“It’s time for a change.” As the calendar turns to 2008, it’s more than likely that you’ve made such an assertion–whether it’s about your diet, job, or even relationships. But you might want to add your finances to the list. Now is the perfect time to perform an annual portfolio checkup to determine whether you should make any adjustments.
That’s exactly what’s on the agenda for newlyweds Lisa and Terence Dillard. Having built up their individual retirement accounts, the Atlanta couple is in the process of working with a financial planner to help meld their finances. So far, Lisa, a physician, and Terence, a high school assistant principal, have the majority of their holdings in domestic equity mutual funds. And although their portfolios include some international exposure and a stake in a healthcare mutual fund, the Dillards have yet to make a meaningful foray into areas outside of equities. In a market where subprime mortgage fears and credit concerns rule the day, it’s a step the couple may want to take. “We want to protect what we’ve gained in the market,” says Lisa, “and in a volatile market it’s important that we see where we are and how diversification can help us take the next step.”
A portfolio tune-up is a prudent measure for all investors–particularly after the 2007 market swings. For instance, the S&P 500 rose 9.5% by mid-July only to surrender almost all of those gains by mid-August. Sure, the Federal Reserve stepped in to help by cutting interest rates, but by mid-November the S&P hadn’t recovered its past gains and was up just 4.4% for the year.
So heading into 2008, step away from the commotion and take the necessary measures to fireproof your portfolio. “Investors certainly got a reminder last year that allocation of _assets outside of stocks is just as important a strategy as putting money into equity markets,” says David Braverman, a vice president for Standard & Poor’s.
It’s a strategy that institutional investors took steps to employ in 2007, and the evidence lies in the performance of investments outside of the stock market. “By August, we in the bond market saw definite signs that money was moving in a flight to quality _positions,” says Mary Pugh, president of Pugh Capital Management in Seattle (No. 13 on the be asset managers list with $1.1 billion in assets under management). Investors, meanwhile, bid up the price of gold on worries that oil prices near $100 a barrel would ignite inflation.
In uncertain times, the big money goes hunting for returns outside of the stock market because diverse asset classes, such as bonds, real estate, and gold, can cushion the blows.
Striking a Balance
Sometimes investing in other asset classes can
But keep in mind that balanced investing is certainly possible for individual investors via mutual funds. While you may not be ready to think about expanding your bond holdings, remember that even within your stock portfolio, you should make sure that you have an appropriate mix of domestic and international, small- and large-cap holdings, and growth and value options.
As you rebalance, keep a long-term outlook in mind. Ultimately, you don’t want to make a change just for the sake of change. If you chose a poorly performing fund, before you unload it, consider if you’re really in a better position to pick a stronger replacement. Your existing fund may still have solid holdings but its overall performance could be suffering from the shocks of a volatile market. Also, don’t lose sight of the transaction costs and tax implications that may come with selling.
But a word of caution: “Effective diversification only works if you don’t chase after each and every trend,” says Frank Paré, a financial adviser with PF Wealth Management Group in Oakland, California. “Instead, pick a weighting for stocks, bonds, and the rest, and stick with it.”
To help you with your portfolio checkup, we worked with Morningstar to identify top-performing mutual funds that offer exposure to a variety of asset classes. Finalists were chosen with the best 10-year record in each category to judge how each fared in both the stock market’s bear and bull cycles. All have managers who’ve been in place for five years or more and charge lower-than-average expenses to keep costs from cutting down returns.
Bonds: A Steady Income
It’s easy to think of the bond market as a diversification starter kit. That’s because fixed-income securities tend to rise in value when stocks fall. Indeed, the factors that slow stock market performance are often welcome news for bond investors. One clear example is that when interest rates rise, investors often flock toward bonds to lock in a solid rate of return.
Bonds are essentially IOUs issued by a government, municipality, or other entity. They return a specified interest rate in the form of regular dividend payments and repay the value of the bond at maturity. All told, bonds offer an attractive stream of steady income, as well as a hedge against a downturn in the stock market.
While bonds issued by a rock-solid creditor, such as the U.S. government, have clear appeal, investors can get an added benefit from municipal bonds, or munis, which are issued by local governments to fund schools, roads, and a host of other projects. The dividend return provided by munis is tax-free. For example, in the case of a bond paying 4.2% interest, an investor in the 33% tax bracket gets an income boost equivalent to 5.6%. There’s more: If you buy a muni in your home state, there’s a good chance your dividend payment will get a waiver on local taxes as well.
That’s been Judith Jones’ stock in trade (no pun intended). A 64-year-old hospital psychologist from Miami, Jones began reading up on bonds when she took an investment class 40 years ago. She liked their stability and took the plunge with an issue floated by Jacksonville, Florida. As a bonus, Jones got federal and state tax breaks on the 7% interest she _received at the time. “I kept at it, and I told all of my friends about how good of a deal this was,” she says.
