Plunged into doubt?
Amid the recent market turmoil, maybe you are wondering whether you have the right mix of investments. A few thoughts to keep in mind:
+ Taking stock.
If you are a bond investor who is petrified of stocks, the wild price swings of the past few weeks probably confirmed your worst suspicions. But the truth is, adding stocks to your portfolio could bolster your returns without boosting your portfolio's overall gyrations.
How? While stocks and bonds often move up and down in tandem, this isn't always the case, and sometimes stocks rise when bonds are tumbling. That happened in this year's first six months, when U.S. stock-mutual funds soared 10.8 percent, while taxable bond funds slipped 0.3 percent, according to Lipper Analytical Services.
Indeed, Chicago researchers Ibbotson Associates figures a portfolio that's 100 percent in longer-term government bonds has the same risk profile as a mix of 83 percent longer-term government bonds and 17 percent blue-chip stocks that constitute Standard & Poor's 500-stock index.
But while the risk level is similar, the bond-stock mix had better returns over the past 25 years, gaining 10.2 percent a year, compared with 9.6 percent for longer-term government bonds alone.
+ Great taste, more filling.
All right, you'll buy a few stocks. But you're sticking strictly with blue chips. A good move?
Ibbotson Associates calculates that a portfolio that's 100 percent in the S&P 500 is about as risky as a mix that includes 73 percent S&P 500, 6 percent smaller-company stocks and 21 percent foreign stocks. But the globally diversified portfolio was more rewarding over the past 25 years, climbing 12.9 percent a year, compared with 12.2 percent for the S&P 500.
+ Padding the mattress.
On the other hand, maybe you're a committed stock market investor but would like a calming influence in your portfolio. You've got a bunch of choices, but none are great.
Some investments, like gold and Treasury bills, really help to damp a stock portfolio's ups and downs, but their recent returns haven't been anything to rave about. Other choices, such as bonds and real estate investment trusts, don't crimp returns too much, but they also don't provide a lot of downside protection.
What should you do? When investors look to mellow their stock portfolios, they usually turn to bonds. Indeed, the traditional balanced portfolio, which typically includes 60 percent stocks and 40 percent bonds, remains a firm favorite with many experts.
A balanced portfolio isn't a bad bet. But if you want to calm your stock portfolio, I would skip bonds and add cash investments such as Treasury bills and money-market funds. Ibbotson calculates that, over the past 25 years, a mix of 75 percent stocks and 25 percent Treasury bills would have performed about as well as a mix of 60 percent stocks and 40 percent longer-term government bonds, and with a similar level of portfolio price gyrations.
So why do I favor the stock-cash mix? First, it offers more certainty, because you know that even if your stocks fall in value, your cash never will. By contrast, the stocks and bonds in a balanced portfolio can get hammered at the same time.
Second, a mix of stocks and cash should offer fewer tax hassles. It will kick off less in total interest and dividend income each year, and you can dip into your cash investments without realizing a capital gain. That's not the case with stocks or bonds, where a sale usually results in a capital gain or loss that then has to be reported to the Internal Revenue Service.
+ Patience has its rewards, sometimes.
Stocks can generate miserable short-run results. During the past 50 years, the worst five-calendar-year stretch for stocks left investors with an annualized loss of 2.4 percent.
But even conservative investments can generate disappointing results over shorter periods. In their worst five-year stretch during the past 50 years, longer-term government bonds lost 2.1 percent a year, while Treasury bills gained just 0.8 percent.
But stocks do at least sparkle over the long haul. As a long-term investor, your goal is to fend off inflation and taxes and make your money grow. And on that score, stocks are supreme.
Jonathan Clements writes for the Wall Street Journal.