The basic principles of asset allocation need to be revised," says MIT finance professor Andrew Lo. He and other experts argue that since market volatility is rising, you must now own other assets—such as hedge-fund-like investments—in addition to stocks and bonds to manage risk. And you must be prepared to shift your mix tactically from time to time. "You need to be proactive and adjust as the market changes."

Andrew W. Lo, a finance professor at MIT, enjoys a setup that many other academics would envy: tenure at a top university, opportunities to earn extra money through consulting, and acclaim for his research. That's not enough for Dr. Lo. He wants to show the world that his theories and computations can generate profits to investors. "If you go into finance instead of math, you're interested in having an impact," he says.

MIT Sloan Prof. Andrew Lo says, "Everyone lost out last year due to the tremendous volatility in markets. But the typical retail investor is left to their own devices in managing disloction, and some product innovation is needed to help with this."