01/08/2010 10:41 pm ET Updated May 25, 2011

Are Bigger Stock Market Returns Really Better?

It's not surprising that small investors are staying away from the market. According to a recent article, $592 billion has exited from stock mutual funds and found a new home in bond funds.

This reaction by investors is consistent with studies of investor behavior. Investors tend to buy and sell at the wrong times, driven by emotion and incompetent advice from their "financial professionals." Burton Malkiel, the author of A Random Walk Down Wall Street, recently noted in an article in the Journal of Indexes that more money entered the market at the height of the internet bubble in late 1999 and early 2000 than had even done so ever before. More money left the market before the recovery in 2002. This pattern repeated in 2008 and 2009.

Malkiel also made the surprising observation that institutional investors make the same mistake. Their market timing skills are no better than those of amateur investors.

There is a better way, which is especially relevant for those planning for retirement and retirees.

Change your investment goals.

With few exceptions, the cost of increased returns is increased risk. Adding to the confusion is the fact that it is a rare broker who can measure risk, so many investors are taking "uncompensated risk," which could be eliminated through proper diversification.

What if, instead of gunning for big returns, you were willing to settle for a rate of return that would keep pace with inflation, net of taxes?

The benefits of this reorientation are significant: Low volatility, preservation of capital and preservation of buying power. This is perhaps the most significant benefit. You would need $924,000 today to replace $500,000 of buying power twenty years ago.

Few investors have any idea how to achieve this new goal. It can be done with less than 20% exposure to the stock market, depending on the mix of low cost, globally diversified, stock and bond index funds in your portfolio, based on long term historical data. Even in a down market like 2008, this portfolio incurred very small losses.

This is a far more successful strategy than bouncing in and out of the markets, usually at the wrong time.

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