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MANAGING YOUR MONEY / Earning More, Keeping More : GAIN WITHOUT PAIN : A handful of strategies boost return while actually lowering risk.

November 09, 1993|KATHY M. KRISTOF

In today's era of single-digit yields, everybody is looking for a gimmick--something that will add new sheen to the lackluster returns many investments now offer.

Generally speaking, however, when you boost your return, you also increase your risk. And that's a less attractive concept.

Still, investment experts say, a handful of strategies exist that can not only raise your profits but actually lower your risks at the same time. To wit:

* Diversify. Every investment primer tells you to do it, but few people actually put their investment eggs into a variety of baskets. The reasons range from confusion about what diversification really means to fear of investment categories viewed as risky.

But a properly diversified portfolio can be less risky than one concentrated in a single "safe" investment, such as government-backed Treasury bills.

Why? Because investment risks come on several fronts. There's the risk of principal loss--losing part or all of the money you originally invested. That's the risk most people know about and fear.

But there's also inflation risk, which boils down to not earning enough on your investments to keep up with the rate of inflation. If all your money is in certificates of deposit or Treasuries, that's a very real risk.

"Ninety-four percent of the performance in anyone's portfolio has to do with having the right percentages of your money in the right asset classes at the right times," says Victoria Felton-Collins, vice president and partner at Keller, Coad & Collins, a financial planning and asset management firm in Irvine. "As long as you are diversified, that will take care of itself."

Diversification has two elements. One is to spread your investments into different categories, such as stocks, bonds, real estate, certificates of deposit and annuities. The second element requires you to diversify within each category.

Such a strategy sounds complex, but it's actually simple to put into practice. Indeed, thanks to the growth of mutual funds, diversification is easier and cheaper than ever.

To illustrate, consider a hypothetical couple we'll call Jane and John Smith. Jane and John both work and earn $60,000 between them. They own a $150,000 home, which supports a $100,000 mortgage. They're just starting to invest, but they have $4,000 in a bank account for emergencies.

Each is able to set aside $100 a month. How do they diversify?

First they take stock of what they've got. That's $50,000 equity in real estate and $4,000 cash. (In investment circles, certificates of deposit, checking and savings accounts and short-term Treasury bills are all considered "cash" investments.)

To round out their portfolio, they would want to concentrate new investments in stocks and bonds. But since they're investing relatively small amounts, buying individual shares of stock is impractical. Brokerage fees would eat up the bulk of their monthly investments.

Instead, they can call any one of a number of mutual fund companies that have programs for small investors. Two such companies are Janus Funds in Denver and 20th Century in Kansas City, Mo., which set up automatic investment plans for those investing as little as $25 a month.

Since Jane and John are relatively young and have plenty of cash set aside for emergencies, they decide to put most of their money in the stock market, which tends to perform well over time but can be volatile in the short run. They put $50 into an intermediate-term bond fund, $50 into an international stock fund and $100 into a domestic stock fund.

They're done. They now have stocks, bonds, real estate and cash--a respectably diversified portfolio for any young investor.

As they build up their savings, they may decide to diversify further by picking up investment properties, real estate investment trusts, junk bonds or specialized stock funds, such as so-called small-cap or select funds that invest solely in small companies or companies in a single industry.

* Dollar-cost-average. That's a fancy way of saying you should invest set amounts in the stock market regularly and not worry too much about the price.

The premise behind dollar-cost averaging is that investment values rise and fall over the short run, but tend to rise over time. If you're investing a set amount each month or year, you'll probably get some bargains and some high-priced stocks. But you'll never get all of either.

* Ladder maturities. If you invest in municipal bonds, Treasuries or certificates of deposit, consider laddering their maturity dates. In its simplest form, that just means you buy bonds that mature at different times.

Laddering accomplishes two things. First, it reduces your risk of paying an early withdrawal penalty--or having to sell your bonds at a loss--in the event you need some of your money in a hurry.

Second, if emergencies don't arise, it means you'll be reinvesting at different times. That reduces your risk of having to reinvest your total bond portfolio in a low-rate environment.

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