| BUSINESSWEEK ONLINE : NOVEMBER 15, 1999 ISSUE | ||||||||
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| BUSINESSWEEK INVESTOR
Fear Not. Shelter Stocks, Not Bonds John Shoven, a Stanford University economist, exploded two myths of personal investing in a National Bureau of Economic Research working paper this past March. Myth No. 1 is that tax-conscious investors should keep bonds in tax-sheltered accounts and stocks in unsheltered accounts. Myth No. 2 is that risk-averse, long-term investors should invest heavily in bonds. Start with the question of where to put stocks and bonds, assuming that you want to hold both and that you have both a tax-sheltered account such as a 401(k) and an ordinary, unsheltered account. The typical financial planner might advise putting bonds in the sheltered account because interest on corporate bonds is taxed more heavily than long-term capital gains on stocks. NASTY BIT OF NEWS. The first problem with that idea is typical actively managed equity mutual funds produce returns that are quite heavily taxed after all. They throw off lots of dividends and capital-gains distributions. Second, not all bonds are taxed hard: Municipal bonds are exempt from state and local taxes. Third, since there's a limit on your annual contributions to a tax-sheltered account, it makes sense to keep it for the asset that's likely to grow the fastest once it's inside--namely, stocks. It's better to shelter a big, fast-growing portfolio of stocks than a small, slower-growing portfolio of bonds. Shoven's advice: stocks in the shelter, muni bonds outside. Shoven's recommendation changes when your equity mutual fund is managed to keep taxes extremely low: If only one-sixth of your return comes from dividends and long-term capital-gains distributions, then it does make sense to put stocks outside the shelter and bonds--corporate bonds--inside it. To check Myth No. 2, Shoven ran tens of thousands of computer simulations of the future performance of stocks and bonds, assuming they were properly allocated between sheltered and unsheltered accounts. His average forecast was for stocks and bonds to do about the same in the future as they have over the past 70 years, but in some of the projections they did much better or far worse. In a good 30-year stretch, stocks do much better than bonds; in a very bad 30-year stretch, they do only a little worse. In other words, long-term investors who go heavily into bonds are surrendering the likelihood of huge gains from stocks in exchange for the pale assurance that if things go really bad, they will do only slightly better than if they were heavier into stocks. Shoven says an investor with a 30-year horizon who simply wants to maximize return should be 100% in stocks. Someone who is moderately risk-averse should be 70% in stocks, 30% in bonds. Even a very risk-averse person--who wants to minimize the downside of a scenario worse than 99% of all possibilities--should be 60% in stocks and 40% in bonds. Shoven, 52, says his portfolio is 80% to 90% invested in stocks. By Peter Coy _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ BACK TO TOP |
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RELATED ITEMS Planning a Smooth Financial Ride TABLE: Financial Planning: An Economist's Approach Fear Not. Shelter Stocks, Not Bonds INTERACT E-Mail to Business Week Online | |||
