| (for the purposes of protecting the privacy of this employee I have
entered this note without the identity of the author. Mail sent to me
regarding this reply can be forwarded to the author.)
One of the hardest things for me since I've been "managing my own money"
has been asset allocation and creating an investment model. I subscribe to
Sheldon Jacobs' monthly newsletter, "The No-Load Fund Investor", read Smart
Money, Money, WSJ, and Morningstar Reports to track opinions on the funds
I have invested in.
Some facts:
I'd like to retire within the next 8-10 years
I fully fund the 401K plan at work
I contribute 2K a year to an IRA
Based roughly on Sheldon Jacobs' model portfolios in his newsletter, I
constructed my own portfolio (based on my risk tolerance and years till
retirement).
As I get within 5 years or so of retirement I plan to move more into
bond/fixed-income funds, to a 25-30% weighting. However, the allocation
now looks like this:
65% equities
- Growth 20%
- Growth/Income 20%
- Income 20%
- Aggressive Growth 5%
20% International
10% Bonds
5% Cash
********************************************************************************
Specifically, the breakdown of funds (with % of total portfolio) is:
Equities:
Fidelity Asset Manager 4%
Fidelity Blue Chip 4%
Fidelity Growth & Income 16% (1/2 in IRA)
Fidelity Puritan 14% (all in IRA)
Fidelity Select Health 1%
Vanguard Inst. Index 2% (401K)
Vanguard Windsor 7% (401K)
Banker's Trust Russell 2000 5% (401K)
Dreyfus Third Century 9%
Digital Stock 3%
******************************
International:
T. Rowe Price Intl. Stock 10%
T. Rowe Price New Asia 10%
******************************
Bonds:
MA Transport Municipal Bonds 7%
T. Rowe Price Spectrum Inc. 3%
******************************
Cash
Fidelity Cash Reserves 5%
While I realize that some of the funds I own have loads outside of IRA
accounts (Blue Chip, Growth & Income), I do not plan to make any additional
investments to any loaded funds. I'll buy similar no-load funds when I add
to investments in those categories. Also, all of the mutual funds I own
are recommended as "buys" in the newsletter.
I realize that Dreyfus Third Century has had almost two years of sub-par
performance, so I was thinking of switching it to the Peoples' S & P MidCAP
Index fund (also recommended). I was also considering Gabelli Asset fund
or Oakmark for the switch.
o Any comments on the mix and/or funds I have chosen (or am thinking
about)?
o If I switched Dreyfus Third Century to the Dreyfus Midcap Index fund,
is having over 15% of a portfolio in index funds (broken up between
small, mid, and large cap) a wise thing?
I'll appreciate any comments/suggestions.
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| Focus On... 1994
- Kylelane Purcell, Morningstar 5-Star Investor, February 1994
In 1994, Diversification May Save 1993's Profits
Investors of all stripes made out like bandits in 1993, but the greatest
improvement from 1992's returns was scored by investors who jumped from cash
into more-volatile securities. Whether in the Asian markets, the over-the-
counter market, or even the junk-bond market, concentrating risk was the key
to 1993's profits.
In the absence of another blockbuster year like the one past, however, the
key to keeping those profits in 1994 will be the investor's skill in
diversifying his or her risks away. Although diversification may not be a
terribly innovative way to prepare for future events, it is one worth
re-emphasizing now that so many risk-averse investors have taken positions in
the stock, junk-bond, and international markets.
It's easy to see why investors spurned cash-equivalent securities in 1993.
Since 1991, when inflation first showed signs of a long lasting dormancy,
annual cash returns have averaged about 4%--a far cry from the 9.7% annual
average return these securities posted from 1980 through 1990. In 1993, those
returns fell to just above 3%, barely ahead of the 2.75% inflation rate.
Although most high-quality-bond funds have produced impressive total returns
in the early 1990s, their income payouts (the returns that fixed-income
investors rely on most) have sunk to 6% or lower--hardly digestible for
investors used to the 9% cash payouts of the 1980s. In this environment,
investors seem convinced that the only truly palatable returns--the ones in the
double digits--are to be had in the most-volatile markets.
