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The 6 best investing ideas you've never heard of

By David Futrelle, Barbara Kiviat, Paul J. Lim, George Mannes and Penelope Wang

(Money Magazine) -- Never get too comfortable.

Sure, you want to keep your investing as simple as possible. So you invest steadily and hold fast to some simple but time-honored strategies: Keep your focus on the long term. Subtract your age from 110 (or maybe 100) and hold that percentage in stocks. Diversify as much as you can. Rebalance your portfolio on a regular basis.

All reasonable advice. But the hard thing about investing is that you're trying to manage the unpredictable future. No doctrine is entirely secure. So it's a good thing to consider, from time to time, ideas that go against the grain.

You might realize that the conventional strategy doesn't suit your situation or that you are missing out on a chance to do better. And even if you dismiss an idea as impractical, far-out, or just too chancy, it can teach you something important about what to expect from your investments or about weak points in your strategy.

What follows are six surprising ideas that will make you see your portfolio in a new way. Not all are sure bets -- indeed, in some cases, one contradicts another. Nonetheless, you'll profit from understanding the logic behind them.

Idea 1: Think having 100% in stocks is risky? How about 200%?

You should hold more in stocks when you're young, and less when you're old. That's the conventional wisdom. After all, stocks tend to do well in the long run but are volatile in the short term. But when you're in your twenties or thirties and have the longest to run, you might have only a few thousand bucks in the market. By the time you're in your fifties and sixties, you'll have the most money but will want to risk less of it.

In their book "Lifecycle Investing," Yale economists Ian Ayres and Barry Nalebuff propose an audacious solution: Increase your stock position with borrowed money when you're young. You can do that with a margin loan from a broker. Or, as Ayres and Nalebuff prefer, with LEAPS, which are options to buy an index like the S&P 500 in the future at a low price. (You win if stocks beat that price plus your cost.) Either way, your top allocation to stocks should be 200% of assets, meaning every $1 of your own money is effectively matched by another $1 borrowed.

You may think such leverage is crazy speculation, as it amplifies both gains and losses. But hear Ayres and Nalebuff out. Many young people can afford to be hyperaggressive with stocks because they have another big asset: decades of future salary. A 27-year-old who saves $5,000 this year will earn enough to salt away hundreds of thousands over a lifetime. The question, the pair contends, isn't how much of $5,000 to risk on stocks, but how much of the hundreds of thousands. In that case, leverage looks less wild.

Over time, Ayres and Nalebuff say, this strategy reduces the chance of falling short, since you rely less on good stock returns in later years. "It's safer to buy the S&P 500 than just five stocks," says Nalebuff.

"Similarly, it's safer to spread your stock investments across 44 years." He and Ayres calculate that an investor starting at 200% stocks at 23 and tapering down to 32% at 67 can expect the same average return as a conservative investor who held 50% in stocks the whole way. Yet the range of lifetime outcomes is narrower in the leveraged portfolio the highs aren't as high, but, crucially, the lows aren't as low.

HANG ON A SECOND ... This strategy has two big problems. First, it's tough to execute. Second, however it works on paper, it's psychologically taxing. People tend to be most excited about leverage when markets are high and then bail on stocks when they're low. Ride those mood swings on a margin account and you could destroy a lot of wealth. --Barbara Kiviat

THE LESSONS: Ayres and Nalebuff are right that you should consider your assets beyond your portfolio, especially your earning power. Even without leverage, younger people with strong career prospects should seize the opportunity to be aggressive.

This idea also highlights the fact that most savers rely a lot on good returns in a small set of years -- those closest to retirement. This should spur you to save and invest more early on.

If the idea of leverage sounds nuts to you, consider this: A mortgage is leverage too. Sure, it gives you a place to live. But when home prices far outstrip the cost of renting -- as they did just a few years ago -- investment leverage might be a better alternative for young wealth builders.

Idea 2: Then again, you may have too much in stocks already.

Boston University economist Zvi Bodie thinks the problem for most investors is hardly that they're too timid to bet big on stocks. It's that they're far too optimistic. Remember, the standard view is that stocks aren't such a risky bet if you can hold on to them for a long time. Bodie says that's bunk.

Risk, he says, isn't the probability of something bad happening. It's probability times the severity of the consequences. Granted, on average, stocks tend to make money over long periods of time. Just like, on average, you get heads half of the time when you flip a coin.

