newjerseynewsroom.com

BY WARREN BOROSON

NEWJERSEYNEWSROOM.COM

Here’s a strong argument for owning mutual funds rather individual stocks:

If you had owned the top 10 percent of stocks in the Standard & Poor’s 500 Stock Index for the ten years ending in 12/31/2010, your return would have been a delightful 23.8 percent.

Whereas if you had owned the bottom 10 percent of that stock index during that time, your return would have been a miserable minus 7.3 percent.

Now, the S&P 500 contains – as you might have guessed – over 500 stocks. So, even if you had owned 50+ stocks (10 percent of the S&P 500) during most of that time, you could have lost 7.3 percent of your investment.

Lesson: Even if you own lots of stocks, you can get badly hurt. Hence the powerful case for buying mutual funds instead of individual stocks, funds where typically you own 100 or more different stocks  -- and in different industries.

That was a point made by Maria Bruno in a talk she gave recently to a financial study group at the Institute for New Dimensions in Paramus.

Bruno, a CFP who is an investment analyst with the Vanguard Investment Counseling & Research, spoke recently about how to build a nicely diversified, all-weather investment portfolio.

The single most important investment decision, she said, is asset allocation: How much of your money should be invested in stocks, in fixed-income vehicles, and in cash or cash equivalents. The answer depends on various things, like your age, your ability to take risk, and your goals, and she suggested going to the Vanguard website to take a questionnaire to help you decide your asset allocation.

Your asset allocation has a powerful effect on your investment returns. If your portfolio had been entirely in bonds from 1926 to 2010, your return would have been 5.5 percent a year. Whereas if you had owned only stocks, your return would have been almost twice as much: 10.0 percent. (Based on popular indexes.)

Whereas if you had a portfolio of 60 percent stocks and 40 percent bonds – as is often recommended – you would have enjoyed a perfectly decent return of 8.7 percent a year – without the scary volatility of a portfolio more tilted toward stocks.

So, Bruno suggested, decide what your asset allocation should be before you decide which investment to buy. You wouldn’t want to buy (say) a bond fund if that would foul up your (say) 60-40 asset allocation.

Are you tempted to avoid the risk of stocks altogether – remembering the long, agonizing bear markets of the past?

Well, said Bruno, it’s true that if you had owned a portfolio 100 percent in stocks 1926-2010, you would have suffered losses 29 percent of the time, the worst of which was 43.13 percent in a single year. A portfolio 100 percent in super-safe Treasury bills, on the other hand, would have given you losses a mere 1 percent of the time, and the worst was only 0.02 percent.

But what if you adjust for inflation? When prices go up, fixed-income investments like bonds tend to get murdered. And if you adjust for inflation, Treasury bills and bonds have had negative calendar-year returns as often as stocks have. (Granted, the losses in stocks , adjusted for inflation, have been higher – minus 37.29 percent in the worst year versus minus 15.05 percent in the worst year for Treasury bills.)

Besides deciding on and adhering to your asset allocation, Bruno went on, you want a nicely diversified portfolio. But while it’s tempting to bet on yesterday’s winners, they tend to turn into today’s losers. In 2006, real estate investment trusts – for example -- returned 35.03 percent. In 2007, minus 15.7 percent. In 2008, minus 37.73 percent. In 2009, they rebounded – up 27.99 percent.

To have a diversified portfolio, the analyst continued, you must decide how much exposure you want to U.S. stocks versus foreign stocks; the percentages you want in large, mid-sized, and small U.S. companies; the percentage you want in growth stocks (generally, stocks doing well) versus value stocks (generally, stocks that have done poorly); and what types of fixed-income investments to own.

A point she made: Remember, in choosing bonds, that long-term bonds provide the highest yield – but also are the most volatile. And in the past, intermediate-term bonds have provided 90 percent of the return of long-term bonds, with only 45 percent of the volatility. What’s wrong with volatility? Well, for one thing, you may need to raise money just when your bonds have taken a big hit.

Bruno also made a case for index funds, funds that simply mirror an investment market and that, therefore, have low expenses.