Your assets should have class
One of the best ways to reduce
investment risk is to have a diversified portfolio. Diversification
entails spreading your money among a number of different types of
investments or asset classes, such as stocks, bonds and cash. Among
these investments, you can diversify even further, into large and
small or domestic and international companies.
In the old days, financial experts
used a simple formula to help people with their investments: older
people should buy bonds and younger people should buy stocks. As
you can probably guess, it's not that simple anymore.
Many experts now recommend that
portfolios be based not only on the investor's age, but also on
the investor's tolerance for risk and expectations for performance.
The portfolio likely will include stocks, bonds, mutual funds and
"One of the key things is not to
put all your money into one asset or specific type of asset," says
Harvey Hirschhorn, portfolio manager of the Stein Roe Balanced fund.
"If you had put 100 percent of your money into Asia a couple of
years ago, you wouldn't be thinking that the 1990s was one of the
greatest bull markets of all time."
When you diversify, it prevents
one poor investment from ruining your entire portfolio. One of the
most effective ways to diversify is to invest in mutual funds, especially
if you don't have enough money to buy a lot of individual stocks.
The case against diversity
However, some very successful investors have made bets on a handful
of stocks and won. They say having a concentrated portfolio is less
risky than you think. J. Morton Davis, author of From
Hard Knocks to Hot Stocks: How I Made a Fortune Through Smart Investing
and How You Can Too, quotes Mark
Twain: "Put all your eggs in one basket, but watch that basket."
If you're going to be in the stock market, you must be willing to
embrace the risk, Davis writes. If you want to outperform the market
averages, you should be very aggressive with 30 percent of your
portfolio -- otherwise, you might as well buy mutual funds.
Although a diversified portfolio
won't completely eliminate risk, it's one of the best ways to protect
yourself during market corrections or crashes. You can get help
diversifying your portfolio by using computer software programs
or consulting an investment professional.
If you think diversification is a good idea, you'll love asset allocation.
According to many studies, most
of your portfolio's return is determined by how you allocate your
assets among different types of investments. These studies show
that asset allocation is the most critical factor in determining
your portfolio's long-term performance.
Advice on asset allocation has
changed over the years. Several years ago, investors were told to
put 50 percent in stocks and 50 percent in bonds. Others recommended
60 percent in stocks, 30 percent in bonds, and 10 percent in cash.
Then the financial experts said to subtract your age from 100 and
invest the percentage into stocks. For example, if you are 35 years
old, you subtract 35 from 100 and you end up with 65 percent into
stocks and 35 percent into bonds. Although some people still use
this simple calculation to determine how to divide their investments,
many experts recommend that you don't use this calculation.
Risk and time horizon
The new strategy is to base your asset allocation on two factors:
the amount of risk you are willing to take and your time horizon.
In addition, many experts advise that a portion of your money be
invested in stocks, no matter what your age.
Harvey Hirschhorn believes that
individuals don't always give enough thought to asset allocation.
"If you get the asset allocation right and you have X percent in
stocks and Y percent in fixed income, that can go a long way to
provide you the kind of returns you need over the long-term vs.
a lot of shifting in and out."
Elaine Garzarelli, president of
Garzarelli Capital Management, agrees. She says many individuals
make the mistake of being too conservative by allocating too much
into cash. If you're younger, you should have 70 percent or more
in stocks; if you're older, you should put in less.
No matter what your age, you should
spend a lot of time thinking about asset allocation. Most brokerage
companies are willing to help. If you feel you need a more thorough
analysis, you can always hire an investment adviser or financial
planner to design a portfolio that meets your specific financial
-- Posted: Nov. 17, 2000