Allocate those assets, and watch them grow; Tinkering: Experts recommend that novice investors do what the professionals do: Diversify their investments among appropriate asset classes.; DOLLARS & SENSE


To the adage "don't put all your eggs in one basket," satirist Mark Twain once retorted: "Put all your eggs in one basket -- and watch that basket!"

Twain was a wonderful writer. He might not have made it as a portfolio manager, however.

How you apportion your eggs among the many available baskets available -- an exercise known as "asset allocation" -- could actually be more key to your investing success than the specific stocks, bonds or mutual funds you buy. Indeed, studies show that more than 90 percent of the difference between the returns earned by different investment portfolios is attributable to asset allocation.

"I spend 90 percent of my time on asset allocation," said Harold R. Evensky, a Miami-based certified financial planner and author of "Wealth Management: The Financial Advisers Guide to Investing and Managing Client Assets." "Most novice investors spend zero time on it."

Asset allocation disciplines you to diversify your investments. It forces you to confront your "risk tolerance" and to spend time studying the available investments. Available asset classes include, but aren't limited to: cash, Treasury bonds, corporate bonds, junk bonds, U.S. growth stocks, U.S. value stocks, foreign stocks, emerging market stocks, real estate and collectibles.

Experts say the first step in developing an asset-allocation strategy is honestly assessing just how much risk you can take -- a "gut check" to see if you can stomach the short-term, whipsaw movements of the stock market, or need the haven of such cash investments as certificates of deposit.

"A couple should stand in front of the mirror and ask: 'How much can we afford to lose?' " said Bill Bresnan, a finance commentator and author of "Getting Started in Asset Allocation."

They, or you, also need to decide how the money will be used, and when it will be needed. Money that will be needed soon -- say, for a down payment on a house -- should be placed in investments with less short-term risk. By contrast, with the advantage of a longer-time horizon, a big chunk of the money aimed at funding your newborn's eventual college education or your own retirement could be funneled into better-returning investments such as stocks or stock mutual funds.

Lastly, to allocate your assets properly, you have to decide how much money you will need, particularly for retirement, since that will help decide the kinds of investments you have to use. For instance, over the long haul, cash earns less than bonds, which earn less than stocks.

But, at any point, it's possible for the opposite to be true: Interest rates could jump, causing the market values of stocks and bonds to plunge, generating a negative return for both, meaning that plain old passbook savings could outperform these investments -- despite the passbook interest rate of less than 3 percent.

That's why risk-tolerance is so important, said Bresnan. Success as an investor demands a sound plan and a long-term commitment that will give that plan time to work. If you take on more risk than you can "tolerate," when times inevitably get choppy, you are apt to abandon your plan in a retreat to safety -- too often just as your strategy would have started to work.

When investors think about asset classes, they usually focus on cash, bonds and stocks, including mutual funds for each group. Each of these classes has subsets. For bonds, that includes junk bonds, investment-grade corporate bonds and government bonds, which include short- and long-term Treasury bonds and locally issued municipal bonds.

For stocks, the two broad categories are growth (shares in fast-growing companies that usually don't pay a dividend) and value (shares that have either been beaten down or just lagged behind a surging market, typically because the company is having some problems). Just like with bonds, growth and value shares can each come in many flavors: domestic, foreign, emerging-markets and technology, to name a few. What's more, each of these has an additional level of subsets: small-, medium- and large-capitalization shares.

Now you can craft your portfolio.

According to one rule of thumb, you subtract your age from 100 to determine what percentage of your money to place in stocks.

There's logic behind this task: Younger investors can afford to take more short-term risk, meaning they can have more money in stocks. That's just how this calculation plays out: The lower your age, the lower the number that will be subtracted from 100, the higher the resultant number -- the percentage of your money destined for stocks.

With this "Rule of 100," 65 percent of a typical 35-year-old's portfolio would be in stocks (100 - 35 years old = 65 percent). By comparison, only 35 percent of a typical 65-year-old's portfolio would be in stocks (100 - 65 years old = 35 percent).

However, Donald L. Cassidy, a Lipper Inc. analyst and finance author, advocates a bigger weighting in stocks. "People are living longer," explains Cassidy.

He's proposed the "Rule of 110," in which 75 percent of our 35-year-old's portfolio would go into stocks (110 - 35 years old = 75 percent). Even a 70-year-old would have a portfolio that's 40 percent invested in stocks (100 - 70 years old = 40 percent).

But such rules are only starting points. For instance, if you are 45, but have a high tolerance for risk, you might want stocks to make up more than the allotted 55 percent or 65 percent of your portfolio. Maybe your retirement saving started late because you had to pay for your children's college education.

Indeed, with the 20-year horizon of someone who is 45, the stock market's volatility is effectively "smoothed out," says Ned Notzon, president of the T. Rowe Price Spectrum funds, each a "fund of funds" that's essentially an exercise in asset allocation.

Within each asset class, investors must take a wide view, says Notzon. That's because the movements of different investments aren't correlated, meaning their values don't move in lock step. Thus, when stocks do poorly, bonds might do well. Or when foreign stocks do poorly, U.S. stocks might gain.

"People need to be broadly diversified, once they decide their tolerance for risk," Notzon says. "For instance, in the equity markets, they can't focus on just one market segment."

With bonds, for example, investors can't just concentrate on U.S. Treasury bonds or investment-grade corporate bonds. One example: Place 80 percent of the money allotted for bonds into high-quality "investment grade" bonds and the remaining 20 percent into junk bonds, Notzon says.

Just as they can with stocks, individual investors can use mutual funds as their investment vehicle for bonds. That saves on transaction costs, keeps the investor from having to examine the credit quality of individual bonds and provides diversification, which makes junk bonds a safer investment than you might think.

Stock holdings, too, must be diversified. In recent years, investors have increasingly embraced "index funds" -- mutual funds that mirror the composition, and performance, of an index such as the Standard & Poor's 500. But one index may not diversify your portfolio enough, since, for instance, the S&P; 500 is composed of large-capitalization stocks -- and not small- and mid-cap shares.

In addition, many investment gurus say foreign stocks should account for perhaps 10 percent to 20 percent of any long-term portfolio. Broad international stock funds provide enough diversification, experts say.

Emerging economies such as China, other parts of Southeast Asia and Latin America also present allure.

Investors can also include specialized funds, such as emerging-markets or high-technology funds, as a sliver of their portfolios as a means of playing these promising parts of the "New Economy."

Overall, a sound asset-allocation plan should leave an investor with six to seven well-chosen funds, according to Price's Notzon.

The final question is how to manage that portfolio. Financial experts say you should review it at regular intervals: Every month or each quarter, for instance.

Under one strategy, you periodically adjust your portfolio to maintain the asset allocation ratio you set for stocks and bonds. That means taking money out of the better-performing part of your investment cache and funneling it into the laggard portion. For instance, if your assets are apportioned 60 percent in stocks and 40 percent in bonds, and a rising stock market causes a 73/27 split, it might be worthwhile to sell enough stocks or mutual funds to bring the relationship back to 60/40.

With this approach, your portfolio will continue to be in synch with your risk profile.

Of course, with this particular strategy, you're consistently selling down your winners. And since stocks over the long haul outperform bonds, that means that most of the time you will be taking money out of the best-growing portion of your portfolio.

Another approach is to allow your investments to grow, without tinkering, which ultimately would result in a portfolio more heavily weighted toward stocks -- but greater in value than one being managed by a rebalancing disciple. That could induce nervousness -- and perhaps sleeplessness -- if your psyche isn't girded for such risk.

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