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Tips on Managing your Holdings

- Alan Lavine and Gail Liberman

What determines most of your investment returns? Is it the type of assets you own or your stock or bond picking ability?

The answer, particular for mutual fund investors, lies in the type of assets held by your funds.

Landmark 1986 research in the Financial Analysts' Journal by Gary Brinson, L. Randolph Hood, and Gilbert L. Beebower, shows that 90 percent of the return is determined by the "asset class" or type of investments. Asset classes may include undervalued stocks, growth stocks, U.S. bonds, overseas bonds, cash, real estate and precious metals. Skill in picking securities, market timing and luck combine to give you about 10 percent of your investment return.

It works this way. Say you own bonds and large, medium and small company stock funds run by managers who like to buy stocks cheap based on future earnings growth: Your holdings gain 10 percent in one year. The fact that you held stocks and bonds in general contributed 9 percent of your10 percent return.

Check your fund's performance against the following: The S&P 500, which represents large stocks, and the Russell 2000, which represents small stocks. Chances are your mutual fund returns are in line with these indexes.

Does this mean you should just buy index funds that track the markets?

  • Yes, if you want to buy and hold for the long term. Index funds are low-cost. They have historically outperformed 60 percent of all actively managed funds, according to Morningstar Inc., Chicago. You also can invest in exchange traded funds that track specific markets. With an exchange traded fund, you own stock in basket of stocks that trades on the stock exchange.

  • No, if you have the skill to pick individual securities or mutual funds. Research by Mark Kritzman, published in the Summer 2003 Journal of Portfolio Management, found that stock and bond picking ability can contribute more to the return on your investments. But the study stresses that you had better be a great stock picker to profit.

    So how do you make good stock, bond and mutual fund picks? There is no easy answer. One clue: Other financial research published by Eugene Fama, in the Journal of Finance, shows that buying undervalued stocks that are mispriced based on a company's earnings have outperformed growth stocks over the long term.

    Good luck!


    Alan Lavine and Gail Liberman are husband and wife columnist and authors of The Complete Idiot's Guide To Making Money With Mutual Funds, (Alpha Books).

    To read more columns, please visit the column archive.

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