What Your Retirement Portfolio Needs Now

For the domestic portion, one smart way to play this is to blend together large-cap and small-cap. A good proxy for domestic large-cap is the iShares Russell 1000 Index Fund(IWB Quote).

For small cap, the SPDR DJ Wilshire Small Cap ETF(DSC Quote) should work well. Based on where the current stock market cycle appears to be, 10% in IWB and 5% in DSC is prudent for now, but when the next bull market begins, I would switch those percentages around.

Looking at the foreign developed equities portion, the easy pick would be iShares MSCI EAFE(EFA Quote), but EFA allocates almost 20% to Japan. I would prefer to have less exposure than that, as I do not believe the country is anywhere close to getting back on the right track. The WisdomTree DEFA Fund (DWM Quote) delivers comparable exposure with only 9.28% in Japan. For smaller-cap exposure, the fairly new iShares MSCI EAFE Small Cap Index Fund(SCZ Quote) is off to a good start in this segment. Here again, I would favor larger over small for now with the same 10% to 5% split.

Allocating 12% into emerging markets means more exposure to that group than most people have. Anyone with 5% to 6% in emerging markets increasing it to 12% of holdings would mean signing up for noticeably more volatility. While that increased exposure to emerging markets might be the right weighting over the course of an entire market cycle, the next big dip in the market could be painful.

Medium-sized declines in the U.S. have often meant large declines for emerging markets. This year has been a good microcosm to see how funds react to market stresses, and over the course of 2008, the smoothest ride for a broad-based emerging-market fund came from the WisdomTree Emerging Market High Yielding Equity Fund(DEM Quote), regardless of your allocation amount.