Making Over Lee

Lee, 63, was doing quite well with his investments until late last year, when he started selling some of his utilities and buying technology and telecommunication mutual funds as well as funds invested in health care and large-cap blue-chip stocks.

His investments started heading south and continued south even though he started to make what he thought were corrections to the portfolio.

He's frustrated because he was working with a full service financial adviser and doing his own research by consulting Value Line. Lee wonders what he is doing wrong.

Well, the stock market has also been heading south since Lee began to change his portfolio strategy, so some of his losses would probably have occurred even if he hadn't altered his strategic mix of investments. I think the question perplexing Lee is how much damage did he contribute with his changes to an already declining portfolio?

Eggs in One Basket

From Lee's description of the changes to his portfolio, I would venture to say that he made a couple of strategic errors.

The first is that he was probably chasing performance. Since he was working with an investment adviser, he probably was shown recent past performance of the funds he invested in, not realizing that these areas of the market were hugely overvalued and were due for a collapse.

Whenever we see unusual market performance we should always ask ourselves — are these numbers sustainable going forward? The answer is usually "no" when the performance is way above or way below the average longer-term trend.

Lee compounded his first error by overly concentrating his portfolio by buying sector funds.

We now know how overvalued the technology and telecommunications sectors became. Many of these stocks were also household names such as Intel, Microsoft and Cisco, giving otherwise rational investors comfort to invest in this overvalued area. These also happened to be large-cap stocks, considered blue chips by many people. So Lee's portfolio became highly concentrated in a sector of the market that was due for a correction.

The Solution

First, Lee, should decide on an asset allocation that is right for him and the time horizon needed for these investments to work. All portfolios should have an appropriate mix of stocks, bonds and cash.

For example, let's assume he has a 10-year time horizon and a moderate tolerance for risk. His portfolio might have a 5 percent cash position, 30 percent in bonds and a 65 percent stock position.

Second, he needs to decide which investments to make in those areas. We prefer money market funds for the cash position, a laddered portfolio of individual bonds and well-diversified no-load mutual funds for the stock position.

We also suggest that Lee include small-cap, mid-cap and large-cap funds, as well as some international funds in his stock portfolio. Be sure to maintain a balance between growth and value stocks too.

Finally, over time Lee needs to be sure to rebalance his portfolio when one section takes him significantly out of balance. This will help him control the portfolio's risk and volatility over a 10-year period, and it will help him stay invested and not wander off looking for a better strategy.

Guest columnist Ronald W. Rogé, MS, CFP, is president of the fee-only wealth management firm R. W. Rogé & Co. in Bohemia, N.Y. WORTH magazine named him one of America's Best Financial Advisors. Medical Economics says he's one of the best financial advisers for doctors. His company is rated by Bloomberg magazine as one of the country's top wealth management companies.

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