Reviewed by Jim Wiandt, Managing Editor

A bewildering array of new portfolio theories confront the investor as he tries to put together an investment strategy. Cochrane's paper touches on some of the more important studies, and ultimately comes to a number of conclusions that should come as no surprise to index investors.

Taking a machete through thickets of data-mining and the occasional suspect conclusion, Cochrane emerges with some lucid thoughts. Know your risk factors. Apply multifactor efficient-frontier logic to your portfolio. Remember the law of averages. Avoid fees, taxes, and snake oil salesmen.

Risk Factors

1) Know how much certainty you are willing to sacrifice for the promise of high returns. Do you have the fortitude to carry your plans through? For Cochrane it is just a matter of deciding whether or not you are more risk tolerant that the average investor. If you are, you'll invest 60% of your money in equities. If not, you will invest less. The exact ratio, of course depends largely on point two.

2) Understand your investment horizon. The shorter your horizon, the less risk you want to take. A graphic illustration of this point can be found in Larry Swedroe's risk article. Over most longterm periods, stocks outperform other asset classes.

3) What are and are not your risks? You should adjust the factors in your portfolio analysis to match the risks you face. If your job is at the front end of the New Economy for instance, you may want to diversify away from the market. Conversely, if you are living on investment income and are unconcerned about a recession, you will want to invest in recession-sensitive sectors of the economy that hedging investors avoid, driving up their risk premiums.
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