Archive for Sunday, April 1, 2001

Mull asset allocation, new investment when stocks seem scary

April 1, 2001


What now?

If you're not tearing your hair out over this stock-market disaster, you must at least be scratching your head. Is it time to dump stocks? Buy more?

Well, I'm not going to predict whether the market's headed up or down other than to stick with my belief that 10 years from now, stock indexes will be much higher than they are today. By then, most of us will be at a loss to recall just how much we lost, on paper or for real, in the bear market of 2000-2001.

An investor who can afford to keep money tied up for 10 years or longer probably should avoid the impulse to do anything radical today with an existing portfolio. If you were to dump stocks and stock funds now, how would you decide when to get back in? To make selling now pay off, you'd have to buy back when prices are lower. That takes a combination of nerve, judgment and luck that's hard to come by.

Still here are some things to consider:

l Asset allocation: The plunge in stocks, and in technology issues in particular, may have changed your mix of stocks, bonds and cash. Even if you invest primarily in a Standard & Poor's 500 index fund, technology stocks now make up only 19 percent of that index compared to 34 percent a year ago. That's because stocks with bigger capitalization share price times shares outstanding have more weight. Falling prices have reduced the techs' capitalization.

Clicking for analysis

The best way to assess asset allocation is with computer software or an online service that does all the hard work. I've used the Quicken 2001 program as well as the free online version at Both use the semiannual reports filed by mutual funds to assess the user's fund holdings, in addition to tallying individual stocks, bonds and cash. And both have lots of useful data on the returns, based on past performance, that might be expected from various asset combinations.

But be careful not to take the advice of a robot too literally, as a slavish obedience to these recommendations could lead you to costly and unnecessary trading.

In my case, Quicken's online service figured that my portfolio's allocation should provide long-term returns averaging about 10 percent a year. It said about 63 percent of my portfolio is in big-company ("large-capitalization") stocks. I could expect about the same average annual return, and reduce my risk, by trimming the big-stock share to 41 percent. The program suggested I should put more into bonds, small-company stocks and international stocks.

What would I get for that radical surgery? I'd reduce my portfolio's expected "standard deviation" to 14.1 percent from 14.8 percent. This is a measure of how widely a portfolio's returns will vary from the average. In other words, with an average return of 10.2 percent and a standard deviation of 14.8 percent, I can expect that in two out of every three years the actual return on my portfolio will be somewhere between minus 4.6 percent and plus 25 percent.

By making the recommended asset shifts, I'd change that to minus 4.1 percent and plus 24.1 percent. But this virtually insignificant reduction in volatility wouldn't be worth the commissions, taxes and hassles involved.

While I'm going to just leave my allocations alone, it was worth checking whether my portfolio's projected risks and returns fit my long-term plan. Quicken, Microsoft Money 2001 and similar programs guide users in setting appropriate allocations.

Reducing tax bill

l Sell judiciously: If you decide to sell stocks or stock funds, you obviously should look first at those that you think have the greatest chance of losing money. But if you have a choice among those, select sales that will not trigger big tax bills on past profits.

One way is to confine selling to tax-sheltered accounts, such as 401(k)s and IRAs. The proceeds then can be moved into bond funds or money market funds in the same accounts.

If you must sell taxable investments, target those purchased at the highest prices. These will show the smallest profit, or largest losses, and therefore reduce your tax bill next year.

With a block of shares accumulated over time in a specific stock or fund, you can order your broker or fund company to sell just the ones for which you paid the most. This order should be made in writing. First ask the broker or fund company about the right procedure.

l New investments: Even an investor who decides to leave an existing portfolio alone may wonder what to do with new savings.

The traditional advice is to keep building stock investments with regular contributions regardless of whether prices are up or down. That way, you buy more shares when prices are down, minimizing your average cost over time.

But if stocks seem too scary, this isn't a bad time to put money into a short-term certificate of deposit or a money market account that allows a withdrawal at any time.

Plenty of six-month CDs are paying annualized rates exceeding 5.5 percent, while many money market funds are paying more than 5 percent. Today, a 10-year Treasury note only pays about 4.75 percent.

Usually, you get more from long-term investments in exchange for tying your money up. But things are upside-down right now because bond investors expect future rates to be lower than current ones, so you don't need to lock your money away for years to get the best yields.

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