Smart Moves

The first nine months of 1995 were a stock investor's dream. The Dow Jones Industrial Average set record after record, and the Standard & Poor's 500 recorded fabulous returns. Small stocks were winners, too, with returns on the NASDAQ over-the-counter segment rising as fast as the high-flying technology companies that dominate it. You could have invested using a dart board and still hit a bull's eye.

So what's an investor to do for an encore?

First, take a look at your portfolio. If you're like most investors, you'll find a combination of well-known company stocks, highly rated mutual funds that invest in large companies for growth, a bond fund or two, and a few oddball stocks you bought on a hot tip. This doesn't mean your portfolio hasn't given you a great deal of satisfaction, especially in the past year. The problem is, what happens to it when the markets turn around and go the other way, as they did in 1987?

One of the most important objectives in portfolio management is lowering risk through diversification. If all your investments are in the same place, the value of your assets won't be protected in a market decline. To lower your risk, make 1996 the year in which your portfolio goes where no portfolio has gone before. Instead of just another highly rated, widely recommended mutual fund with remarkable similarities to the giants you already own, seek out the areas of the investment road that are less traveled. Over There

International and global funds have been the bane of investors for the past several years. In fact, in four of the past six years, this category of funds has underperformed the U.S. stock market. When currency fluctuations, government upheavals, wars and differences in securities regulations are taken into account, are these funds worth the risk? If you seek to increase long-term return and lower your overall portfolio risk, the answer could be yes.

As the U.S. economy moves from fast-paced to slow growth, European and Far Eastern economies could be on the road to recovery, with increases in corporate earnings on the horizon. The fall of the Mexican peso and earthquakes in Japan scared investors, but now shares of many foreign funds are priced at bargain levels compared with shares of funds invested solely in U.S. stock, many of which are at near historic highs.

Allocating your assets to foreign investments increases the level of risk to that money, but it simultaneously lowers the volatility of your portfolio as a whole. Why? Foreign economies and markets don't always move in tandem with those of the United States. If one part of your portfolio droops, the rest could take up the slack.

If this is your maiden voyage abroad, consider a small investment in a diversified fund that invests overseas. Global funds usually have some exposure to U.S. markets, while international funds invest outside the United States only. If you can handle a greater degree of fluctuation with the potential of a higher return, consider an "emerging markets" fund investing in the stock and/or bond markets of countries with emerging economies. If you'd rather spread your risk over time, make a small initial investment, and add to it monthly.

Electric Avenues

Utility stocks aren't just for income anymore. While just about all stocks rose in 1995, utilities were noticeably left behind. Is there light at the end of the tunnel?

Many utility stocks trade on the strength of their dividends. Income-oriented investors often compare the rates paid by money market funds, certificates of deposit and short-term Treasury bills with those paid by utility company shares, but the latter are by no means as safe. If these short-term fixed-income investments are similar in yield, sharp investors often select the safer alternative; thus the lackluster performance of utility stocks in 1994 and 1995.

However, should interest rates fall, as anticipated, in the 1996 election year, utilities could provide a bright spot for investors who seek a good total return on their investment (yield plus capital gain).

Mergers between utility companies can also mean a win-win situation for investors. The hookup of Baltimore Gas & Electric Co. and Potomac Electric Power Co. could give investors a company with improved growth prospects. As regulations tighten and electricity consumers demand more for their money, an increasing number of utilities will feel the urge to merge to remain competitive.

If you have a burning desire to learn more about utilities, start with local companies. Many of them have programs that allow you to invest monthly without commission. If you seek diversification, many mutual funds invest in utilities and also accept monthly investments.

Just as with mutual funds, utility funds may invest for income or growth. To find out the objective of a fund you are considering, read the prospectus before you invest.

Land, Ho!

Scarlett O'Hara might have been right: You can always go back to the land. If diversity is what you seek, you may want to learn more about Real Estate Investment Trusts (REITs).

REITs invest in different types of real estate. Shopping centers, apartment complexes, factory outlet stores and medical care facilities are among the types of REITs available.

Unlike stocks, REITs march to their own drummer-who, by the way, has played a discordant beat for the last few years. The fortunes of REITs often follow interest rates (as with bonds and utilities) instead of following the stock market. In years when stocks rose, REITs had lower or flat returns. In years when the market did poorly, REITs have outperformed the S&P 500.

While they can have high yields, few REITs have scored big capital gains. If you're looking for a candidate for high income and low price, consider individual issues of REITs or mutual funds investing in this area.

One caveat: If more than three-quarters of your net worth is tied up in your home or investment or vacation property, REITs may be duplicating that effort, providing anything but diversification.

Top-Down Investing

If you've ever ridden in a convertible, you know it's not for everyone. So it is with convertible stocks. Convertible securities combine the higher dividend yield of bonds with the capital appreciation potential of stocks. They're attractive to investors who seek a regular interest payment and don't mind that it may be lower than that of bonds.

Unlike bondholders, holders of convertible securities may be rewarded by having their investments converted into the stock of the underlying company, an occurrence that's triggered by a rising stock price. On the other hand, convertibles are unsecured, so if the company goes bankrupt, you may not get your money back. If that bothers you, a mutual fund investing in convertibles may be the answer. Though shares in a mutual fund are not guaranteed either, because funds invest in many issues of stock, the risk to long-term investors is lower.

Although convertibles don't pay as much interest as a bond or rise as much as a growth stock, they can add stability to your portfolio. In the case of market decline, convertible securities usually retain much of their value.

Whichever road you choose to take in '96 and beyond, be prepared to stay with your strategy for the long term or until the underlying fundamentals of your investment choice change sufficiently to warrant a trip to the exit ramp. After all, in investing as in life, it's the journey, not just the destination, that matters.

Lorayne C. Fiorillo is a financial advisor at Prudential Securities in Charlotte, North Carolina, and publisher of the financial newsletter Wall Street Wise.