Use a Light Touch to Tweak Portfolio
Swoons like the 247-point drop in the Dow Jones industrial average on Aug. 15 are tough on the nerves. It’s human nature to want to react.
But what’s the correct response for mutual fund investors who generally want to pursue a buy-and-hold strategy? Might it be better simply to do nothing?
Those are valid questions that are best pondered during market lulls rather than the excitement of a swift decline. The problem is that sharp setbacks are usually the times when investors pay more attention to their holdings.
“And the more often you look at your portfolio, the more likely you will feel the need to take some action,” says Mark Stumpp, senior managing director at Prudential Investments in Short Hills, N.J.
Taking drastic action is probably something you don’t want to do. Historically, the really big gains have accrued to investors who stuck with their mutual funds for years at a time, especially those who reinvested all dividends and capital gains distributions automatically.
But holding tight isn’t easy to do emotionally. With that in mind, here are some mini-actions you can take while generally maintaining a buy-and-hold posture:
* Make sure your portfolio includes major diversification building blocks. Consider complementing your stock fund holdings with modest investments in bond or money market funds, which will add stability to your portfolio while providing a source of cash for further stock fund investments should the market drop sharply.
Also, divide your stock fund holdings into sub-categories, such as large and small U.S. stocks and foreign holdings. Although major international markets don’t always offer much of a refuge during sharp declines, they do provide an important diversification benefit over time.
“The key is to look at them on a long-term basis,” says Jennifer Zils, a product manager at investment consultant Ibbotson Associates in Chicago. “International funds are still a good means of diversification based on the different economic cycles and other factors that you find in foreign markets.”
A foreign-fund weighting of at least 10% or 15% is a good idea for most people, says Tom Miltenberger, a general principal at brokerage Edward Jones in St. Louis.
* Look at your portfolio in terms of its overall returns, not the performance of individual funds. If you own a good mix of funds, some naturally will drop sharply during down-drifts. For example, funds tied to the Standard & Poor’s 500-stock index took it on the chin Aug. 15, even though they have been leaders during this year’s rally. The lesson is to avoid selling off your more volatile performers after a market plunge.
It’s also important to use appropriate benchmarks to evaluate the performance of individual funds. Although the Dow and the S&P; 500 receive the most media attention, barometers such as the Russell 2,000 index of smaller stocks and Morgan Stanley’s Europe, Australia and Far East index make for better comparisons when it comes to small-company or international funds.
* Re-balance your holdings if needed. This involves making minor adjustments to a general asset-allocation mix that you have already established.
Suppose you aim to keep 30% of your money in funds that target large U.S. stocks, 20% in small-stock funds, 15% in international-stock funds and 35% in bond funds. If a market correction reduces the large-stock component to, say, 25% while the bond fund weighting rises to 40%, you might sell some of your bond fund shares and move the proceeds into stock funds.
During rising markets, one key advantage of re-balancing is that it allows you to take profits in funds that have performed well while reinvesting in laggards. However, re-balancing could involve transaction costs and tax consequences and therefore shouldn’t be done frequently. Both Stumpp and Zils suggest that you look at your portfolio with an eye on re-balancing just once a year.
Zils says another option is to re-balance when any of your funds has moved more than 5 percentage points from its target, as in the example above, in which the large-stock fund slipped to 25% from 30%.
* Re-balance by shifting dividends from one fund into another or by channeling new investment dollars into laggard funds only. The idea here is to leave your current principal amounts alone, which makes sense if you would incur transaction costs or lock in a taxable gain by selling shares.
Mutual fund companies typically allow for dividend reinvestments from one portfolio into another, and many people take advantage of them.
“We probably have 40,000 to 50,000 accounts doing that to some degree,” Miltenberger says.
Most common are dividend shifts from conservative stock and bond funds to more aggressive equity choices.
* Consider a dollar-cost-averaging strategy. This approach is based on socking away a fixed amount of money on a regular basis--say, $250 each month. It’s a convenient way to invest. Also, it provides some psychological comfort because if the market drops, you will be able to purchase more shares with your next investment. Most fund companies offer dollar-cost averaging plans.
Just keep in mind that dollar-cost averaging usually doesn’t work as well as simply investing everything you can as soon as you can.
“If you’re investing for the long term,” Miltenberger says, “you’re better off putting in the money today and forgetting about it.”
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Russ Wiles is a mutual fund columnist for The Times. He can be reached at russ.wiles@pni.com
