Portfolio Advice: Diversify to Survive

March 9, 2001 -- Obsessive love affairs are destined to end badly.

So it goes with technology stocks — who could blame you for falling inlove? Those triple-digit returns you were getting from tech stocks andtech-filled mutual funds were so hard to resist. You blew off other sectors— which seemed boring in comparison. And when the tech bubble deflated,you just couldn't let go.

Now look at you: Stuck with a sagging portfolio that's stilloverweight in technology, and trying to figure out how to get things backin order.

You might feel like you're alone, but financial planners across the countrysay they are seeing this scenario every day. Although the tech crash hasknocked down investors' tech allocation a bit, that may not have doneenough. At the end of January, the National Association of InvestorsCorporation top 100 index of most widely held stocks showed a techweighting of almost 34 percent, compared with the S&P 500's 24 percent weightingin tech at that time.

Letting Go Is Hard To Do

"What we've been seeing is many investors that think they're diversifiedand they own seven or eight large-cap growth funds; or four large-capgrowth funds, one mid-cap growth funds and an S&P 500 fund," says LouStanasolovich, a certified financial planner with Legend FinancialAdvisors in Pittsburgh. "That's when they want to evaluate what theyhave."

The most difficult part of the diversification process is letting go, sayplanners. Before investors sell their beaten-down tech stocks or mutualfunds, they need to come to terms with the fact that what once made themrich, if only on paper, is now worth a fraction of what it once was. That'swhy many investors are often reluctant to sell their tech holdings, becausethey cling to fond memories of the past.

For that reason, many planners say investors should not go on the rebound.Most recommend dollar cost averaging, or selling your investments little bylittle over a period of time, as the best way to wean yourself off oflosing stocks. That way, investors can not only come to gripspsychologically with selling off their losers, but also decrease the riskof selling a stock or a fund at too low of a price.

"I would avoid doing anything dramatic or selling it all right away, justfor the purpose of dollar cost averaging," says Matthew Reading, acertified financial planner with Austin Asset Management in Austin,Texas. "No matter what, you don't know what's going to happen to a stock.That's true on the upside as well as the downside."

Reading also suggests that investors place a limit order to sell at acertain price that is good till cancel. That means you place an order tosell a stock only when it reaches, say, $25 or higher. That way, youdecrease the risk of selling a stock at a really low price. The downsideis, if the stock never reaches that $25, your sell order won't getfulfilled. If that happens, you may need to place another order to sell thestock at a lower price.

Move Quickly to Diversify

But not everyone agrees you should divest gradually. Some, like RogerGibson, president of Gibson Capital Management in Pittsburgh, arguethat the longer your portfolio is undiversifed, the worse it's going to befor you in the long run.

When he is counseling someone to diversify, Gibsontells clients to imagine that they were starting from scratch and devise anoptimal portfolio from there. Once that's determined, Gibson says he movesas quickly as possible to get their portfolio there. "I would say bite the bullet and let's move," says Gibson.

Figuring out what to sell is another difficult step. Stock picking is hardfor professionals, let alone amateur investors, and there are no hard andfast rules about which stocks to sell. Most planners say investors shouldtake a hard look at their stocks' fundamentals, outlook and earnings anddetermine whether or not they still believe in the company's future. Ifnot, it could be time to sell.

One of the biggest hurdles for investors selling stocks is thepsychological factor. It is difficult to unload a stock after you'vewatched it soar to lofty heights and plunge to bottomless depths becauseyou're still probably thinking that it could go up again.

Though selling losing stocks is indeed painful, the good news is you canuse those losses to offset any capital gains you might make during theyear, a process called tax-loss selling.

Planners say one of the biggest mistakes investors madeduring the bull market is that they were afraid to sell stocks at the topnot only because they were greedy, but because they were afraid of payingthe capital gains taxes. Investors need to be careful not to let anypotential tax burdens get in the way of prudent investment decisions.

The Right Asset Allocation

What investors should do, say planners, is re-evaluate their portfoliosevery one or two years, take profits on those stocks that have had a goodrun and get rid of those losing stocks that seemed to have lost their willto live.

"People have to remember that at the end of the day, if you're payingtaxes, that's a good thing because that means you made money," says BryanOlson, vice president at the Schwab Center for Investment Research.

Figuring out the optimum asset allocation for you is another complicatedtask that should be determined taking into account your age, income, risktolerance and time horizon. But many planners say a simple way to balanceyour portfolio is to get your sector weightings in line with the broadermarket, namely, the S&P 500. That way, when one sector is out of favor inthe stock market, investors will be somewhat shielded by thediversification.

"Use the market," says Olson. "Obviously if you have strong feelings oneway or the other, slightly overweight or slightly underweight that sector.But to go to any extreme, you're making a very conscious bet and exposingyourself to added risk."

The caveat there is that the sector weightings in the S&P 500 fluctuateaccording to what the market has a mania for, so investors should bemindful of that.

Legend Financial's Stanasolovich has a different view, recommending thatinvestors have an equal weighting of different sectors or asset classes intheir portfolios. So, your large growth allocation is equal to your smallvalue stake and so on. The planner says this strategy will serve investorswell in most market environments.

To figure out if you're having an unhealthy relationship with technology,Stanasolovich recommends looking at both your individual stocks and all ofthe holdings in your mutual funds (information that should be available onmost mutual fund companies' Web sites or on fund tracker Morningstar'ssite).

After you've determined out how much you have in what, then you need tofigure out what kind of asset allocation you want to achieve and decide howquickly you can handle getting there. Breaking up with your tech stocksmight be hard to do, but it might be the only way to get your life backtogether again.