What percentage of one's portfolio should be invested in mutual funds?

Paul's Answer:

This varies with each individual, but I strongly believe that the majority of everybody's portfolio should be in mutual funds. Mutual funds provide a combination of professional management, diversification, low costs and liquidity that is simply not available anywhere else.

I invest 100 percent of my family's money in mutual funds and variable annuities, which are similar.

I'm passionately interested in investments, but I don't regard investing as a hobby, an avocation or a source of fun. Maybe that's because for me it's a business, a means to an end. And maybe it's because I've seen too many people suffer the consequences of their investing bravado - or of their brokers' recommendations.

I know there are many investors who like the challenge of picking individual stocks, and some of them are successful at it. But these investors are rarely diversified the way they should be, and they are usually taking far more risk than they realize.

If I thought I could successfully outperform mutual funds by picking stocks, I'd probably do it. But I don't see how anybody can properly diversify a stock portfolio with less than $1 million. And even then, how can an amateur, on a part-time basis, effectively follow the fortunes of 100 or more companies and their competitors?

Even if you were the most powerful person in the world and could somehow manage to have a regular conference call with the chief financial officer of every important company, how are you going to make sense of all the information they give you? How would you figure out what to do about it?

And even if you did all that perfectly, it's not clear from the available evidence that you'd have any statistical advantage over index funds.

Here's my bottom-line advice: Put most of your important money in mutual funds. If you want to try your hand at picking stocks, or if you have some thorough, current knowledge of a particular industry, allocate up to 10 percent of your portfolio to your own picks in a discount brokerage. If you are very successful, it will make a noticeable difference to your portfolio's overall return. If you fail miserably, you will have learned something, and your financial wounds will be limited.

In other words, 90 percent in mutual funds, l0 percent for fun - if that's your idea of fun.