also dampen returns when the stock market rises as it has done since mid-March. My 50-50 Two-Fund Solution rose about 4 percent in April compared to the S&P 500's 10-percent gain.

That's why each investor has to decide for themselves the appropriate potential risk-versus-reward balance. Whatever the right mix for you, the Two-Fund Solution can be a simple way to get started on a sound path toward long-term investing.

This work is the opinion of the columnist and in no way reflects the opinion of ABC News.

David McPherson is founder and principal of Four Ponds Financial Planning in Falmouth, Mass. He previously worked as a financial writer and editor for The Providence Journal in Rhode Island. He is a member of the Garrett Planning Network, whose members provide financial advice to clients on an hourly, as-needed basis. Contact McPherson at david@fourpondsfinancial.com.

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