Asset Allocation Funds Explained

Historically, stocks have outperformed other investments. But stocks also carry more risk than many other investments, and they are more volatile (perhaps you've noticed some gyrations in the stock market lately?). That's why many financial experts tout asset allocation. They tell us that asset allocation -- investing assets across asset classes (such as stocks, bonds and cash) and across international borders (which means in the U.S. and in other countries) -- is critical for making money over the long haul and protecting our assets from market downturns.

Morningstar, a leading provider of mutual fund information, reports that there are 247 asset allocation funds and 81 international hybrid funds, all offering worldwide exposure to stock and bond markets. So, what's the best way to take advantage of the benefits of asset allocation?

There are two primary types of asset allocation strategies: strategic and tactical (see sidebar). Studies show that tactical asset allocation doesn't benefit investors over the long haul because you can't make money by taking advantage of markets or individual securities that are mispriced. Harry Markowitz won a Nobel Prize for his research way back in 1952, in which he counseled that it is more profitable to own investments that don't bounce around.

So, what are some one-stop solutions to asset allocation? Schwab recently introduced one that will allocate your assets across large-cap, small-cap and international stocks -- all in one convenient package called MarketTrack Portfolio. One of the portfolios is a 100 percent equity fund that invests in three different Schwab index funds -- a large cap fund, a small cap fund and an international fund. (The fund managers may also try to generate additional returns for the funds by investing in common stocks directly).

There are some other one-stop solutions to asset allocation that diversify even more fully in stocks and bonds, domestically and internationally, such as Merrill Lynch's Global Allocation Fund and SoGen International Fund. Morningstar categorizes them as international hybrid funds, which are appealing because of their flexibility in pursuing a variety of investment strategies. Fidelity Asset Manager is another alternative offering worldwide asset allocation.

The problem with many of the international hybrid funds is that few are older than five years and don't have a well-established track record. Also, a few funds with especially strong performance have skewed the category averages, according to Morningstar. And there is clearly an element of market timing involved.