Diversify, and think long term

STAYING AHEAD

June 06, 1994|By JANE BRYANT QUINN | JANE BRYANT QUINN,Washington Post Writers Group

NEW YORK -- Whatever happened to the safety net that many investors thought they had? Their strategy was to diversify. They thought that by buying different types of mutual funds, they'd always have at least one or two that were going up.

Then came the decline of '94. Practically every market got hit: U.S. stocks, emerging markets, many foreign-country funds, short- and long-term bonds, even gold-stock mutual funds.

So what went wrong? Is asset allocation just another fad that investors should forget?

Absolutely not. It's the best long-term strategy you could have. You simply may need more information about how it works and what it does.

Asset allocation doesn't stop your investments from losing value when markets go down.

But it does save you from having most of your money in sectors that do the worst, says Marshall Blume, a finance professor at the Wharton School.

Asset allocation also stops you from having most of your money in the sectors that do best. But you can't guess which those will be in advance. Even if you get just average performance in rising markets, you'll come out ahead as long as you don't lose a lot in the years when the market goes down.

Investors also need more schooling in how to diversify. You haven't done it if you own Twentieth Century Growth, Berger 100 and Fidelity Magellan. Those are all growth funds. They'll all rise and fall at about the same time.

Instead, you need funds that perform differently from each other, says Carmen Thompson, a consultant at the investment research firm Ibbotson Associates in Chicago. When one fund is performing poorly, you want others that are doing better (either rising in value or not declining as much).

Take international stocks. Over the past five years, they have sometimes moved with U.S. stocks and other times, not. But Ibbotson data shows that their diversification effect is good. They could easily cushion your portfolio when the American stock market drops.

During the recent market decline, you saw pretty big losses in some narrowly targeted foreign funds, especially those invested emerging markets.

But the well-diversified internationals gave you exactly the cushion you'd want. While general U.S. funds dropped 3.1 percent from January through the middle of May, the international funds rose 2.1 percent.

Between them, that's practically no loss at all.

Small stocks are more likely to move in the same direction as big stocks, so there's not as much protection there. But they move differently enough to give you some benefit from this mix.

Bonds have traditionally cushioned the risk of owning stocks. Prior to 1970, there was no relationship between the movements of stocks and bonds, says Ibbotson managing director Scott Lummer, which made them an ideal diversification.

Since then the relationship has gotten closer. Still, stocks and bonds make a good match for asset allocators. "We won't always see the lock-step movements we have in the last month," Lummer says.

There's no good price index for real-estate values, to see how much diversification you really get from owning property. As a proxy, investors might use real estate mutual funds or real estate investment trusts (the trusts can be bought on stock exchanges). Although these funds and trusts behave much like stocks, they do offer some diversification. So far this year, the real-estate funds are up 1.5 percent.

The commodities indexes tend to move in the opposite direction from stocks -- a fine example of investments that can go up when stocks go down.

But averages are one thing; making money in commodities or commodities funds is another. I wouldn't risk them unless I had Hillary Clinton's cattle-futures broker.

Gold stocks usually move differently from other stocks, but this year they, too, sank.

The disinterest in gold in recent years shows up the human weakness that can torpedo good asset allocation. We think we want to be in the key sectors. But we dump assets that have been weak for a while, thus wrecking our long-term allocation goals. Last year, gold stocks came roaring back, rewarding investors who stuck by them.

But there's no such thing as a perfect hedge for all markets.

If you got burned in this decline, reconsider how good your allocations have really been -- and try again.

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