Over time, Jones amassed a bond portfolio valued at some $300,000. Beyond her pension, she says dividends kick in about $25,000 of her yearly income and enabled her to semi-retire in 2006. Jones’ financial adviser, _Gerald Grant of AXA Advisors, says munis make sense for clients who make more than $30,000 a year or married couples whose combined income tops $60,000. “They are appealing to investors in high tax brackets _because the interest paid is free of federal income tax,” he says.
Keep in mind the criteria for sound bond fund holdings. Morningstar analyst Lawrence Jones recommends intermediate duration funds–vehicles that invest in bonds that mature between four and 10 years–and advises sticking to portfolios that invest in bonds with average quality ratings of AA as determined by research companies such as Standard & Poor’s, Moody’s, and Fitch, firms that do the dirty work of examining the balance sheets and overall fiscal fitness of issuers. Although these agencies are under fire for mistakes made in the subprime mortgage market, they remain the best way to
gauge a bond or a fund’s quality. “If you’re looking for a good counterbalance to equities, high-quality bonds have a lower correlation to stock market performance than high-yield bonds,” says Jones, noting that lower-quality bonds will often simply mirror the stock market.
For an array of top-performing bond funds, see the sidebar “Seeking Stability.” Our screens sort out key bond categories. For starters, the intermediate-term funds
invest in a mix of government, corporate, and international offerings. Government bond portfolios, meanwhile, concentrate on bonds issued by the U.S. Treasury and issues that are floated by federal government agencies. Finally, the muni bond funds presented are made up of national portfolios that earn a federal tax break. In states where income taxes are high–such as California, Massachusetts, and New York–it’s worth examining state-specific funds that will help you avoid an additional bill.Gold: An Ounce of Prevention
King Midas worshiped the stuff. Ancient Egyptians brought it with them to the grave. A few nuggets in California started a stampede to the _Pacific Coast in the 1800s. Yet for all its mystique and lore, gold gets a decidedly ho-hum review from many Wall Street minds. That’s because, for all of its run-up this past decade, gold has posted lousy investment returns over the long haul. According to Standard & Poor’s, since the stock market crash of 1987, gold has delivered an annual return of 2.4%, a number that trails the 3% growth rate of inflation. For now, S&P strategist Sam Stovall says that his firm views gold investments favorably because the price of gold is benefiting from a weak U.S. dollar and low _interest rates, which make it easier to borrow to buy precious _metals. “Another factor is that global demand is up,” Stovall says, “thanks to emerging markets such as China and India, where a boost in wealth has people spending more on jewelry.”
Gold seems to glitter every time trouble crops up. Triggers for a gold price rally include terrorist attacks or inflationary pressures. In the 1970s, when oil prices and inflation battered the U.S. economy, gold rose from $36 an ounce to more than $850 by the early ’80s. Conversely, gold sinks when the economy is strong, and stable economic growth in the U.S. drove prices down to about $300 an ounce by 2000.
Saint Louis University English professor Stephen Casmier recently turned to gold for a second time as an investor. Initially, after reading about economic aftershocks the war in Iraq might trigger in 2004, he placed a $10,000 stake in the Tocqueville Gold fund (TGLDX), which as of mid-November had an average five-year annualized return of 28.7%. When he cashed out two years later, the investment had grown to $15,000. When it comes to precious metals funds, it’s good to know what you’re in for. Their price swings can be one heck of a roller-coaster ride. Precious metal funds dove 41.2% in 1997. Their returns in 2005 and 2006 topped 30% on average, according to Morningstar.
Casmier’s more recent foray was more practical. In April of 2007, he secured a position to teach in Madrid for a year. The dollar, meanwhile, was plummeting on currency markets. “I knew my salary in dollars would get crushed by the Euro the way things were going,” he says.
After a few weeks of research, Casmier put some $6,000 into Canadian gold coins known as Maple Leafs. He hasn’t yet had to cash out the 10 coins he bought. One reason is the sheer difficulty of trading gold. Transaction fees ran $20 a coin for the 10 he bought in April. Now, by Casmier’s estimate, he’d have to hand over perhaps $50 in fees each time he cashes out. The upside of his investment is clear, however: Gold fetched about $600 an ounce when he made his investment. Just six months later its price had appreciated to nearly $850, roughly the same price Casmier would get for each coin.
As Casmier discovered, trading in gold can be an expensive proposition. Besides commissions, there’s additional overhead, such as the cost of a safe-deposit box or even insurance. Precious metal funds are easier because they tend to invest in a basket of holdings in companies that mine gold, silver, and other valuable ores. The mutual fund route, however, isn’t foolproof. It’s often recommended that your stake in the asset–whether in mutual funds or otherwise–be no more than 5% of your total portfolio.
Real Estate: Still Worth a Look
There is a rock-solid, both-feet-on-the-ground appeal to real estate that few other assets can match. The downside: Real estate is expensive. So to gain the type of location, location, location that helps protect your investment over time, most individual investors turn to shares of REITs.
