Allocate those assets, and watch them grow

Tinkering: Experts recommend that novice investors do what the professionals do: Diversify their investments among appropriate asset classes.

Dollars & Sense

October 03, 1999|By William Patalon III | William Patalon III,SUN STAFF

To the adage "don't put all your eggs in one basket," satirist Mark Twain once retorted: "Put all your eggs in one basket -- and watch that basket!"

Twain was a wonderful writer. He might not have made it as a portfolio manager, however.

How you apportion your eggs among the many available baskets available -- an exercise known as "asset allocation" -- could actually be more key to your investing success than the specific stocks, bonds or mutual funds you buy. Indeed, studies show that more than 90 percent of the difference between the returns earned by different investment portfolios is attributable to asset allocation.

"I spend 90 percent of my time on asset allocation," said Harold R. Evensky, a Miami-based certified financial planner and author of "Wealth Management: The Financial Advisers Guide to Investing and Managing Client Assets." "Most novice investors spend zero time on it."

Asset allocation disciplines you to diversify your investments. It forces you to confront your "risk tolerance" and to spend time studying the available investments. Available asset classes include, but aren't limited to: cash, Treasury bonds, corporate bonds, junk bonds, U.S. growth stocks, U.S. value stocks, foreign stocks, emerging market stocks, real estate and collectibles.

Experts say the first step in developing an asset-allocation strategy is honestly assessing just how much risk you can take -- a "gut check" to see if you can stomach the short-term, whipsaw movements of the stock market, or need the haven of such cash investments as certificates of deposit.

"A couple should stand in front of the mirror and ask: `How much can we afford to lose?' " said Bill Bresnan, a finance commentator and author of "Getting Started in Asset Allocation."

They, or you, also need to decide how the money will be used, and when it will be needed. Money that will be needed soon -- say, for a down payment on a house -- should be placed in investments with less short-term risk. By contrast, with the advantage of a longer-time horizon, a big chunk of the money aimed at funding your newborn's eventual college education or your own retirement could be funneled into better-returning investments such as stocks or stock mutual funds.

Lastly, to allocate your assets properly, you have to decide how much money you will need, particularly for retirement, since that will help decide the kinds of investments you have to use. For instance, over the long haul, cash earns less than bonds, which earn less than stocks.

But, at any point, it's possible for the opposite to be true: Interest rates could jump, causing the market values of stocks and bonds to plunge, generating a negative return for both, meaning that plain old passbook savings could outperform these investments -- despite the passbook interest rate of less than 3 percent.

That's why risk-tolerance is so important, said Bresnan. Success as an investor demands a sound plan and a long-term commitment that will give that plan time to work. If you take on more risk than you can "tolerate," when times inevitably get choppy, you are apt to abandon your plan in a retreat to safety -- too often just as your strategy would have started to work.

When investors think about asset classes, they usually focus on cash, bonds and stocks, including mutual funds for each group. Each of these classes has subsets. For bonds, that includes junk bonds, investment-grade corporate bonds and government bonds, which include short- and long-term Treasury bonds and locally issued municipal bonds.

For stocks, the two broad categories are growth (shares in fast-growing companies that usually don't pay a dividend) and value (shares that have either been beaten down or just lagged behind a surging market, typically because the company is having some problems). Just like with bonds, growth and value shares can each come in many flavors: domestic, foreign, emerging-markets and technology, to name a few. What's more, each of these has an additional level of subsets: small-, medium- and large-capitalization shares.

Now you can craft your portfolio.

According to one rule of thumb, you subtract your age from 100 to determine what percentage of your money to place in stocks.

There's logic behind this task: Younger investors can afford to take more short-term risk, meaning they can have more money in stocks. That's just how this calculation plays out: The lower your age, the lower the number that will be subtracted from 100, the higher the resultant number -- the percentage of your money destined for stocks.

With this "Rule of 100," 65 percent of a typical 35-year-old's portfolio would be in stocks (100 - 35 years old = 65 percent). By comparison, only 35 percent of a typical 65-year-old's portfolio would be in stocks (100 - 65 years old = 35 percent).

However, Donald L. Cassidy, a Lipper Inc. analyst and finance author, advocates a bigger weighting in stocks. "People are living longer," explains Cassidy.

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