As the Market Shifts, Should Your Assets Too?

In June, as the stock market fast began losing steam, Merrill Lynch analyst Richard Bernstein decided it was time to make a strategic shift to lower risk: In his team’s recommended asset allocation model, he cut stocks from 60% of holdings to 55%, while increasing bonds from 30% to 35%.

With stocks’ broad slump in recent weeks, many individual investors may be asking themselves if it’s time to consider changing their mix of stocks, bonds and cash as well.

It depends on how you reacted to Tuesday’s sell-off, and whether you can meet your long-term investing goals with a reduced equity stake, financial planners say.

“If you were shook up a little on Tuesday, maybe it’s a good time to at least see if you have the correct asset allocation,” says T. Rowe Price financial planner Christine Fahlund.

Chances are you don’t.

That’s because for more than three years U.S. stocks, as measured by the Standard & Poor’s 500-stock index of blue chips, have delivered 20%-plus returns.

“If you had allocated your portfolio two or three years ago, there’s a strong possibility that you’re going to be over-weighted in large U.S. stocks and stocks in general,” says Ron Meier, who teaches an investment course at the College for Financial Planning in Denver.

So what should investors do about it?

First, if your original allocation called for 60% stocks--and you now have 70% stocks thanks to the market’s gains--consider moving that “excess” 10% out of stocks to preserve it, financial planners say.

Depending on your circumstances, that could mean putting that money into short- to intermediate-term bond funds, or into a “cash” account like a money market fund, for the time being.

Then, reevaluate your tolerance for risk. “Chances are, many investors woke up this morning realizing they have a much lower tolerance for risk than they thought they had,” says Gary Schatsky, a fee-only financial advisor in New York City.

Risk can be measured two ways: your financial ability to sustain losses in the stock market, and your emotional tolerance for volatility, Schatsky says.

If, after consideration, you feel you shouldn’t jeopardize capital you will need in the short- or near-term (that means money to be used within one to five years for things such as a house, a car or your child’s college tuition), consider trimming your allocation in stocks further.

Ridgewood, N.J.-based financial planner Paul Westbrook, for instance, is advising his clients to seriously consider reducing their equity holdings.

“I’m erring on the conservative side at this point,” says Westbrook.

Before you take this step, Meier of the College for Financial Planning suggests reducing risk within your equity holdings.

For instance, he says there are two asset allocation decisions people must make: “strategic” decisions, which determines how much of your holdings should be in stocks, bonds or cash; and “tactical” decisions, which revolve around what portion of your stocks should be in large-cap, mid-cap or small-cap equities.

If most of your stock holdings are in domestic growth funds, he suggests shifting some of that money to growth and income portfolios, which tend to buy stocks with dividend payouts that cushion market volatility.

Indeed, according to Lipper Analytical Services, its Growth & Income Fund Index fell just 8.9% between July 17, the Dow Jones industrials’ peak, and Aug. 4. That means these funds lost 12% less than growth funds and 28% less than small-cap funds during the meat of the market correction.

(If you decide to reduce your stock holdings, an easy way could be to turn in a growth fund for a balanced portfolio, which invests in both stocks and bonds.) Still, financial planners say investors shouldn’t flee stocks altogether.

Since 1926, for instance, stocks have returned nearly 11% a year, on average. That’s more than any other asset class. And to meet long-term goals, including retirement, you’re going to need to invest in stocks--and you’re going to have to be in the market, to some extent, at all times.

Elda DiRe, a partner in Ernst & Young’s personal financial planning unit in New York City, says that academic studies have shown that even missing a few days in the stock market could mean drastically reducing your portfolio’s total returns over long periods.

That’s why she suggests making the asset allocation adjustments first with your short-term and mid-term money. That’s money you’ve put into stocks and bonds and cash that you know you’ll need to pull out in five years or less. It can also include money in an emergency fund.

Because many investors won’t need--and shouldn’t withdraw--money invested in their 401(k)s and IRA plans for at least 10 years, asset allocation decisions you make in these accounts should be made as a last resort, she says.

More Coverage

* Many analysts are skeptical the feeble rebound is cause for cheer. A1

* The Dow, still smarting from Tuesday’s 299-point loss, rose 59 points. D4

* Mutual fund investors stayed away in the wake of this big decline. D4

(BEGIN TEXT OF INFOBOX / INFOGRAPHIC)

Stocks’ Growing Share

Stock mutual funds accounted for just 40% of total fund industry assets in 1994. The bull market--and investors’ hunger for equities--has lifted that share to 55% today. Industry assets at year-end 1994 and on June 30:

1994

Stock funds: 40.0%

Bond funds: 31.6%

Money market funds: 28.3%

*

Now

Stock funds: 55.1%

Bond funds: 22.2%

Money market funds: 22.6%

Note: Totals don’t add to 100% because of rounding.

Source: Investment Company Institute