by Archie M. Richards, Jr.
July 17, 2006

Norm writes about several matters:

1. "I look forward to every one of your columns and consider you the media's best financial writer."

   Thanks, Norm. You can uncross your fingers and toes now.

2. "I know you recommend splitting a portfolio between stocks and bonds. How about using flexible or balanced mutual funds and allowing the managers to do the allocating? Won't they know better than I do when to switch between stocks, bonds, and cash?"

   No. Just like the rest of us, fund managers are poor at anticipating trends. Studies show that mutual funds generally hold the least cash at market tops and the most cash at market bottoms - the opposite of what they should. Guessing when to switch between stocks, bonds, and cash isn't necessary anyway. Just rebalance every year and a day no matter what the market's doing. If a mutual fund or ETF has moved up a lot, sell some of it to bring the value back to the percentage of the portfolio you originally intended. Add the proceeds to funds that are weak. (The spreadsheet in archierichards.com > Suggested Portfolios can help with the rebalancing.)

3. "I have followed your advice of investing 30 percent of the portfolio in international stocks. But is this a good idea for a 64-year-old retiree like me who needs 4 or 5 percent income?"

   You need growth as well as income, Norm. The growth potential of foreign stocks is probably better than that of U.S. stocks. Some nations have a long way to go to catch up with where we are now, but they can use existing technology to get there. In more and more nations, voters are learning that governments should enforce property rights, cut tax rates, and otherwise let the economy alone. This enables the poor to launch themselves into the middle class. (Mexico is undergoing this process right now, and will continue doing so.) To attain the best possible growth potential with reasonable risk, include foreign stocks. As the portfolio grows, your 5 percent income becomes larger and larger. By all means, remove the income you need. (To avoid depleting the portfolio, don't exceed 6 percent a year.) Here's how to go about it: Direct that each fund transfer dividends and capital gains to the money market fund. Every three months, empty the money fund. In the final quarter, take out a higher amount, if necessary. The extra cash requires selling. But you're rebalancing anyway. Sell a larger amount to provide for the higher withdrawal. Delaying the extra payout until after the year-and-a-day rebalancing avoids short-term gains.

4. "Finally," writes Norm, "Can 'long-short' mutual funds protect my principal when the market falls?" (Short selling enables a person to profit when prices go down.)

   Sure. But if the short positions equal the long positions, the portfolio's value won't change at all, no matter what the market does. What good is that? You want the portfolio value to change; you want it to go up. It doesn't rise every day, of course, and it may disappoint for a year or more. But in the long run, stock prices rise. Concerning long-short funds, don't expect any fund manager to be able to predict which stocks will fall especially far on the short side and which stocks will rise especially far on the long side. No one can do that consistently. You have 30 years, Norm, before reaching age 94. Think long term. The creation of wealth by the people of the world will cause stock prices to rise substantially. Trying to prevent reasonable declines in the short run ruins the portfolio's growth in the long run. Just spread your money among various asset classes whose price trends differ from one another, take out your withdrawals, and rebalance annually. Otherwise, the more changes you make (or make possible for others to make), the worse the results.