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Special Report

A Milder Approach

Our Strategy Might Not Be for Everyone
We recognize that it takes an iron stomach to buy some of these unpopular categories. Some of you may be a little more timid. Perhaps you don't want to own three funds focused on Asia. Or maybe you've never been interested in niche offerings, like natural-resources or health-care funds. More importantly, maybe you simply aren't in the position to cover the minimum investments on three funds, plus the costs associated with moving in and out of funds every three years.

With this in mind, we retooled our strategy a bit this year and focused on the asset flows of the nine categories that make up the Morningstar style box, as well as the foreign- and world-stock categories. (These groups of funds are more likely to make up the core of your portfolio.) We took a look at cash flows in and out of these categories and identified the popular and unpopular funds all the way back to 1987.

It turns out that poetic justice isn't confined to triumphant post-high school careers and exotic fund categories. Unpopular core categories have outperformed popular categories over the next three years 63% of the time.

The results of this focused approach don't favor unpopular funds quite as much as the results of our original study. But then, they don't need to: We think this is a compelling argument for rebalancing your portfolio, so you won't be switching completely from one fund type to another. Chances are, more-popular categories have been posting more-popular returns, and you're becoming more dependent than you realize on their continued success. That makes your portfolio pretty vulnerable. But no investment style stays in favor forever. This year, you should tilt your portfolio toward 2000's unpopular categories--the large-value, mid-cap value, and mid-cap blend groups.

How to Execute
Use this strategy in much the same way you'd use our original one.

First: Take profits from popular categories. If you had trimmed your exposure to the popular small-, mid-, and large-growth categories in 1999, for example, you would have limited your exposure to their ugly returns come 2000. And, you would have enjoyed the performances of the unpopular categories--small- and mid-value funds and small-blend funds blossomed throughout the year.

Second: Do nothing drastic. Again, your rebalancing shouldn't affect more than 5% or 10% of your overall portfolio.