From a university professor and from one of the top financial advisers in the nation comes a new study suggesting that investors, particularly retirees, can benefit by switching between stocks and bonds in response to changes in the rate of inflation.

But, the study concludes, switching does reduce volatility and lowers the risk of investors suffering a big loss at just the wrong time, such as when they need to make withdrawals from their portfolio for living expenses.

The study, Dynamic Asset Allocation During Different Inflation Scenarios, was conducted by David N. Nawrocki, professor of finance at Villanova University, and Harold Evensky, chairman of the investment advisory firm Evensky, Brown & Katz in Coral Gables, Fla.

The findings are significant because Evensky, a highly regarded, nationally recognized certified financial planner, has long been known as a foe of market timing, or jumping in and out of stocks to try to capture short-term gains.

There is an issue of semantics here, Evensky said. What we believe in is the concept of `tactical’ asset allocation.

Tactical asset allocation, as Evensky’s firm defines it, means making adjustments to the mix of assets in a portfolio as economic conditions change. Market timing, on the other hand, involves moving in and out of stocks in response to purely technical factors, such as whether stock prices are up or down.

So why do the study? While inflation is currently quite low, financial planners are long-term investment advisers, Nawrocki and Evensky wrote. The nature of their business suggests that a re-exploration of the economic significance of the inflation/stock relationship is important to financial planners.

That relationship, based on many previous studies that have spanned decades, is that stocks don’t do well when inflation perks up.

With that in mind, Nawrocki and Evensky set out to see whether moving in and out of stocks depending on the prevailing rate of inflation would smooth out the investment bumps and provide liquidity to those who need it, such as retirees and endowment funds.

Their study, which looked at data from January 1950 through December 1998, found that stocks provide the best returns as long as inflation doesn’t exceed 4 percent a year.

When inflation climbs to between 4 and 8 percent a year, investors are better off moving out of stocks and into intermediate-term bonds.

If inflation runs 8 to 12 percent a year, U.S. Treasury bills perform best, according to the study. And surprisingly, when inflation rises above 12 percent, the financial markets seem to adjust, and stocks again provided the best performance, the study found.

In their study, the pair tested the switching strategy using various allocations of stocks and bonds. While all worked better in terms of risk and return than not making any switches at all, the best overall risk/return performance occurred with an initial allocation of 70 percent stocks and 30 percent intermediate bonds that was switched to 100 percent intermediate bonds when inflation ran between 4 and 8 percent, to 100 percent U.S. Treasury bills when inflation climbed to between 8 and 12 percent, and back to a 70/30 mix of stocks and intermediate bonds when inflation rose above 12 percent.

Switches using this strategy occurred on average only once every 20 months. So the average trade would qualify for the lower long-term capital gains rate (for assets held more than a year).

Humberto Cruz can be reached at AskHumberto@aol.com or c/o Tribune Media Services, 435 N. Michigan Ave. Suite 1500, Chicago, Ill. 60611.