How to Cut Risks in High-Priced Market

It’s natural for people to want to shy away from stock funds when the market hits record highs, as it has in recent days.

After all, the name of the game is to buy low and sell high, and that’s hard to do when prices reach uncharted territory.

Placentia investor Gilbert Golden, for instance, says he’s concerned that higher income taxes or implementation of the Clinton health plan could knock stocks and stock funds for a loop this year or next.

“Those factors have to have some impact on corporate profits,” says Golden, a retired company auditor. He plans to hold off on putting more money into U.S. stock funds until the market comes down a bit.

Golden isn’t alone in harboring a cautious outlook. Various psychology or sentiment measures show that investors are fairly skittish right now. The Dow Jones industrial average closed Friday at a record 3,867.

However, people who wait for corrections to occur sometimes wait in vain. For investors like Golden who are optimistic long term but worry about bumps along the way, a number of strategies can help reduce the risks of investing when the market looks expensive.

One such approach is dollar-cost averaging, the idea of easing into stock funds by investing relatively small amounts on a regular basis.

Emery Jensen, a commercial-insurance underwriting manager in Glendale, Ariz., has been investing $100 a month into two separate domestic stock funds for the past year, with the money taken directly out of his bank account.

“This is a painless way to invest, because when you don’t see the money, you don’t miss it,” says Jensen. He became familiar with the concept by having money deducted from his paychecks and invested in his 401(k) retirement plan at work.

Jensen says he doesn’t know what to make of the market trading at such high levels. But he adds that a dollar-cost averaging strategy eliminates a lot of the worry, because if his funds fell he would buy more shares with future purchases for the same cost.

An offshoot strategy, known as value averaging, takes a somewhat different tack. Here, the idea isn’t to put a specific amount of money into a fund each month or quarter. Rather, you want to ensure that your account grows by a certain amount.

How is that different? Consider this example: Suppose your goal is to have your account increase by $100 each month, and suppose further that it rises by that much one month simply because the fund appreciates. If so, you wouldn’t need to add any more money.

Instead, if the fund jumps by $200 one period, you would actually sell $100 worth of shares. Or if it declined by $50, you would contribute $150 to stay on schedule.

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This strategy may perform better than dollar-cost averaging because it forces you to buy more shares when prices are low and buy fewer or even sell some when the market is high, says Harvard professor Michael E. Edleson, author of the book “Value Averaging” ($22.95, International Publishing Corp., Chicago).

But drawbacks include more work, more taxable transactions and the challenge of coming up with some big cash to invest following months when stock prices really tank.

And there are additional wrinkles to ease into the market.

Tom Lydon, a spokesman for Fabians’ Investment Resource newsletter in Huntington Beach, says his firm recommends that new clients commit a third of the amount they want to invest into a stock fund, then wait for that to appreciate by 5%. When that happens, they would commit the second third, and so on.

“Incremental purchasing gives people a plan, so they can emotionally handle the ups and downs of the market,” says Lydon, whose firm also makes use of market timing to help limit risk.

As another alternative, you might consider a simple buy-and-hold or averaging strategy using slower moving equity-oriented funds, such as those listed in the accompanying chart.

To reduce fluctuations, some managers load up on conservative stocks or anchor their portfolios with a lot of bonds or cash holdings.

One advantage of these types of funds is that they typically pay bigger dividends--and when these payments are automatically reinvested, investors enjoy a type of dollar-cost averaging.

Investors with substantial bond-fund holdings can gain some equity exposure in another manner--by reinvesting dividends into stock portfolios that are part of the same fund family.

This is another form of dollar-cost averaging and may provide comfort to people who don’t want to risk their original principal, although it obviously won’t work for investors who need to cash their bond-fund dividends to meet living expenses.

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As yet another risk-reducing strategy, you might consider buying some international funds. This might seem like a contradiction since foreign stocks are generally riskier than U.S. equities, especially in countries where the national currency is not pegged to the dollar.

But by combining a small amount of foreign with U.S. funds, investors can reduce their overall volatility, as the various markets will move in different directions, or at least degrees.

For a global strategy to work, however, shareholders need to learn to view their holdings as part of an overall package--without worrying too much about bumps and bruises among individual funds.

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Americans are becoming more optimistic about saving money but apparently have mixed feelings about investing it, according to a survey by the American Capital fund family in Houston.

Of the 1,000 people surveyed in January, 41.9% rated the next two to three months as a good to time invest, up from 38.3% in December. A rising number also indicated they would put more money into “savings or investments” over that period.

But only 33.3% rated the stock market as promising over the next two to three months, down from 35.3%. And both stock and bond funds lost support over that period. The asset category showing the biggest jump in investor enthusiasm was real estate other than one’s own residence.

An American Capital spokesperson attributed the general uptick in enthusiasm to an improving economy and continuing low interest rates.

Easy Riders

Investors looking for some stock-market exposure without much risk might consider some of the following mutual funds. None has lost as much as 5% in any quarter since 1988 nor posted an annual loss over that period. In addition, all have had the same manager in place over this span.

Max. Avg. sales yearly Phone Fund Type charge return (800) Gateway Index Plus Growth & income None +11.9% 354-6339 Phoenix Balanced Balanced 4.75% +13.9 243-4361 Smith Barney Utilities Utility 5% +12.6 451-2010 Stagecoach Asset allocation 4.5% +12.5 222-8222 Vanguard Wellesley Income None +13.7 662-7447

Note: Average annual return is for the five-year period ending Dec. 31, 1993.