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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 cash.

"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."

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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.

Asset allocation
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 needs.

-- Posted: Nov. 17, 2000

 

 

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