Tech's bust shows need to diversify

Portfolio: A healthy investment mix is a wise thing, but some basic guidelines such as goals and tolerance for risk still apply.

Dollars & Sense

October 28, 2001|By Meredith Cohn | Meredith Cohn,SUN STAFF

The investor who sank all his savings into a small set of sure-fire dot-com stocks two years ago expecting to retire early is likely still at his job, according to financial planning experts.

The investment strategy may have seemed like a safe get-rich-quick scheme just a short time ago, as tech shares skyrocketed.

"But many people got their clocks cleaned," said Manny Schiffres, a senior editor at Kiplinger's Personal Finance.

Schiffres and other investment experts said the heady days of the tech boom - and subsequent bust - gave investors a sharp lesson in one of the hallmarks of a good investment strategy: diversification.

A diverse portfolio - with investments in different securities, industries and even countries - is the key to success.

Gene Swanson, professor of finance and head of the MBA program at the Johns Hopkins University, said investors are rewarded over the long haul for taking risks. For example, historical returns show stocks will outperform fixed-income securities such as municipal or corporate bonds. And they will outperform Treasury bills and certificates of deposit.

So, why not just buy a bunch of stocks and let them ride?

Because while the reward may be greater, so is the risk, he said.

"People get in trouble by thinking the laws of risk and return never get repealed," Swanson said.

So in planning the appropriate ratio of assets, investors need to consider their goals, time frames and tolerance for risk.

Schiffres cited the example of a 30-year-old apartment dweller whose wife has just had a baby.

He's saving to buy a car next year and a house in three years, plans to send the child to college in 18 years and to retire in 35 years.

Investments for the car would be the most conservative - Treasury bills rather than more volatile stocks. Investments might be a bit more aggressive for the house and be the most aggressive for college and retirement.

John Dolan, president of Silver Spring-based Dolan Financial Corp., said diversification has to be tailored for each investor.

"I start by getting information from them rather than telling them what to do," he said.

Dolan makes sure they understand the risks involved.

Financial planners call it the "sleep" factor: Investors have to be able to sleep at night, he said.

Dolan said the risk diminishes, but never disappears, as the portfolio is diversified. Diversity comes with a mutual fund, but not enough. Investors might need some large-cap stock funds and some international stock funds.

"The reality is that some might be doing well, and some might be doing poorly," he said.

Stock diversity can be achieved in other ways, too, said Jonathan P. Murray, a financial adviser and wealth management specialist at Legg Mason Wood Walker Inc.

There are value stocks, also called bargain stocks, that investors purchase when the price has dropped. And there are growth stocks, which are an industry's best performers and more costly.

They do not perform well at the same time, so it is smart to have both types, he said.

The bottom line is that numbers matter, as Murray points out to clients who want a 10 percent annual return.

If you have two stocks and one loses 75 percent of its value, the other must provide a 95 percent return. If you have four stocks, and one loses 75 percent of its value, the other three would have to return 38.3 percent. If you have 25 stocks and one loses 75 percent of its value, the others need only return 13.5 percent.

"That says it all," he said.

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