At Personal Finance, we have grown increasingly concerned with the national trend toward underfunded retirement plans. As a service to our subscribers, for the next few weeks we’ll send you a complimentary series of focused briefs to get you thinking about new ways to maximize performance both inside and outside of a structured 401k or similar plan. We hope you’ll find these briefs useful … if they are not applicable to your situation please click here to stop receiving the series.

Wall Street pundits say they divide the history of investing in the United States into two periods: before and after 1952.

Believe me, it’s a dividing line worth knowing – and knowing well – for future 401k Millionaires.

In that year, University of Chicago economic student Harry Markowitz published his doctoral thesis – a thesis that would make up the foundation for his breakthrough treatise on investing called Modern Portfolio Theory. Markowitz’ paper caused such a stir and impacted so many investors that he won the Nobel Prize in Economics in 1990.

What is Modern Portfolio Theory? In Markowitz’ view, ground zero for investors is avoiding risk at all costs.  Markowitz defines risk as a standard deviation of expected returns.

Loosely translated, instead of considering risk on a single security level, Markowitz emphasizes measuring the risk of an entire portfolio. When considering a security for your 401k portfolio, for example, don’t base your decision on the amount of risk that carries with it. Instead, consider how that security contributes to the overall risk of your portfolio.

Markowitz then considers how all the investments in a portfolio can be expected to move together in price under the same circumstances. This is called “correlation,” and it measures how much you can expect different securities or asset classes to change in price relative to each other.

For instance, high fuel prices might be good for oil companies, but bad for airlines that need to buy the fuel. As a result, you might expect that the stocks of companies in these two industries would often move in opposite directions. These two industries have a negative (or low) correlation. You’ll get better diversification in your portfolio if you own one airline and one oil company, rather than two oil companies.

When you put all this together, it’s entirely possible to build a 401k portfolio that has much higher average return than the level of risk it contains. So when you build a diversified portfolio and spread out your investments by asset class, you’re really just managing risk and return.

Diversification allows you to sell high and buy low

Markowitz has a good point about risk, and its implicit partnership with diversification.

After all, everybody’s heard the stories.

How the guy at the gym or the lady at the hair salon who made a fast killing on last year’s stock picks — or how a friend tripled his “investment” one morning at the horse track. These are all well and good, but they’re stories about gambling, not investing. It all amounts to risky business that’s fine for entertainment if you can afford it, but not for 401k planning. That’s because basing your financial decisions on guesswork not only prevents you from growing your money, but also increases your risk of losing it.

Which is one of the many reasons why I like diversification: it’s a technique that, combined with rebalancing, removes the guesswork and emotion from investing in your 401k.

Done with savvy and strategy, diversifying and rebalancing allows you to buy when the market is low and sell when it’s high. And if you remain disciplined, it’ll give you returns that far exceed your wildest expectations.

If you can’t get an answer from your company on 401k diversification, go ahead and drop us a line at the 401k Millionaire – we’ll answer your question promptly.

Good luck, and good 401k savings – and I’ll see you next week.

Brian O’Connell is an investment analyst at Investing Daily, and the editor of the 401K Millionaire. An ex-Wall Street bond trader, he has appeared as an expert financial commentator on CNN, NPR, Fox News, Bloomberg, CNBC, C-Span, CBS Radio, and many other media broadcast outlets, and is the author of two best-selling books on retirement investing.