Once again, as speaks Alan Greenspan, so goes the market.

With the reception of his mild remarks of December 5, that perhaps the Federal Reserve may ease off to neutral or move to an implied interest rate cut next year, investors gleefully took all of that cash sitting on the sidelines (discussed last week) and jumped back into the US stock market head first, picking up many undervalued stocks at fractions of their real market value.

This rally (and we hope it will continue through the end of the year) is selfishly and badly needed. Selfish from the standpoint of money managers who are paid on performance (and haven't had any this year) and badly for individual investors hoping to see their beaten down portfolios receive a lift. What remains to be seen is whether there will continue to be another sell off of yesterday's discards (albeit at a slightly higher price).

Last week, I commented on the differences between two portfolios of stocks; our MockPortolio (down (27 percent), which is fairly negative reflective of average market returns this year; and the Favorite Stocks portfolio which was showing a extremely modest return year-to-date of a positive 3.3 percent.

If this was the first time you were contemplating investing in the market, you might say, why bother? I can do better than that in fixed deposits. Ah, yes, you can, but over the long haul, markets have consistently outperformed fixed deposits by a minimum of 4 percent or more.

There have been exceptions to that statement, isn't there always; when in the late seventies and early eighties, the interest rate rose to around 21 percent. That's right, 21 percent.

Everyone was fully invested in certificates of deposit paying those great rates. After all, you could double your money in less than five years with no risk. It was great for those with plenty of extra cash, and just devastating for others (the elderly and retired as prices quickly escalated upward faster than interest rates).

Business investment in operating facilities and new construction projects just ground to a halt. Home sales languished as buyers, unable to afford those pricey mortgages, balked; real estate agents left the profession by the thousands. Inflation was rampant and so was unemployment, particularly in the construction industry, which nationwide is the number two employer in the US.

At that time here, in Bermuda, the effect was less noticeable as the local interest rates were less tied to global markets. Today that is no longer true; ask any mortgage lender what rate they use to mark their mortgage rates against. Generally, the answer will be some offset of LIBOR or other prime rate. LIBOR standing for London Inter Bank Official Rate.

Today, in order to beat inflation by not seeing the value of your savings erode over time, you need to consider diversification of assets, all of your assets. And in addition to diversification, having liquidity leeway.

It does no good to boast of the great returns you are receiving at the Bank of Finland, or the Grand National Bank of the West Indies, or Russia Roulette Bank (all fictitious names) if you cannot get your money back when you need it.

What is even worse, is when you are forced to sell assets at a loss in order to cash out quickly. Great returns boasted of on paper are just that. As Tom Cruise, the inveterate promoter says: `show me the money'.

Diversifying assets is a delicate balancing act. Too much of one type and a disproportionate amount of another can have damaging effects. Let's take a look at the composition of the two portfolios enclosed, accompanied by a brief lesson in some kinds of common investments.

Large capitalisation (large cap) usually means solid well developed, well heeled, dividend paying companies with net worth in excess of one billion dollars. They generally have consistent revenue earnings each year, good reputations, good products, reliable service and many diversified subsidiaries supplying them with raw materials and/or parts for production. The perception is that they may tend to plod along with a fairly constant growth rate of say (15 percent) per year, not terribly exciting, but pretty predictable. This is not always true.

Small cap companies tend to be less than one billion dollars in market capitalisation; some have just gone public, have yet to even show a positive earnings stream, are valued on projected future earnings (if any) and the amount of free cash they currently hold.

What's free cash? This is the amount of money raised in the initial public offering, buy-ins from venture capitalists and investment bankers, and perhaps, a bond debt offering or several for additional cash. If the small cap company does not turn a profit in a given time frame, it must go, hat in hand, back to the bank (and others) to convince lenders that they do indeed have a product that will earn millions in the future, and request more operating cash on that premise.

If the confidence in their company and stock is shaken badly by rumours, loss of consumer interest, and earnings shortfalls, their prospects for additional cash infusions become dim to none. In truth, rumour becomes reality, the stock goes into a free-fall; analysts start rating the company by the number of free cash weeks left (cash left to cover operating expenses).

When that's gone, dot.com and tech companies fold like fans, with one of the last indignities before bankruptcy being placed on the delisted stock list. In the meantime, disillusioned employees who flocked to these kinds of companies and worked so hard for the promise of riches garnered through stock options, are faced with little to show for such a promising time as well.

This scenario does not happen to all small caps; many, many of them go on to become lumbering giants. They all started in a small way. On their way to that target, small caps run through explosive growth and can add tremendous pop to a diversified asset mix.

Bonds are added to asset mixes because generally, they react in an opposite way to stocks. High-grade bonds are considered safer than stocks, usually pay a nice dividend every six months, and can be bought and sold just like stocks.

Who would ever think that General Electric, for instance, could default on a bond? Fixed deposits and your very own home real estate also play a part in an asset mix. Your home or rental property usually appreciates at a slower rate than stocks and can also be very illiquid. While having a totally paid off mortgage is great from a pride and psychological perspective, a short-term demand for cash can squeeze you into making a force decision to sell, perhaps having to accept far less than your lovely home may be worth. This, then can be the beginning components of a very basic beginning diversified portfolio.

There are many other ways to try and limit the risk of all of your assets heading under water; far too many to list here or discuss in any detail. You can diversify by sectors of stocks and bonds, countries, value and growth, statistical correlation or lack thereof, kinds of managers, kinds of styles and so on.

But for purposes of showing diversification of a smooth return over time that maybe greater than fixed deposits, this is what we will be working with. Note that this is the whole purpose of taking on risk in investments with no guarantees; to leverage your total portfolio to a higher rate of return.

Let's take a look at the three charts at right. Keep in mind that this is a representation of a general concept.

Chart A Each investment is represented; fixed deposits earning around 5 percent, real estate between 5 and 7percent, large cap stocks around 12 percent, small cap anywhere from 13 percent -- 100's of percents, options, commodities for the daring, reckless and savvy investors. Everything is positive; this is a dream portfolio. Note that more than 50 percent is invested in the most risky investments. We should all be so lucky and many were during the last ten years of a bull market and the longest period of prosperity in US history.

Chart B And this is what happened in April of 2000 to so many investors holding large positions in small cap companies, and other risky investments.

Chart C Represents the smoothing out or weighting process by diversification.

We may be using essentially the same investments but in totally different proportions.

Some investments may be up, some may be down but overall and over time, you are achieving a better rate of return than investments in fixed deposits alone. Note that in all three charts, the fixed deposits trundle on at about the same rate.

It has been said that there is no such thing as a perfect portfolio, that is, all investments showing great continuous gains. The technique in managing a portfolio to try and achieve an overall average positive return is not learned overnight. It is comes with experience, patience and the culmination of financial planning with long-term goals and objectives in mind.

Martha Harris Myron CPA is a Bermudian, a NASD Series 7 license holder, a United States Tax Practitioner and a Comprehensive Financial Planner. She is Programming Director for the Financial Planning Association of Bermuda.

Under no circumstances are the comments in this column to be taken as recommendations on the purchase or sale of securities or any other investment.