Business - Of Mutual Interest 4 tips for a midyear portfolio checkup

By David Pitt

AP Personal Finance Writer

DES MOINES, Iowa (AP) -- A lot has happened in the stock market. In recent weeks there have been some dramatic swings as investors reacted to the European debt crisis and other news of the day. Yet, so far this year, the market is basically flat. The Standard & Poor's stock index is down less than 1 percent.

Flat performance is hardly the goal of any investor, but there's only so much you can do in a languishing market. Still midyear is an ideal time for a check of your portfolio.

You don't need to become a full-time money manger, but you should know whether the money in your 401(k), IRA or other investments is growing or if there's a potential problem developing where you might need to make some changes.

Here are four questions to help weigh whether your investment strategy is measuring up.

1. How many mutual funds is too many?

There's no set threshold. The answer depends on how much time you want to spend managing your portfolio, and should be dictated by your risk tolerance.

To be well diversified, a portfolio should cover large-, mid-, and small-cap stocks, foreign stocks, emerging markets, precious metals and real estate investment trusts. Then there should also be some bond holdings including corporate, U.S. government and municipal bonds of varying maturities.

Covering all of those bases is obviously for ambitious investors with the time and desire to focus attention on portfolio management or a trusted adviser to help.

A do-it-yourself investor would likely need at least a dozen funds to adequately spread money among the asset classes, said Boston-based financial adviser Jonathan Pond.

Typically workers with a 401(k) have an average of 20 investment options from which to choose. The Investment Company Institute, a trade group, says the median number of funds owned by mutual fund investors is four.

Still more funds doesn't necessarily translate into higher returns or greater stability. Research has indicated minimal additional benefits come from owning more than 15 well diversified funds

Investors who don't want to assemble a portfolio have the option of target-date funds, which are designed to be diversified and to lower the risk as an investor approaches retirement or lifestyle funds which carry various levels of risk. They can be perceived as a one-stop-shop, yet investors are well advised to keep tabs on their performance to ensure that they're still meeting their investment goals.

2. Do I have an appropriate mix of investments in my portfolio?

You'll frequently hear two terms in discussions about properly spreading out investment risk -- asset allocation and diversification.

First, "asset allocation" is dividing your portfolio among stocks, bonds, real estate, cash, and other investments. Historically it's rare that all asset classes lose money at the same time. Spreading your money across investments will help lower the volatility of your portfolio.

Second, "diversification" is spreading money around among different investments within an asset class to reduce the risk of loss. So you'll want to have stock in companies of different sizes and from different industries.

Wells Fargo investment advisers put together a portfolio of 27 percent bonds, 55 percent stocks, 11 percent real estate investment trusts and 7 percent commodities for illustrative purposes. From 2000 to 2010 it had a positive return of 45 percent. During the same time the S&P 500 dropped 2.7 percent.

Diversification really matters and some advisers say it should be your top concern.

Investors in specialized sector funds -- which concentrate on stocks in one industry, such as financial services or real estate -- are assuming the risk that the sector will perform well. If there's little or no diversification elsewhere in the portfolio and the sector tanks, losses could be extreme. Limiting sector funds to no more than 5 percent of a portfolio is a good idea.

The efforts to diversify should go beyond just ensuring a mix of asset classes.

How about diversification among income sources? How much of your portfolio's return comes from bonds versus dividends? Think about how much exposure there is to inflation and other economic factors and don't forget to consider changing government policies.

Morningstar Inc. offers its Instant X-Ray tool to help analyze your portfolio to help make sure you're diversified. It's available at http://tinyurl.com/22nljc5.

3. What's the best way to measure performance?

A portfolio that's well tuned to make gangbuster returns in an up market is probably also ready for a big fall when the bears crash the party.

The tech boom and bust is a good example. All those investors who chased performance by investing in risky technology companies were hurt badly when the bubble popped.

One good practice is to measure a fund's performance against its peers. It might not be wise to dump a fund that lost 5 percent in a given year, especially if you compare it to similar funds and find the peer group lost 9 percent. On the flip side, you may be happy to see another fund gained 5 percent until you find its peer group earned 15 percent during the same period. It's the comparison to similarly invested funds that's a good benchmark. Such comparisons are available on Morningstar.com.

Ultimately, you want to avoid making quick moves. Instead, monitor a fund that seems to be falling behind and see if it picks up.

4. What's a good way to determine whether I have enough cash?

You have enough cash if you can weather a volatile market without worrying about needing to cash out your investments.

Feeling right about this issue is perhaps second only to asset allocation in importance to investors, said Junkans, the Wells Fargo bank investment officer.

There's no formula to determine the right amount, it's highly individual and determined by near-term expenses. For example, if you know you're going to buy a car in the next 12 months, a down payment or cash for that purchase should be set aside. Perhaps there's a home improvement or repair project. Aside from those somewhat predictable occurrence, you should have enough put away to be able to relax.

"If you don't have enough you're going to be more nervous about it. You need to take money off the table," Junkans said. "Otherwise you're going to be reducing risk exactly at the time when you shouldn't be. That's why it's so critical."

An investor who panics when the market tumbles probably should have more of a cash cushion. This should help lessen any temptation to overreact from day-to-day changes.

Published: Wed, Jun 23, 2010

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