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Think Diversification

- Alan Lavine and Gail Liberman



Chances are there would be less moaning about how much people lost in the three-year bear market if they paid attention to the bottom line of investing: Diversification.

Diversification means splitting up investments in different assets to spread your risk.

What you have when you diversify is a less volatile investment with steadier performance.

Now that people are hurting, mutual funds have been launching all kinds of new investments to get you to diversify. Their goal is to come up with a lower-risk investment that performs well in both up and down markets.

But why not do it yourself and keep it simple? By sticking with stocks, bonds and cash, you can get the same returns as complicated mutual funds. For example, here is how some simple mixes of assets would have performed over the past 10 years.

  • If you had kept 75 percent of your money in a fund that tracked the S&P 500, 15 percent in bonds and 10 percent in Treasury bills, your investment would have grown at a 7.8 percent annual rate. That is about 4.8 percentage points more than the rate of inflation.

  • If you had kept 50 percent in a fund that tracks the S&P 500, 30 percent in bonds and 20 percent in Treasury bills, your investment would have grown at a 7.1 percent annual rate. That's 4.1 percentage points over the annual inflation rate.

  • If you kept 30 percent in stocks, 50 percent in bonds and 20 percent in Treasury bills, your investment would have grown at a 6.6 percent annual rate. That's about 3.6 percentage points more than the annual rate of inflation.

    If you want protection from inflation, you also can put some money into precious metals funds, real estate stock funds and inflation-indexed U.S. Treasury Bonds.

    Other research shows that adding overseas stock funds to the mix can help increase your return and reduce your risk of losses. Research by Burton Malkiel, author of "A Random Walk Down Wall Street (Norton)," found that emerging market stocks can be the best overseas stocks to add to your stock fund holdings. Emerging market stocks perform almost independently of our stock market.

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    Alan Lavine and Gail Liberman are husband and wife columnist and authors of The Complete Idiot's Guide To Making Money With Mutual Funds, (Alpha Books).


    To read more columns, please visit the column archive.




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