(MONEY Magazine) – At first glance, Terry and Rowella Thomason are the picture of prudence. Before proposing five years ago, Terry paid off $13,000 in student loans and saved up for an engagement ring. "My father taught me that if you have to charge it, you probably can't afford it," he says. The couple now save 20% of their combined $135,000 annual income--he's a senior analyst at E-Trade, she's a revenue analyst at Intel--and have nearly $60,000 in retirement accounts to show for it. And they've already funded a college plan for one-year-old son Tristan. Sure, the 30-year-olds stretched to buy a $340,000 house in Citrus Heights, Calif. three years ago, but with the property now worth $500,000, the risk has paid off. Buoyed by this solid foundation, they have a clear goal in mind. "We want to do whatever we can so we can enjoy life and retire as early as possible," says Terry. This is where the prudence ends, for when it comes to investing, the Thomasons appear a little too eager: Almost three-quarters of their money is sitting in extremely volatile foreign markets, leaving them with a portfolio that's far too risky, even for young investors.

Where They Are Now

Saving comes easily to Terry and Rowella. He stashes 5% of his salary into his 401(k), fully capitalizing on a 50% match. She recently upped her 401(k) contribution to more than 20% and plans on saving the $15,000 legal maximum in 2006. The bulk of their portfolio sits in Roth IRAs, which they've funded through annual deposits and 401(k) rollovers from previous jobs. By funneling $2,000 a year into a Coverdell Education Savings Account, they estimate they'll have enough to cover half of state college costs in 17 years. Terry favors a Coverdell over a 529 because he can manage the money himself. "I like taking an aggressive stance," he says, "because over the long run you get paid for taking risks."

That high tolerance for risk, however, has led the Thomasons to make some questionable choices. Buying exchange-traded funds for their IRAs is smart; these mutual funds that trade like stocks have razor-thin annual expenses. But the ETFs they've picked track a hodgepodge of volatile indexes, from Brazil to Austria to Taiwan. Tristan's future hangs on the success of the MSCI Emerging Markets index, which dropped as much as 30% in a single year. Their major stock holdings are their employers (Intel and E-Trade) and Amazon.com, which Terry admits he bought on a whim.

What They Should Do

The couple may be impressive savers, says Tom O'Connor, a certified financial planner with Kubera Portfolios in Pacific Palisades, Calif., but their lack of diversification is alarming. "Early retirement requires a more aggressive portfolio," he says, "but they're essentially betting their future on a series of hunches."

In place of their veritable United Nations of single-country ETFs, O'Connor suggests a mix of ETFs and traditional funds that track broad U.S. and foreign markets, including iShares Russell 1000 (IWB), iShares Russell 1000 Value (IWD), iShares MSCI EAFE (EFA), iShares MSCI Emerging Markets (EEM), Vanguard International Explorer (VINEX) and Third Avenue International Value (TAVIX). Tilting the portfolio toward small companies and value stocks with iShares Russell 2000 (IWM) and iShares Russell 2000 Value (IWN) should help the Thomasons outpace the market over the long run and have a shot at early retirement.

Adding real estate and commodities to the mix with the Vanguard REIT Index (VGSIX) and Pimco Commodity Real Return Strategy (PCRRX) can also reduce volatility and enhance returns. "Both tend to do well when inflation is up and bonds are underperforming," notes O'Connor.

Buying single-country funds and individual stocks may satisfy Terry's appetite for risk, but O'Connor suggests limiting such holdings to no more than 10% of their total portfolio. "Play money serve a useful purpose," he notes, "but it's not okay to concentrate so heavily on emerging markets."

Finally, while both Terry and Rowella have good jobs, they still need to have savings they can tap for the unexpected, especially as their family grows. "Between ages 30 and 50, expenses go up like mad," says O'Connor. To build this cushion and further diversify, he says, the Thomasons should put 18% of their assets in cash and bonds using Vanguard Intermediate-Term Tax-Exempt (VWITX), a MONEY 50 fund. Plus, they need to invest more outside of tax-deferred accounts, which penalize early withdrawals, even if that means making smaller 401(k) contributions. Once the Thomasons pull off these fixes, they can keep moving toward their dream of early retirement, but on a path that's less perilous.

HELP FOR THE THOMASONS