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New Tax Law Makes Portfolio Review More Vital Than Ever

September 21, 1997|TOM PETRUNO

Smart investors usually do a comprehensive portfolio checkup in October or November of each year, to see how they might fine-tune their investments by the year-end tax deadline.

This year there is more reason than ever to take a close look at your portfolio, and sooner rather than later. First, the sweeping changes in federal tax laws in August have the potential to affect virtually all investors, large and small.

Second, the surge in stock market volatility in recent months, and the shift in leadership from big stocks to smaller stocks, may be telling us that more momentous changes lie ahead for the 7-year-old bull market.

Many investors have been comfortably on autopilot for much of this decade, and especially since 1994, as blue-chip stocks have overcome every obstacle to post sensational returns in 1995, '96 and even so far this year.

It has been so easy to make money simply by buying and holding the market's best-known stocks (or mutual funds) that financial planners and other money pros worry that many of their clients are mentally less prepared for market turmoil than ever.


A portfolio review can help you put all of this in perspective and can point up ways to save on taxes, lower your investment risk and steer you toward new investment opportunities.

Where to begin?

* Start with an overview. Is your investment mix as you'd like it? If you set out a few years ago to hold a certain percentage of your assets in stocks, a certain percentage in bonds, etc., you may find that Wall Street's spectacular gains since 1994 have left you with a bigger share of your assets in stocks--and, specifically, blue-chip stocks--than you would prefer.

The rise of smaller stocks in recent months, while many blue chips have stumbled, has sent some investors scrambling to add smaller stocks to their lineup. But those who follow more disciplined asset-allocation programs would have already dedicated some money to smaller stocks, so that they were in place to benefit when that sector suddenly turned.

A portfolio overview simply entails totaling the value of all of your investments (including retirement accounts), segregating them by asset class (principally big stocks, small stocks, foreign stocks, bonds and cash) and deciding whether the percentages in each make sense for you.

* Ask yourself some tough questions about the amount of risk you truly are comfortable taking. Some people like a lot of diversification in their portfolios, to lower the overall risk of loss from a decline in any one asset type. Other investors may be quite happy to be heavily invested in one or two types, even with the higher risk that entails.

There's no one correct asset mix--it's as personal a decision as the type of car you drive.

But financial planners say they see many new clients who think they can take the risk of being almost exclusively invested in U.S. stocks, until the planner points out some historical facts about the stock market--for example, that U.S. blue-chip shares lost 45% of their value in 1973-74.

Could history repeat? Who knows? But as wonderful as the U.S. stock market has been to investors over the last seven years, any reasonable person would have to agree that this can't go on, uninterrupted, forever. At some point the market overall will decline more sharply than the just-under-10% maximum pullbacks we've experienced in the 1990s.

In a raging bull market, it's easy to imagine yourself stoically weathering a bear market. Once the bear arrives, however, people's emotions often get the best of them.


That's why many financial advisors like to keep 20% to 30% of clients' assets in bonds or other "buffer" investments--things that are unlikely to go down when the stock market does, or are unlikely to go down as much. "I don't think we have any client less than 20% in bonds now," says John Blankinship Jr., financial planner at Blankinship & Foster in Del Mar, Calif.

Some clients, he concedes, don't like bonds. They find them dull and the returns paltry. A five-year U.S. Treasury note, for example, yields about 6% annually now--while the Dow Jones industrial average is up 22.5% this year alone.

But a 6% guaranteed return, Blankinship notes, probably would look generous indeed should the stock market fall 25%.

He tries to get clients to think in terms of their total portfolio return, not just the returns on individual asset types. Ultimately, it's that overall return that is key to getting you to your financial goals, Blankinship says.

Asked to explain their investment objectives, many people would instinctively say, "To make as much money as possible!"

In fact, if your goals are typical--to live well, plan for a decent retirement and fund your kids' educations--your investment objective is not to make as much money as you can (which requires taking a huge risk of loss), but rather to earn a particular target rate of return on your total portfolio, with the least amount of risk that can be taken to get there.

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