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Morningstar.com's Interactive Classroom

Course 306
Getting More Aggressive

Introduction

Most of us don't want our 6-year-olds to punch classmates who irritate them, or suggest that they tell their great aunts how they really feel about getting their cheeks pinched. We don't want our kids to be overly assertive.

Yet when it comes to investing, being aggressive isn't the worst thing, especially if you have a long enough investment horizon, an ambitious goal, and, perhaps most importantly, a stomach for volatility.

This course will cover how you can determine if you're being aggressive enough with your investments, and offer various solutions for how to rev up a sedate portfolio.

Are You Being Aggressive Enough?

How aggressive you should be with your investments depends on three things:

  • your investment goal, or how much money you'll need
  • your investment horizon, or how long you plan to invest for the goal
  • your ability to handle volatility

To find out whether your current portfolio is aggressive enough to meet your goals, use an online asset allocation tool.

If you find that your current portfolio is unlikely to allow you to reach your goal, or you find that it isn't as volatile as you may have thought, consider ways to make your portfolio more aggressive.

Shake Up Your Asset Mix

You can do plenty of things to amplify your long-term returns and volatility. The most significant move: Reducing your bond and cash investments and increasing your position in stocks.

Many financial professionals argue that your blend of cash, stocks, and bonds contributes more to your portfolio's return and volatility than what investment styles you practice, what sectors you have exposure to, and what individual securities you choose.

While we believe all of these factors play important roles in your volatility and return, we agree: Asset allocation is huge. And the more of your portfolio you have in stocks and the less you have in bonds and cash, the more intense your portfolio's performance will be.

Rev Up Your Bond Mix

In addition to altering your asset mix, you can inject some excitement into specific asset groups, too.

Take bonds for example. Short- and intermediate-term bonds and bond funds are commonplace in investment portfolios. To boost your bond component, consider adding one or more of the following types of bonds/bond funds:

Long-Term Bonds
Because the maturity dates of long-term bonds are farther away than those of short- and intermediate-term bonds, long-term bonds tend to yield more. They also tend to gain more when interest rates fall and lose more when interest rates rise.

You can find long-term bond fund ideas using screening tools like Morningstar.com's free Fund Screener. Analyst recommendations such as Morningstar.com's Fund Analyst Picksare also a good source, if you are a Morningstar.com Premium Member.(Nonmembers cansign up for a free trial toMorningstar's Premium Service.)

High-Yield Bonds
High-yield bonds are corporate bonds issued by lower-quality corporations. These bonds carry more credit risk--or the risk that the issuer will default on the debt--than higher-quality bonds do. As a result, they generally yield more than the average high-quality bond.

The returns of high-yield bonds very often follow the returns of the stock market more than the returns of the bond market. Why? Because the performance of high-yield bonds is influenced by the growth and earnings of the company that issued the bond, just as the performance of a stock is influenced by the growth and earnings of the company that issued the stock. Rising or falling interest rates have little bearing on the performance of high-yield bonds.

You can find ideas by using online screening tools such as Morningstar.com's Fund Screener. Using that tool, select the following inputs using the drop-down menus and checkboxes: Fund Group = Taxable Bond; Morningstar Category = High Yield Bond; and MorningstarStar Rating = 4, 5. You can change the inputs to narrow the search further.

Analyst recommendations such as Morningstar.com's Fund Analyst Picksare also a good source, if you are a Morningstar.com Premium Member.(Nonmembers cansign up for a free trial to Morningstar's Premium Service.)

Convertible Bonds
Convertible bonds are stock surrogates even more than high-yield bonds are. That's because convertible bonds can be, as their name suggests, converted into stocks.

We're not going to get into the details of that here. But because of this conversion feature, convertibles behave very much like stocks. They are generally less volatile, though, because they pay a fixed coupon (or yield). They are bonds, after all.

You can find convertible fund ideas by using online screening tools such as Morningstar.com's Fund Screener. Using that tool, select the following inputs using the drop-down menus and checkboxes: Fund Group = All; Morningstar Category =Convertibles; and MorningstarStar Rating = 4, 5. You can change the inputs to narrow the search further.

Analyst recommendations such as Morningstar.com's Fund Analyst Picksare also a good source, if you are a Morningstar.com Premium Member.(Nonmembers cansign up for a free trial to Morningstar's Premium Service.)

