ARROYO GRANDE, Calif. (MarketWatch) -- Yes, they're on a roll, all eight passive "Lazy Portfolios" are beating the benchmark S&P 500 on a three-year and five-year basis.

Three of the eight got outrun by the S&P for the year, due to their exposure to REIT funds. But the short-term cycles aren't forcing changes in their long-term asset allocations. The real estate cycle always rebounds, plus housing is a fundamental sector in their portfolio diversification strategies.

The real big question: What's ahead for 2008? Our "Fab-8" team offers some fascinating insights about the year ahead, especially regarding rebalancing and taking profits now, asset-allocation changes and cutting back foreign equities.

So please, read closely what the team has to say after you review this summary of the current rankings based on five-year returns of the equity funds in each portfolio. These returns were calculated by Morningstar Inc. as of year-end 2007. The fixed-income allocation depends, of course, on factors like your risk tolerance, age and time to retirement:

Equity returns for 8 Lazy Portfolios

Portfolio Equity % No. of funds 1-year return 3-year annualized return 5-year annualized return Aronson Family Taxable 80% 11 13.54% 16.23% 21.47% FundAdvice Ultimate Buy & Hold 60 11 6.93 14.44 20.32 Margaritaville 67 3 10.51 14.01 18.63 Yale U's Unconventional 70 6 2.78 12.08 18.12 Dr. Bernstein's Smart Money 60 9 3.72 11.43 17.75 Dr. Bernstein's No-Brainer 75 4 6.79 11.59 17.47 Second Grader's Starter 90 3 8.83 12.31 17.02 Coffeehouse 60 7 -0.23 9.75 16.71 S&P 500 100 n/a 5.49 8.62 12.83

Source: Morningstar Inc. data as of Jan. 3.

Aronson Family Portfolio

Ted Aronson's AJO Partners manages $27 billion in institutional assets. The equity funds in his family's taxable portfolio averaged a return of more than 21% the past five years, thanks to his high 40% in foreign funds: But "I realize a change -- a big change for a lazy investor -- is needed. Time to take some profits off the table," says Aronson.

"For a U.S.-based investor, 40% international is way too high at this juncture. With the dollar's weakness goosing up foreign returns, and emerging markets having gone almost straight up for five years, time to trim the tree."

So Aronson is taking 10 whole percentage points "out of emerging markets and putting half into TIPs and half into high-yield bonds." His detailed reasons:

• Everything has gone up double digits over the past five years -- except bonds
• Emerging markets have gained 36% a year -- nearly a five-fold increase
• Dollar is weak retrospectively
• Moving money from emerging markets to junk bonds leaves plenty of capital at risk (how you make money)

So, since most portfolios are likely out of balance, Aronson recommends this key asset re-allocation: "If an investor held anything like 20% in emerging markets five years ago and was 'lazy' in the interim, your holding is more like 40% of the portfolio by now! Moving it down to 10% (from an original 20%) will entail lots of gains. C'est la vie." My translation: No one goes broke taking profits.).

Now comes this year's big lesson: Aronson warns that most investors will psychologically resist selling the big winners and buying lesser performers. But that's what rebalancing and "Modern Portfolio Theory" (the theory behind Lazy Portfolios) is all about. You stick to your asset allocations as sector performance waxes and wanes over the long-term. Otherwise you're just chasing hot sectors and engaged in high-risk market-timing.

Alternatively: If you're serious about your long-term results, instead of doing an end-of-year rebalancing, rebalance each month. But not by selling high performers, just add new money from your regular monthly savings program to keep your portfolio in line with the original allocations.

Fund

Allocation

1-year return

3-year annualized return

5-year annualized return

Vanguard 500 Index (VFINX)15% 5.39% 8.49% 12.69% Vanguard Emerging Markets Stock Index (VEIEX)20% 38.90 33.39 36.38 Vanguard European Stock Index (VEURX)5% 13.82 18.38 22.70 Vanguard Extended Market Index (VEXMX)10% 4.33 9.55 17.49 Vanguard High-Yield Corporate (VWEHX)5% 2.04 4.31 7.62 Vanguard Inflation-Protected Securities (VIPSX)10% 11.59 4.76 6.10 Vanguard Long-Term U.S. Treasury (VUSTX)5% 9.24 5.82 5.44 Vanguard Pacific Stock Index (VPACX)15% 4.78 12.89 18.80 Vanguard Small Cap Growth (VISGX)5% 9.63 10.06 17.20 Vanguard Small Cap Value Index (VISVX)5% -7.07 5.53 14.78 Vanguard Total Stock Market Index (VTSMX)5% 5.49 8.90 13.80 Total portfolio 100% 12.55 13.97 18.44

FundAdvice.com's Ultimate Buy & Hold Portfolio

The equity funds on FundAdvice.com's Ultimate Buy & Hold Portfolio also generated returns over 20% on a five-year basis. And Paul Merriman's keeping "the same asset allocation in 2008. But for many investors it's time to make major adjustments and rebalance back to the original asset allocation."

Also, you'll notice, this portfolio's held steady at 60% in equities for years while Aronson had 80% last year and is cutting back to 60%.

Merriman re-emphasizes the big lesson: "While the rebalancing process is simple it isn't easy because rebalancing requires selling part of what's been making you money and putting those excess profits into last year's poor producers."

