Stocks Are Still the Allocation of Choice

Are you still comfortable with your investment allocations among stocks, bonds and other categories?

Based on the allocation suggestions of planners and investment companies, stocks are still where the bulk of a portfolio should be--despite the volatility of the stock market last year, despite the Asian collapse that roiled the market, despite a mixed bag of earnings reports and despite the best three-year run in stock market history. This assumes, of course, that the investor has a long time horizon and won’t need to use the money soon.

Much has been written about money moving to bond funds and bonds for security, but investment professionals see this more as a re-balancing act designed to reduce exposure to equities that have grown beyond investors’ original intentions, rather than as a sea change in investment patterns.

Although bond fund investment almost quadrupled from 1996 to 1997, last year’s total was still only about 19% of the $231 billion in new money that went into stock mutual funds.

For the professionals, stocks are the place to be.

“I think the Asian concerns are overblown and fully priced into the market. And in our view, the interest rate and economic environment are good,” said Kevin McClintock, senior portfolio manager of Dreyfus’ asset allocation fund and head of taxable fixed income at Dreyfus in New York, explaining why he had increased the asset allocation fund’s investment in stock to its maximum level of 80%. The other 20% is in bonds.

Last fall, he said, the ratio was 60-40 stocks to bonds.

“This is a very aggressive fund, and we can change the allocation monthly, although [we] usually do it quarterly,” he said.

Also bullish is Robert Froehlich, chief investment strategist for Zurich/Kemper Funds in Chicago. Froehlich, who believes the market could have an unprecedented fourth year of 20% growth, said his allocation for his company’s model portfolio is steady at 75% stock, 20% bonds and 5% cash. “I think we are in for a strong run in the stock market, and I don’t think it will slow,” he said.

Byron Wien, Morgan Stanley chief domestic equity strategist, seems to agree, adding 5% to his equity position and reducing cash in his model to only 3%. But his bullishness is limited to the year’s first half, after which, “I still think this will be the worst year for the stock market since 1994, with a difficult second half,” he said.

But the worst year since 1994 could simply mean a return to historical returns of about 11% annually, instead of the 20% to 30% of each of the last three years.

A lower return and a much more volatile market are what Arnold Kaufman, editor of Standard & Poor’s Outlook advisory newsletter, expects. Kaufman said he changed his model allocations earlier this month by adding 5% to stocks from cash, bringing it to 55% equities, 35% bonds and 10% cash.

With that outlook, why more stocks? “I think a 9% return after a 115% return [on the S&P; 500 index] over the last three years isn’t bad,” he said.

But for investors used to three years of sailing with the wind at their backs, the year Kaufman and others envisage would be like swimming in a choppy sea, riding the peaks and troughs of waves and expending a lot of effort to move a short distance.

For many new investors, it will require an unexpected effort and some discipline to stay in place.

To help investors cope, many fund companies recommend asset allocation portfolios based on investor risk profiles. Putnam’s asset allocation funds offer a growth portfolio with 80% stocks, 15% bonds and 5% money market funds; a balanced portfolio that is 65% stocks, 30% bonds and 5% money market; and a conservative portfolio that is 35% stocks, 5% cash and 60% bonds (including 10% in high-yield securities).

Within those broad categories, there are breakdowns in where the money is invested. For example, the Putnam growth portfolio has 25% in large-company value stocks and 15% in small-company stock; the balanced portfolio has 20% in the value category and 10% in small cap; and the conservative has 10% and 5%, respectively.

Bohemia, N.Y., financial planner Ron Roge, who runs similar model portfolios, has no cash at all but has 40% bonds in the conservative, 25% in the moderate and 15% in the aggressive categories.

Roge breaks his categories down more finely than Putnam: 7% in international equities in the conservative portfolio, 14% in real estate and 7% in natural resources. He said that last year the moderate and conservative models did better than the aggressive one, which was more heavily weighted to international stocks.

Investors may also want to look at their holdings to see if they want to reallocate. Some investors, for example, may have wanted only 60% in stocks, but gains may have pushed their stock weighting up to 70% or 80%.

There are ways to redress that. They can sell stocks and reinvest in bonds or cash. Or they can invest new money in bonds, for example, to reduce the overall percentage in stocks.

If you’re going to be selling stocks, take care to consider taxes. You can make changes in tax-deferred accounts without tax consequences, so remember to consider all your holdings when making reallocations. When possible, take the capital gains in tax-deferred accounts and the losses in taxable accounts.

Brian Mattes, a principal with Vanguard Group in Malvern, Pa., said it appears that most its investors are re-balancing by putting new money into bond funds instead of by selling off stock funds and using that money to buy bonds. Officials at other funds said they have seen the same pattern.