ASK KIM
Stocks Still Tops for the Long Term
by Kimberly Lankford

How well did stocks do last year? Are they still the best place to put my long-term savings?

They sure are. Large-company stocks (as measured by the Standard & Poor's 500) returned 10.9% in 2004 while small-company stocks (the smallest 20% of the market by market capitalization) returned an excellent 18.4%, according to Ibbotson Associates, which has been keeping these figures for nearly 80 years.

Over the long run, stocks have done much better than any other type of investment -- with large-company stocks averaging 10.4% per year since 1926 and small-company stocks averaging 12.7% per year, according to Ibbotson. Meanwhile, long-term government bonds have only averaged 5.5% per year during that same period (even though they had a pleasant 9.4% return in 2004) and cash -- defined by Ibbotson as 30-day Treasury bills -- only returned 3.7% per year. With inflation averaging 3% over that time period, keeping too much money in cash would have barely kept up with the increasing cost of living.

But you really need to match your investments with your time frame. Even though stocks are great for long-term investors, they can be too risky for your short-term money.

In their best year since 1926, large-company stocks returned nearly 54%, but lost 43% in their worst year.

The fluctuation is even greater for small-company stocks, which gained 143% in their best year but lost 58% in their worst year, according to Ibbotson.

By contrast, bonds remain popular despite their lower returns because they are less volatile. Long-term government bonds only lost 9% in their worst year, and 30-day Treasury bills only lost .02% at their very worst.

Because of these risks, it's important to have a diversified portfolio -- even for your long-term investments. Our recommended long-term portfolio includes funds that invest in large companies, funds that focus on small companies, and funds that invest in foreign companies.

As your goals get closer, we recommend gradually shifting more money into bond funds. For money you'll need within the next year cash is king because you don't have time to wait for your investments to bounce back.

For investing ideas that match several time frames, see Kiplinger's Fund Portfolios.