Psychologically, it's "tough to sell a portion of your international funds (including emerging markets) and move that money into U.S. laggards (including REITs). That's why so few investors do it" and wind up losing when performance shifts.

Still, if you're committed to a passive investment strategy: Set your allocations. Pick indexes that match each asset class. Buy the low-cost index fund for each index. Then stick with your allocations long-term, rebalancing by adding new money from savings.

Fund

Allocation

1-year return

3-year annualized return

5-year annualized return

Vanguard 500 Index

6%

5.39%

8.49%

12.69%

Vanguard Value Index

6%

0.09

9.40

14.82

Vanguard Small Cap Index

6%

1.16

7.90

17.01

Vanguard Small Cap Value Index

6%

-7.07

5.53

14.78

Vanguard REIT Index

6%

-16.46

8.08

17.50

Vanguard Emerging Markets Stock Index

6%

38.90

33.39

36.38

Vanguard Developed Markets Index

12%

10.99

16.65

21.48

Vanguard International Value

12%

12.66

19.18

23.53

Vanguard Short-term Treasury

12%

7.89

4.44

3.34

Vanguard Intermediate-term Treasury

20%

9.98

5.09

4.20

Vanguard Inflation-Protected Securities

8%

11.59

4.76

6.10

Total Portfolio

100%

8.03

10.60

13.92

Margaritaville Portfolio

Here's proof you don't need a lot of funds to win big. The equity returns for Dallas Morning News columnist Scott Burns's megasimple three-fund portfolio also beat the S&P 500 with average returns near 19% on a five-year basis.

Scott's popular Margaritaville Portfolio has a third each in foreign equities, domestic equities and inflation-protected securities (which did surprisingly well in 2007 for fixed-income!).

Fund

Allocation

1-year return

3-year annualized return

5-year annualized return

Vanguard Inflation-Protected Securities

33.3%

11.59%

4.76%

6.10%

Vanguard Total International Stock Index (VGTSX)33.3% 15.52 19.13 23.45 Vanguard Total Stock Market Index 33.3% 5.49 8.90 13.80 Total portfolio 100% 10.87 10.93 14.45

Yale University Unconventional Portfolio

David Swensen is the supersuccessful manager of the Yale Endowment Fund. The equity returns of the six-fund retail portfolio in his bestseller "Unconventional Success" were down on a one-year basis due to 20% allocation in REITs. But he's still beating the S&P 500 by averaging over 18% longer-term.

Fund

Allocation

1-year return

3-year annualized return

5-year annualized return

Vanguard Inflation-Protected Securities

15%

11.59%

4.76%

6.10%

Vanguard REIT Index

20%

-16.46

8.08

17.50

Vanguard Long-Term Treasury Index

15%

9.24

5.82

5.44

Vanguard Emerging Markets Stock Index

5%

38.90

33.39

36.38

Vanguard Developed Markets Index

15%

10.99

16.65

21.48

Vanguard Total Stock Market Index

30%

5.49

8.90

13.80

Total portfolio

100%

5.07

10.04

14.41

Dr. Bernstein's Smart Money and No-Brainer Portfolios

Both the next two portfolios are from neurologist and financial adviser Dr. William Bernstein, author of "The Four Pillars of Investing" and the "Intelligent Asset Allocator." We first saw his nine-fund portfolio in his Smart Money column years ago. Bill shows the right attitude an investor should have toward passive long-term asset allocations:

"I really don't pay that much attention to these portfolios. I'm comfortable with them in the long run. I'll stick with them." And why not, he's looking at returns over 17% with both handily beating the S&P 500 on a five-year basis.

One final word of caution: "Your foreign equity should absolutely be no higher than it was in 2002. I'm certainly a good deal less sanguine about buying foreign equity than I was in 2002."

Smart Money

Fund Allocation 1-year return 3-year annualized return 5-year annualized return Vanguard Emerging Markets Stock Index 5% 38.90% 33.39% 36.38% Vanguard European Stock Index 5% 13.82 18.38 22.70 Vanguard Pacific Stock Index 5% 4.78 12.89 18.80 Vanguard REIT Index 5% -16.46 8.08 17.50 Vanguard Short-Term Investment Grade Index (VFSTX)40% 5.86 4.34 3.86 Vanguard Small Cap Index 5% 1.16 7.90 17.01 Vanguard Small Cap Value Index 10% -7.07 5.53 14.78 Vanguard Total Stock Market Index 15% 5.49 8.90 13.80 Vanguard Value Index 10% 0.09 9.40 14.82 Total portfolio 100% 10.89 10.65 9.21

No-Brainer

Fund Allocation 1-year return 3-year annualized return 5-year annualized return Vanguard 500 Index 25% 5.39% 8.49% 12.69% Vanguard European Stock Index 25% 13.82 18.38 22.70 Vanguard Small Cap Index 25% 1.16 7.90 17.01 Vanguard Total Bond Market Index 25% 6.92 4.51 4.35 Total Portfolio 100% 6.82 9.82 14.19

Second-Grader's Starter Portfolio

Also, no changes in Kevin Roth's three-fund Second-Grader's Starter Portfolio. And why should the kid change; his equity funds topped the S&P 500 with 17% returns. Once again proving anyone can set up a winning portfolio with just a few funds!