GETTING GOING / By JONATHAN CLEMENTS
(WSJ 1-26-99)

Numbers Game: Mixing Mutual Funds

How many mutual funds do you really need? Ideally, you might own just two funds one for long-term goals and the other for short-term, needs. But most folks can't keep their finances that simple, and their portfolios may run to a dozen or more funds. Here's my thinking on combining different funds and how you can use it in your portfolio:
One Fund for Everyone
In case of emergency, every investor should have easy access to at least some cash. After all, you don't want to sell stocks and bonds every time the furnace dies. The best place to park this cash is a money-market fund held in a taxable account. You can get to the cash easily, there are no tax hassles when you sell, and you should earn a better yield than with a savings account.
Taking Stock
In addition to a money-market fund, every investor should own at least one fund that's largely invested in stocks. This ,is where you stash money earmarked for long-term goals. If you want simplicity, plunk the money in a life-cycle fund. These funds provide one-stop shopping, with a broadly diversified stock portfolio and a mix of more conservative investments wrapped up in a single fund. Many major fund companies offer three or four life-cycle funds, each of which takes a different amount of risk. Beyond simplicity, life-cycle funds also reduce investment stress. Because the funds combine a whole slew of market sectors, they perform less erratically than stock funds with a more specialized focus.
Spreading It Around
Even if your goal is a simple two-fund portfolio, your finances will almost inevitably be more complicated. If you have a family, you, your spouse and your kids may all own separate funds. In addition, you might have, say, a taxable account, an individual retirement account and a 401(k) plan at work, each of which holds at least one fund. Many investors, in fact, see virtue in owning multiple funds. Partly, I suspect, it's a misguided notion that owning numerous funds is both more sophisticated and also somehow more rewarding, because it gives you more "irons in the fire." But there are some real benefits. You can better control your portfolio's diversification, including how much is invested in large, small and foreign stocks. You can tap into fund managers, who focus on a single market and thus, one hopes, are more adept at mining that sector for superior stocks. Finally, if you own a bunch of funds, there is greater chance that. at least one fund will hold up well in a declining market. That will give you something to sell if you need money in a hurry. By owning specialized and hence, more volatile-funds in your taxable account, you also can take a tax write off should any of them fall out of bed. If you want to dabble in specialized managers, consider six funds for the stock portion of your portfolio, consisting of a large company value fund, a large company growth fund, a small company value fund, a small company growth fund, a foreign fund that invests in developed markets and an emerging-markets fund. Growth funds look for companies with rapidly expanding sales or profits, while value funds favor stocks that are cheap compared with assets or earnings.
Settling for Average
If one life-cycle fund seems like too little and six stock funds sound like too many, consider indexing. An index fund buys the stocks that constitute a market index, in an effort to replicate the index's performance. You can build a global stock portfolio with just two funds, a U.S. index fund and a foreign-stock index fund. Preferably, the U.S. index fund will track a broad market index like the Wilshire 5000, rather than just the blue-chip stocks in the Standard & Poor's 500-stock index. Many folks combine index funds with actively managed funds. They might use index funds to lock in market returns with part of their portfolio, while shooting for market beating performance by stuffing the remaining money in actively managed funds. Alternatively, some investors buy an index fund to track the S&P-500, which many consider to be a particularly tough benchmark to beat. Meanwhile, they stick with actively managed funds for small stocks and foreign shares. The notion,is that a skilled manager has a greater chance to beat the market in these two sectors.
Gunning for Income
If you are a conservative investor or you want more income from your portfolio, you could combine a money fund with a life-cycle fund that's heavier on bonds. But many investors want a separate bond portfolio. For these folks, a high- quality taxable, or tax-free short-term bond fund would probably suffice, ' But if you have a hefty bond portfolio or you are light on stocks, you might conbine your short-term fund with a foreign-bond fund and a junk-bond, or "high yield," fund. Because these three sectors-high-quality, junk and foreign- don't always move in sync, you get smoother portfolio performance by owning all three funds.