'10 Questions' Goes Back to School

It's never different this time. Now that we have once again learned this lesson, a lot of investors have to start over. Asset allocation and style diversification are the starting points.

Look at your portfolio and then go on Morningstar, Smart Money or any place that explains style attributions of your mutual funds. Make certain that you have exposure to the following asset classes: large growth, large value, small growth and value and mid-cap growth and value.

Now, how should you allocate those assets? You should have at least a market weighting in small-cap stocks. The unequivocal proof for the last 75 years is that in any 20-year period small-cap stocks have done better. I'm not saying bet the farm on small-caps, but you have to have them included in your portfolio.

So, about 25% of the market according to capitalization weighting is smaller-cap stocks. You should have at least 25% of your portfolio in smaller growth and value.

That leaves 75% for large-cap stocks. How should you allocate between large growth and large value? If you look at the Fama-French historical data, large value outperforms large growth. This is consistent with the data I used for What Works on Wall Street.

You could put 45% in large value, and 30% in large growth. Now, if you are comfortable with a little additional risk, you can tilt your portfolio more toward small-cap, maybe a little more growth. If you are more conservative, you can tilt it more toward large value.

Whatever you decide to do with your asset allocation, you must remember to rebalance. One of the biggest mistakes investors make is that they fail to harvest gains. At the end of the first year, one of those asset classes is going to be overweight. If small-caps rise, you may have 38% instead of 25%. Bring it back to the target.