REITs combine the best attributes of stocks and bonds. They often climb in good stock markets, and their returns generally keep apace with the big stock indices. There’s an added boost that rivals the appeal of bonds. Tax laws require REITs to distribute 95% of their income, which is divvied up to holders in hefty dividend payments–currently an average 4.5 %.
For more on REITs, visit the Website of the National Association of Real Estate Investment Trusts, www.nareit.org and see Moneywise, “Real Opportunities,” (December 2007).
In the end, remember that any changes you make in your portfolio should be part of a larger plan and not made as a quick-fire reaction to any anxiety you may be feeling at the moment. Judith Jones says she’s quite happy she set out to put a diversification plan in her portfolio. “It helps me rest better at night, knowing my money is in a safe place and earning quite a high return,” she says. “I think my friends are starting to reap the benefits of my advice, too.”
Seeking Stability
| Â | Â |
Total Return |
 |  |  | ||
| Intermediate-Term Bond | Ticker | 3 Yrs | 5 Yrs | 10 Yrs | Expense Ratio | Minimum Initial Investment | Web Address |
| Intermediate Term Bonds | Â | Â | Â | Â | Â | Â | Â |
| Metropolitan West Total Return Bond M | MWTRX | 5.52% | 7.55% | 6.65% | 0.65% | $5,000 | www.mwamllc.com |
| Managers Fremont Bond | MBDFX | 4.14 | 4.88 | 6.44 | 0.60 | 2,000 | www.managersfunds.com |
| ING VP Intermediate Bd I | IPIIX | 4.05 | 4.80 | 5.76 | 0.49 | 0 | www.ingfunds.com |
| TCW Core Fixed-Income I | TGCFX | 3.56 | 4.78 | 5.61 | 0.79 | 2,000 | www.tcw.com |
| Dodge & Cox Income | DODIX | 3.93 | 4.54 | 6.18 | 0.44 | 2,500 | www.dodgeandcox.com |
| Government Bond | Â | Â | Â | Â | Â | Â | Â |
| American Century Target Mat 2025 Inv | BTTRX | 6.33% | 6.22% | 8.99% | 0.57% | $2,500 | www.americancentury.com |
| Wasatch-Hoisington U.S. Treasury | WHOSX | 5.00 | 4.68 | 7.16 | 0.72 | 2,000 | www.wasatchfunds.com |
| Dupree Intermediate Govt Bond | DPIGX | 4.22 | 4.50 | 5.66 | 0.51 | 100 | www.dupree-funds.com |
| Analytic Short-Term Govt Inc Instl | ANSTX | 4.14 | 4.20 | 5.13 | 0.60 | 2,500 | www.aninvestor.com |
| Vanguard GNMA | VFIIX | 4.17 | 3.86 | valign=”top”>5.66 | 0.21 | 3,000 | www.vanguard.com |
| National Muni Intermediate Bond | Â | Â | Â | Â | Â | Â | Â |
| DWS High Yield Tax Free S | SHYTX | 5.25% | 4.93% | 5.50% | 0.73% | $2,500 | www.dws-scudder.com |
| Vanguard High-Yield Tax-Exempt | VWAHX | 4.09 | 4.36 | 5.10 | 0.17 | 3,000 | www.vanguard.com |
| Elfun Tax-Exempt Income | ELFTX | 3.78 | 3.92 | 5.17 | 0.12 | 500 | www.gefunds.com |
| USAA Tax Exempt Intermediate-Term | USATX | 3.39 | 3.77 | 4.77 | 0.56 | 3,000 | www.usaa.com |
| Vanguard Interm-Term Tax-Ex | VWITX | 3.07 | 3.24 | 4.54 | 0.17 | 3,000 | www.vanguard.com |
| Precious Metals | Â | Â | Â | Â | Â | Â | Â |
| USAA Precious Metals and Minerals | USAGX | 34.28% | 32.70% | 18.15% | 1.21% | $3,000 | www.usaa.com |
| DWS Gold & Precious Metals S | SCGDX | 22.18 | 30.10 | 14.64 | 1.29 | 2,500 | www.dws-scudder.com |
| GAMCO Gold AAA | GOLDX | 28.20 | 27.22 | 14.61 | 1.44 | 1,000 | www.gabelli.com |
| Real Estate | Â | Â | Â | Â | Â | Â | Â |
| CGM Realty | CGMRX | 35.37% | 39.68% | 19.85% | 0.88% | $2,500 | www.cgfunds.com |
| Alpine International Real Estate | EGLRX | 30.03 | 32.33 | 15.18 | 1.17 | 1,000 | www.alpinecef.com |
| Russell Real Estate Secs S | RRESX | 20.01 | 22.63 | 13.04 | 1.07 | www.russell.com | |
Source: Morningstar, returns through 9/30/07