This shift comes at a time when the traditional models of diversification
have lost some of the currency. Fifteen years ago, investment managers
typically advised their clients to hold a portion of assets in cash for
liquidity, a larger portion in stock for growth potential, another large portion
to bonds to provide steady income and to balance the volatility of stocks, and
a modest 5% to 10% stake in gold or real estate to keep inflation at bay. This
plan was appealing in its simplicity, but it was difficult to practice in the
1980s. Early in the decade, for example, extremely high yields on cash
equivalents drew investor moneys away from the stock market. Those investors
were among the few individuals spared losses during the 1987 crash: Bond,
stock, and even international funds slid in the days surrounding the crash.
Gold and real estate performed so poorly in the decade's later years that even a
modest presence of these securities depressed returns in the portfolios that
held them.
The meager inflation levels of the early 1990s, and the paltry fixed-income
returns that have accompanied those levels, have dealt yet another blow to
the traditional view of diversification. Low inflation has also led investors
to question the need for inflation hedges. These challenges have led personal
money managers to re-examine their asset-allocation ideas. The current
thinking emphasizes equities, de-emphasizes bonds, limits (and, in some cases,
eliminates) cash, and trades in real estate and gold for shiny new positions
in high-flying international stocks. As of the end of 1993, the average
balanced fund held 9% of its assets in cash, 52% in stocks, 35% in bonds, and
7% in foreign holdings.
Adding to the confusion, the supposedly opposing bond and stock markets have
moved together over the past several years (see graph at left..not included).
Indeed, much of the bull-market gains that both stocks and bonds have made over
the past five years owe to the same factor, namely rapidly declining interest
rates. Furthermore, despite tiny inflation growth in 1993, gold and real-
estate funds were among last year's big winners.
That confusion has made it difficult even for professional investors to gauge
appropriate asset allocations. A recent article in "Barron's" noted that
traditional measures of market sentiment among both individual and professional
investors are almost uniformly bearish; asset-allocation vehicles, which in
recent years have often reflected market sentiment, have an average cash
position near 15%. Despite this concern, however, equity mutual funds on the
whole are holding their cash positions down to about 8%--not an easy task during
a time of record mutual-fund asset growth. According to tracking firm INDATA,
cash levels among private pension funds have fallen to just 2.9%.
It makes sense for investors to follow in the footsteps of the professionals;
certainly, investors who shifted to the equity and international arenas in 1993
are pleased that they did so. In many ways, the recent shift toward stocks has
been both needed and welcomed, since investors have historically held too little
of their assets in stocks. For all their recent successes, however, stocks
still retain their place as volatile short-term performers. Perhaps 1994's
stock market will produce the serious correction that the bears anticipate;
perhaps it will be yet another year of equity success. No matter how
incongruous the behavior of the securities markets may have been in recent
years, diversification still provides the best means of preparing for any
contingency in 1994. And perhaps the best form of diversification is the
traditional one--with a slight modification.
Stocks should hold a prominent place in any asset-allocation scheme; so too
should bonds. Yet cash cannot be forgotten. Cash provides the only safe haven
in an overall bond- and stock-market correction; If rising interest rates
punish bond and stock investments alike, investors who retain some cash exposure
will suffer least.
The traditional view of inflation hedges, however, should be expanded to
include any holdings with either the potential to perform well in a high-
inflation environment or the long-term potential to significantly outpace
inflation. This portfolio element would include such supercharged investments
as international or emerging-markets funds, small-cap growth funds, or volatile
sector funds. This modification isn't necessarily a response to market changes
the 1990s have wrought, either: Investors in the mid-1980s could have
substantially bolstered the returns on their domestic portfolios by including
modest stakes in such booming foreign exchanges as Mexico and Japan.
This old-fashioned approach may not always provide double-digit gains, but its
winnings should be consistent, and more importantly, they should stay well
ahead of inflation. The cash investors of the 1980s enjoyed average annual
returns of 9.88%, which afforded an inflation-adjusted real annual returns of
4.75% per year. With inflation currently running under 3%, a portfolio need
only return a modest 7.75% annually to provide the real returns that the 80s
cash investor is already used to.
Any single asset allocation will not be appropriate for every investor;
individuals with a 20- or 30-year time horizon will naturally want to emphasize
equity exposure, and those seeking to buy a home three years from now will
prefer safer, more liquid fixed-income instruments. The traditional approach
to diversification, however, provides a useful template for every investor
that has the best chance to work well within the broadest variety of market
environments.
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