Electrify Your Stock Mix

Most investors build portfolios around a core of large-company stocks or funds. You can heighten your performance (and volatility, of course) by exploring the following options.

Mid- and Small-Company Stocks
Some studies suggest that, over very long time periods, smaller-company stocks return more than larger-company stocks. That's because smaller companies are usually growing faster than larger companies, and stock prices (and thereby returns) usually keep pace with growth. The faster the growth, says theory, the higher the return.

Premium Members looking for good small- and mid-cap funds can browseMorningstar's Fund Analyst Picks. (Nonmembers can sign up for a free trial to Morningstar's Premium Service.)

Stock investors can find ideas by using online screening tools, such as Morningstar.com free Stock Screener, which allows you to screen for several types of mid- and small-cap stocks. Youcan add moreinputs to narrow the search further.

Growth Stocks
Tilting the large-company portion of your portfolio toward growth stocks may also amplify its performance. This occurs for the same reason that smaller companies can add oomph: Over time, a stock's price follows its earnings. As a result, companies that are growing at a decent rate should, theoretically at least, outperform those companies that are growing at a slower rate.

Awaken Your Foreign Mix

Most of the foreign stocks that you'll own, either directly or via mutual funds, will be from large companies domiciled in developed markets. To intensify your foreign position, consider these options.

Mid- and Small-Company Stocks
As in the United States, foreign mid- and small-company stocks theoretically have a growth edge over their larger counterparts, too.

You can find ideas by using an online tool such as Morningstar.com's free Fund Screener. Using that tool, simplyuse the following settings: Fund Group = International Stock; Morningstar Category = Foreign Large Blend; Morningstar Star Rating = 4, 5;Average Market Cap Less than or = $1 billion. You can change the inputs to narrow the search further.

Emerging-Markets Stocks
The world's developing markets certainly hold promise. As deregulation, increasing communications, and free-market thinking grip emerging countries, their stock markets seem poised to benefit.

So far, emerging-markets investors have enjoyed some thrills. In 2003, funds in the emerging-markets category gained about 55% on average, and continued to post strong gains of 24%-37% on average in 2004-2007. But emerging-markets funds fell hard in 2008, dropping 54% on average, compared with a 37% drop in the S&P 500. These funds can also suffer in shorter time frames, posting double-digit losses during 11 rolling three-month periods in the past decade through October 2012, including six such periods when they plummeted 20% or more.

The jury's still out on whether emerging-markets stocks will deliver gains that live up to their promise. But they certainly qualify as aggressive investments.

Test Drive Before You Buy

Before deciding that you want to add small companies, emerging-markets stocks, or high-yield bond funds to your portfolio, find out how these new choices would work with and affect your current mix.

Many online financial Web sites offer tools that can help.

Once you see all of the holdings for your "aggressive" portfolio, answer a few questions:

  • Is this new portfolio more likely to meet your goal than your old portfolio?
  • How much more volatile is this portfolio? Can you handle that possible three-month loss?

You may be surprised by what you find. Becoming more aggressive doesn't always improve your chances of reaching your goal. And it'll almost always deepen your possible three-month loss. Make sure you can handle the volatility that comes with a more-aggressive portfolio.

Quiz 306
There is only one correct answer to each question.

1 How aggressive you should be with your investments depends on what?
a. Your investment goal
b. Your ability to handle volatility
c. Your investment goal, your investment horizon, and your ability to handle volatility
2 What's the most significant move you can make to amplify your long-term returns and volatility?
a. Reducing your bond and cash investments and increasing your position in stocks
b. Reducing your large-company stock investments and increasing your position in small-company stocks
c. Reducing your foreign-stock investments and increasing emerging-markets stocks
3 Which type of bond is most like a stock?
a. Long-term bond
b. High-yield bond
c. Convertible bond
4 Why may tilting your portfolio toward growth stocks theoretically amplify its performance?
a. Because all growth stocks are small-company stocks
b. Because companies that are growing at a decent rate should outperform companies growing at a slower rate
c. Tilting your portfolio towards growth isn't a good strategy for aggressive investors
5 To rev up your foreign investments, consider:
a. Large companies
b. Companies domiciled in developed markets
c. Smaller companies
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