Just as a healthy "balanced" diet promotes good health for your body, a balanced portfolio promotes healthy investment returns. In matter of fact, balancing your portfolio is infinitely more important than WHICH stocks you choose!
The meats always get star billing in a meal and the vegetables are considered "side" items. The salads and breads are simply 'add-ons.' People don't go to a steak house for the vegetables. They spend their time looking through the menu searching for which meat they want to engorge on. The veggies are only a secondary thought and the salad and bread is expected.
It's not much different when it comes to investing- stocks get all the attention and as such, receive all the attention. Bonds are considered 'side' items and cash is your daily bread. However, spending all of your time thinking about your stock selection ignores what has been proven to be the MOST IMPORTANT FACTOR in investing- balance.
The balance I am talking about does NOT refer to how many tech stocks vs. drug stocks you should have. The balance is HOW you divide your assets among the different classes of investments, i.e. stocks, bonds, cash.
A diet of ALL meat will eventually kill you. Lions may be the kings of the jungle but their life-span is literally one fourth that of an elephant. Yes, I realize the lion lives an infinitely more exciting life than en elephant but they pay for it by a carnivorous diet and an early exit from this earth.
A diet of all vegetables may be considered "boring" but it will not kill you. In investing, an all bond portfolio may be boring and will likely lead to inferior performance but it won't kill you. Thus 'balance' in investing holds the same keys as a well-balanced diet.
Then why do most investors spend all their time on stock selection? It is because, just as a lion on the hunt, it is exciting. It stimulates the animal spirits. But just as when we eat too much meat, investors have suffered tremendous heart-burn over the last couple of years because of their terrible eating (investing) habits. Unfortunately, there are no 'antacids' that can relieve the suffering most investors now feel because of their excessive stock binge.
So what are the keys to successful investing? Asset allocation and risk management. Studies show (most recently by Gary Brinson in 1986 & 1991) that over 90% of portfolio performance and variability can be explained by asset allocation- i.e. your mix of stocks, bonds, and cash. The other 10% are factors including market timing and stock selection. And when it comes to your stock selection and positioning, risk management is absolutely imperative.
The next logical question is- what is the "optimal" balance. Unfortunately, there is no "cookie-cutter" approach. This is a very individualized subject based on many factors including age, investment horizon, risk tolerance, etc. The only true way to decipher this question is to seek professional assistance and a good deal of soul searching. However, regardless of how it is done, an investor must give up the notion that an "all stock" portfolio is the only way to outperform. An investor must also BURY (in a deep hole) the stale fable that, to be successful in stocks, one must 'buy and hold' for the long-term. This mantra is simply mind numbing self-serving propaganda spread by the mutual fund community. All markets, sectors, industries and companies have life cycles. Unfortunately, we cannot know how long these cycles will last and riding through some of the down cycles is just a foolish as trying to survive a harsh Alaskan winter in a bathing suit.