But there is no guarantee that the general rule will work in your specific case. It's possible to have long runs of mostly tails in coin flips -- or to have an extended period over which stocks do very poorly. So when it comes to the money in your 401(k), long-term averages are meaningless; what's important is the market's performance in the years you're in it. If a bad run hits you soon before or after retirement, the damage could be irreparable.

Similar to Ayres and Nalebuff, Bodie says you should consider your other income sources when deciding how much stock to hold. But Bodie says that this isn't strictly a matter of time. A tenured professor may expect enough solid lifetime earnings to take a flier on stocks, but not a young real estate agent. And anyone nearing the end of his career should be cautious, even though he still has two or three decades over which to invest.

Bodie's advice: Instead of focusing on the time you'll be in the market, invest in stocks only when you know you have enough income and safe assets to weather any market condition. Bodie particularly likes Treasury Inflation-Protected Securities, or TIPS, bonds that protect your buying power.

HANG ON A SECOND ... If you are saving 10% of your income every year, investing in low-returning TIPS may not get you to the retirement you want. Your savings target may be closer to a daunting 20%.

You may also have to work well past 65. Bodie says he understands that many will resist such a big change to their portfolio -- or their lifestyle. Then they'll just have to live with the chance of a worst-case scenario. As Bodie puts it: "I'm not saying, 'Don't invest in equities.' I'm saying, 'Understand the risk.' " -- George Mannes

THE LESSONS: There's no free lunch. The classic "stocks for the long run" argument has given many people the idea that stocks are volatile (they bounce up and down) but not really risky (they always come back in the end). That's not right -- big long-term losses are always possible, even if not likely. Just ask an investor in Japan.

Even if you decide you can live with the risk of stocks, knowing that risk doesn't go away should be a spur to save more and consider working longer, if you can. The more you are able to put away, the less you'll have to wager on equities to have a shot at reaching your retirement dreams.

Idea 3: There just might be a better kind of index fund.

It's nearly impossible to come up with an investment that reliably beats the humble index fund. Simply by holding a mutual or exchange-traded fund that tracks a benchmark such as the Standard & Poor's 500, you can count on earning the market's return, minus a very low fee. Meanwhile, actively managed funds, which rack up higher costs and tax bills, typically lag behind their indexes over the long run.

Yet some smart investing gurus say they've found a flaw in indexing and argue that there's a way to do it better. So what's the flaw? With a traditional index fund, you hold stocks in proportion to their market capitalization -- the stock prices multiplied by shares outstanding.

This means that when a company's stock price goes up more than others in the index, you also end up owning more of it. So when an industry gets caught up in a bubble -- as tech stocks did back in the 1990s -- your index fund joins right in the party, giving you more exposure to those shares.

"With traditional indexes, you overweight stocks that are overvalued and underweight undervalued stocks -- the reverse of what investors should do," says money manager Rob Arnott, head of Research Affiliates.

To dodge those bubbles, Arnott came up with the notion of "fundamental" indexing. Instead of relying on market capitalizations, he weights stocks according to their economic strength using several financial measures, such as book value, dividends, and sales.

Based on analysis of market data going back to 1962, this strategy would have outperformed the S&P, claims Arnott. The real-life test of his index dates back only to late 2005, when Power-Shares FTSE RAFI U.S. 1000 (PRF) was launched. So far the ETF has an annual average gain of 0.6%, vs. a 1.5% loss for the S&P.

HANG ON A SECOND ... Sometimes an investment that seems to be revolutionary turns out to be kind of ... ordinary. Truth is, with its avoidance of highflying companies, fundamental indexing is really another way of investing in value -- that is, stocks that are cheap relative to their earnings or assets.

Studies have shown that value has outperformed growth-style investing. But there's no guarantee this effect will continue. And there are other ways of tilting toward value, such as adding a traditional index fund that tracks a value index. Vanguard Value ETF (VTV) charges 0.14% a year, vs. 0.39% for the RAFI fund. --Penelope Wang

THE LESSONS: Fundamental indexing highlights a truth many index fans miss. Although indexing is a simple strategy, it's not especially low risk. When the collective wisdom of the market becomes collective madness, you'll get carried along with the crowd in an index fund.

Fundamental indexing should work pretty well because it shares two of indexing's basic advantages: It keeps trading low and expenses down. Both kinds of index funds will probably have an edge over active managers, who tend to trade a lot and charge more for their services.

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