If you've picked up an investment periodical lately, you've seen how much ink has been spent on the topic of our "lost decade." This infamous moniker, of course, is the direct result of the broad U.S. market's struggle over the past 10 years. One needs only to look at the Vanguard 500 Index fund, for example, to see what the buzz is all about. For the trailing 10-year period through Aug. 15, 2008, the fund returned a meager 2.8% annually. That's low enough for most investors to just throw up their hands and move money to the much less volatile Vanguard Total Bond Market fund—a proxy for the Lehman Brothers Aggregate Index—which has delivered a 5.4% average annual return over that same stretch. Some investors have even made the switch to certificates of deposit.

So, yes—investors clearly have something to fret about when they look at the past decade. But who bears the ultimate responsibility for the poor investor returns? Behavioral finance theorists and seasoned market-watchers would probably answer "the investor."

Now, let's turn the clock back to 1998 and paint a picture of that market environment. It was fairly upbeat, when the broad market had adroitly negotiated around such events as the Asian financial crisis, and was in the early days of fueling a tech boom. Financial journalists had returned the usage of the "Nifty 50" to their lexicon. Quite simply, it was a big party and the largest stocks were leading the way. In fact, the Vanguard 500 Index returned as much as 28.62% in 1998, and followed with an encore performance in 1999, delivering more than 21%. Investors couldn't get enough, sending the fund's assets above the $100 billion level by late 1999, more than double its size at the end of 1997.

As is always the case, though, investors were once again blindly chasing performance. As they saw the broad market rise, they plunged in, investing in large-cap equities in large numbers. It was the same bad movie all over again, as the results unfortunately have shown.

But it wasn't a lost decade—not by a mile. Instead, investors who built diversified portfolios and made a concerted effort to manage their portfolios with a contrarian bent thrived. Just think back to what was out of vogue in the late 1990s—small-cap stocks and foreign stocks, for example, not to mention emerging markets and commodities. A moderately aggressive investor who rebalanced annually and held a diversified portfolio of these asset classes plus domestic equities, bonds, Treasury Inflation-Protected Securities and cash would have earned more than 7% per year over the last decade. (This is based on a portfolio of 29% large-cap U.S. stocks, 8% small-cap U.S. stocks, 20% long-term U.S. government bonds, 10% cash, 5% commodities, 5% TIPS, 18% international and 5% emerging equities.)

Those asset classes were largely abandoned as the S&P 500 roared to new heights, but in more recent years it's been those very same asset classes that have risen, more than compensating for the underperformance of large-cap equities. If you've invested in any of those asset classes, you've had anything but a lost decade, even if you've had some portion of your portfolio allocated to U.S. large-cap stocks, as is likely the case.

Of course, the danger now is that, given investors' behavioral tendencies, the next 10 years might really be a lost decade. Flows into foreign and small-cap stocks as well as commodity funds continue to be strong. Despite the fact that chasing performance rarely works out well, investors are betting that the above-mentioned asset classes will continue to escalate unabated. Meanwhile, they are abandoning the stocks of high-quality U.S. companies precisely when those investments are at their most affordable level. The result is that investors who have already been whipsawed by devoting too much money to these stocks in the late 1990s are now ironically likely to be hurt over the next 10 years because they are under-allocating to such stocks.

What Should Investors Do?

At Morningstar Investment Services, we believe that the first step toward fighting your behavioral instincts is to build a diversified portfolio. Once that simple but important goal is met, the next step is to consciously position your portfolio to take advantage of anomalies in the market. To do so, we recommend that rather than piling into yesterday's winners, you instead consider reallocating assets annually to out-of-favor asset classes. Right now, that means overweighting large-cap stocks, particularly in the United States. In fact, noted institutional manager GMO now rates the prospects for high quality U.S. stocks quite favorably. In its seven-year forecast made at the end of July 2008, GMO predicts a 7.5% annual return for U.S. high quality stocks, well above its forecast for domestic small-caps.