IU: What do you think about exchange-traded notes (ETNs)?

Clements: The tax issue aside, I think of ETNs in the same way I think of ETFs. They're offering investors a way to tap into different market segments. Yes, some ETNs are narrowly focused, but some of them are pretty broad, like the commodity ETNs that Barclays Capital introduced based on the broader-based commodity indexes. I'm, of course, aware that—in the case of the iPath funds—they're obligations of Barclays Bank. But unless you think Barclays is going under—which I don't—they seem to be basically the same as an ETF and should be thought of that way.

IU: Do you believe fundamental indexes are a better or worse option than capitalization-weighted indexes?

Clements: If you want to guarantee that you're going to outperform most actively managed funds in a particular market segment, you want to buy a market-cap-weighted index fund. If you buy anything that deviates from market-cap weighting, you are making a market bet. You're not replicating the market, so there's a risk you will fare worse than most active investors.

Fundamental indexing is basically just another way of value indexing. But I don't want to sound too dismissive. I think that fundamental indexing is a brilliant rearticulation of the value concept. I really like the notion that stocks have a fundamental value, that the market is noisy and thus that share prices will stray from those fundamental values. I think that's a great way to think about value investing. But in the end, fundamental indexing is a value tilt. It is a market bet that may not pan out. If you want to guarantee that you'll outperform most investors, you still need to be doing market-cap weighting.

IU: Is a recession a time when people should take another look at their portfolios to see where they're at with them?

Clements: My investment process is really very simple. You build that globally diversified portfolio. For every fund you own, you should have a target portfolio percentage. If you allocated 5% to emerging markets, the economy goes into a recession and emerging markets get creamed, then at some point you should step up to the plate and rebuild your position back up to 5%. If you set target portfolio percentages and you regularly rebalance, you'll find yourself buying low and selling high.

IU: Should investors be worried about the housing market and take it into account in their investment portfolios?

Clements: Everybody knows that the housing market is in rotten shape. That's not news. So presumably that's already pretty fully reflected in market prices. What you want to worry about is the stuff that's not known by the market. The problem is, we don't know what that is. News by definition is unknowable.

The message here is, "Stop trying to be so clever." If the market knows, it's already reflected in prices. If the market doesn't know, you sure aren't going to figure it out on your own.

IU: How important do you think international diversification is, and at what point do you have enough of it?

Clements: In the 1990s, I was saying that people should have 30% of their stock portfolio abroad, and that's the number I still use. Back in the 1990s, people would write to me and say 30% is way too much. Now, I hear from people who say 30% is way too little, and you should have half your money abroad. Clearly, there is a lot of performance chasing going on.

In the 1990s the U.S. market was a great place to be and foreign markets were not so good, so everybody wanted to be invested in the U.S. market. In the current decade, foreign stock markets have done far better than the U.S. market and everybody wants to be heavily invested abroad. But you can't buy past returns. What you get is the future.

I think a 30% allocation is probably about right. That will give you a decent amount of diversification, and it also fits with the liabilities that you're looking to fund. When you retire, you will be spending your money on the early bird special at U.S. restaurants, you'll be getting the blue rinse special from a U.S. hairdresser and you're going to go to bed at night in a U.S. nursing home. Most of your liabilities are going to be in U.S. dollars, so you probably want to have the bulk of your stock portfolio invested in U.S. stocks.

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