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Jay Schabacker, Editor of Mutual Fund Investing, has been writing award-winning financial advisories for the past 18 years. His advice and informative contributions have been used by such sources as Money, Kiplinger’s Personal Finance, Financial World, Personal Investor, The Wall Street Journal, CNBC and Barron’s. A graduate of Cornell University, Jay is the author of the highly acclaimed Winning in Mutual Funds, published by Amacom. His e-mail address is MFI@Phillips.com.
For a free issue of Mutual Fund Investing, please call 1-800-US-FUNDS. |
Now, don’t get me wrong! I believe in diversification as a means of lowering investment risk. You see, even before mutual funds were invented -- or were as popular as they are now -- we owned stocks/common stocks, and we needed to be diversified. What if you bought a stock that your broker told you was going to be a winner -- and your broker was wrong - and the investment went south with all your life savings along with it. So, we learned to diversify our investments in portfolios. Soon the idea of diversification developed into the idea of -- a sort of "asset allocation". In the stock arena, this meant spreading your risks by having a railroad stock, a utility stock, a telephone stock, a steel company stock, etc. Fast forward to the day of mutual funds and diversification -- and asset allocation has taken a giant step in breadth, scope, and complexity. As an example, Morningstar lists a total of fifty-six asset classes covered by mutual funds -- too numerous to list here -- or invest in. But, you can understand that the asset allocation that you have available now really runs the gamut -- large cap value U.S. stocks, Pacific Basin stocks, precious metals, real estate, short term bonds, high yield bonds, municipal bonds, cash. The list just goes on and on. Almost all of us know that a mutual fund by nature gives us diversification. A fund such as Janus Twenty diversifies its portfolio over twenty stocks, while Vanguard Index 500 diversifies its portfolio over the major five-hundred companies in the Standard & Poors 500. Good! This has been a cornucopia of great investment results over the last five years -- blowing away most other major markets. For the last five years, the U.S. large-cap S&P 500 and the Vanguard Index 500 - has performed at about 22% average return per year. Diversification -- yes! But, who needs "asset allocation"? In 1998, emerging markets lost 26%, Pacific Basin stocks lost 15%, precious metals lost 12%, bonds gained just 7% and cash gained just 5%. What gives here? Once again, is the need for asset allocation dead? Yes, it is dead if, from now on, investors just pour money into the largest blue chip stocks of the U.S. or the index funds owning the largest companies - driving the largest companies further up in price. I surmise that there may be two reasons for this current phenomenon. 1.) people are scared of small companies as the millennium approaches -- as the small companies - and emerging markets - may be unprepared for Y2K; and 2.) the new tax code benefits mostly those that go for long term capital gains - where it is best obtained by investments in low turnover growth stock index funds. But, come the new millennium, I believe that asset allocation will be proven to be alive again. I have a theory that shows stocks and bonds to be stressed when inflation is low and cash and precious metals to be stressed when inflation picks up again. If inflation picks up, you will be glad for asset allocation. The fact that bonds, cash and precious metals have not been winners for the last five years does not mean that one or two of these asset classes (we should also add real estate as an asset class here) will not be a winner over the next five years. Hang in there. Come the new millennium, asset allocation will really prove its usefulness. Asset allocation is not dead! |
