Diversification can protect you

Experts recommend deploying assets for growth with safety

Stock turmoil

March 19, 2000|By Eileen Ambrose | Eileen Ambrose,SUN STAFF

Financial advisers drill into their clients the basics of sound planning: asset allocation, diversification and sticking with a long-term investment strategy.

But that message is frequently being drowned out by the gangbuster performance of the technology sector, causing investors to chase the latest hot technology stock.

"It's a continual battle to educate clients," said Lyle Benson, president of L. K. Benson & Co., a financial planning firm in Towson. "The battle gets tougher when you have times like this when there's such disparities of return."

Investors may be more inclined to listen now because of the recent wild swings in the market.

A week ago, the talk was whether a bear market was about to overtake the "old economy" stocks making up the Dow Jones industrial average. Then on Thursday, the Dow had its biggest ever single-day point gain, 499.19 points.

The Nasdaq, which is heavily weighted with technology stocks, seemed more immune to downturns. Then early last week it shed nearly 10 percent of its value before recovering.

A week ago "the so-called new economy stocks were hot. This week, the old economy stocks are hot. As an investor you have to keep your head on straight and not be swayed by the wild swing of emotion," said Jordan Goodman, author of "Everyone's Money Book."

And more wild swings are expected, he said.

So how do you keep your portfolio less susceptible to market swings?

Start with asset allocation, which is how you divide your money among stocks, bonds and cash. The best allocation for you depends on your goals, tolerance for risk and how much time you have to invest.

The stock market is the place to invest money that you won't need for five years or more, experts said. If you need the money sooner, it needs to be parked in more conservative investments, such as a short-term bond fund or a money market fund, experts said.

Asset allocation doesn't guarantee the highest return, but instead spreads the risk and gives a more predictable rate of return, said Richard Stevens, a principal with the Vanguard Group.

It's easy with huge upswings in the market for the asset allocation to get out of whack, leaving investors with a greater percentage in stocks than desired. For instance, you may want 60 percent of your portfolio in stocks, but the bull market has pushed your holdings to 75 percent.

Review your asset allocation annually. When it gets off course by 5 to 10 percentage points, it's time to rebalance your portfolio to return to the desired allocation, Stevens said.

One way to do that without tax consequences is to direct new money into investments where you need to increase holdings, he said.

You can also shift money among asset classes in tax-favored retirement accounts, such as a 401(k) or individual retirement account, without any capital gains taxes, experts said.

Investors can further protect themselves in a volatile market by making sure they are diversified in the stock portfolio, experts said.

"People get so caught up in always owning the leader; it can happen so fast that something else comes into favor and they're out," said Judith Ward, a certified financial planner with T. Rowe Price Associates in Baltimore.

A well diversified stock portfolio includes small-, medium- and large-cap stocks, growth and value investments, foreign and domestic stocks. If, say, domestic stocks tumble, your international stocks may rise and soften the blow to your portfolio.

Another way to better stomach volatile markets is to invest by dollar-cost averaging, or by investing the same amount of money on a regular basis no matter if the market is up or down, experts said.

This way you buy smaller amounts of stock when prices are high and more shares when prices are low.

"Look at volatility as an opportunity," suggested Adam Spector, managing director of Brandywine Asset Management in Wilmington, Del.

Many good companies with healthy balance sheets have seen their stock prices pummeled in the past year, Spector said. This was a chance for investors who previously might have not been able to afford those stocks to get them at lower prices, he said.

"If you had done that in the past year, you were definitely rewarded," he said.

And it's easier to live through a volatile market if you keep realistic expectations, experts said.

More than 90 percent of the assets now in mutual funds have flowed in since 1990, Goodman said. That means many of those investors have never seen a bear market and have come to expect high returns year after year, he said.

"When the stock market keeps going up 25 percent a year, what's risk tolerance?" Goodman said.

Investors need to keep in mind that the historical average return for the stock market is 12 percent, Stevens said. "Going forward, that could be less."

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