Here's advice for cautious investors who want to edge back in.
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Here's advice for cautious investors who want to edge back in.
Despite the charred remains of retirement accounts, every uptick in the market inspires new optimism. Dare we hope? Is a new bull market finally underway?
Wise investors won't wait on the sidelines for the answer they want to hear, say investment advisers. "Historically, some of the largest gains have taken place just as the market began to recover from a downturn," says Stephen A. Brophy, of Brophy Financial Advisory Group in Bedford, NH. "People who are out of the market then often miss out on the most rapid growth." Those who shunned equities from March through May of this year, for instance, already missed one growth opportunity: The S&P rose 15 percent during that time.
So what's the best way to get back into the market? After all, three years of market bleeding have taken a considerable toll on mutual funds.
"There's been a dramatic consolidation in the marketplace," says Bryan Place, a financial adviser with Place Financial Advisors, Manlius, NY. "Funds have been withdrawn or swallowed up by larger funds." Others have shrunk considerably. For example, in 2000, the Fidelity Fund had about $15 billion in assets; these days, it has about $9.7 billion.
Stocks that pay dividends have held up better than the broader market during the past three years and are back in vogue. For one thing, companies that pay regular dividends are more likely to be run by savvy management teams than those that don't. Their managers tend to make better business decisions regarding mergers and acquisitions.
Another plus: "The recent tax law change reduces the tax on certain dividends," says Dean Bahniuk, an investment director with Oppenheimer & Co., in Washington, DC. "While not all get favored treatment, dividends are likely to become more important in the future. Funds holding dividend-paying stocks aren't as volatile and have a better chance of outperforming those investing in stocks that don't pay dividends."
Two such funds worth looking at are Franklin Rising Dividends Fund and T. Rowe Price Dividend Growth Fund. The Franklin fund has hit some rough patches, but its return has beaten the average for the category in nine calendar years. And although it sank with the overall market in recent years, it handily beat the S&P 500 based on both 3-year and 5-year annualized returns.*
T. Rowe Price Dividend Growth also beat the S&P 500 during both time frames. The fund is less volatile than others in its category, and it has low turnover, which helps it minimize capital gains taxes.
While diversificationinvesting in different asset categorieswas always sound advice, it's now more vital than ever. You can diversify by selecting funds that together give you a conservative portfolio overall.
"Each asset class has different properties, and responds differently to various economic and business factors," says Place. "Even if they all move with the market, their growth rates may differ. Diversification insulates you from some of the market ups and downs."
To build a diversified portfolio, include at least one small-cap, one mid-cap, and one large-cap equity fund, as well as an international stock fund, a bond fund, and a REIT (real estate investment trust). These asset classes are different enough that companies held in one fund are less likely to be found in the others.
"You don't want to inadvertently invest too much money in the same company," says Bahniuk. "You want mutual funds with different holdings, so that they aren't impacted by the same factors."
You can scan your funds for stock overlap by using a program called Morningstar Instant X-Ray. At www.morningstar.com , it's available only to members, but it's free to register.
Investing in a variety of fund families also helps prevent overlap, says Brophy. "Every fund family has its own analysts, each of whom has a favorite company. You'll often see that company show up in several of the firm's funds."
Stay cautious by investing no more than 50 or 60 percent in stocks and putting the rest in bonds. "Three years ago, anything other than a 100 percent stock portfolio was considered a dog," says Brophy. "Now, even people who are very positive about the stock market are not willing to go that high."
If the thought of sifting through mutual fund descriptions leaves you cold, consider a "fund of funds" to get instant diversification. This vehicle doesn't buy securities directly; it invests in several other mutual funds, each with a different mission statement.
Fidelity's funds of funds series, known as Freedom Funds, holds shares in several other underlying Fidelity funds. The Freedom 2020 fund, for example, holds shares in the Fidelity Equity-Income, Fidelity Blue Chip Growth, Fidelity Overseas, and the Fidelity Intermediate Bond funds.
The Freedom funds of funds allot their holdings to create a more aggressive portfolio for investors with a longer time horizon. Later, usually a few years from retirement, they rebalance to develop a more conservative portfolio. There's a Freedom 2000, 2010, 2020, 2030, and 2040 fund, each holding a greater percentage of equities.
Vanguard LifeStrategy Funds contains a growth, conservative growth, moderate growth, and income fund. All invest in several index funds, which passively track indexes such as the Lehman Brothers Aggregate Bond Index or the Wilshire 5000 Equity Index. They include the Vanguard Total Bond Market Index Fund, Asset Allocation Fund, Total Stock Market Index Fund, Short-Term Corporate Fund, and Total International Stock Index Fund.
Easy diversification may not come cheap. A fund of fund's expenses can be high, since you may pay an overall fee in addition to the expenses of the underlying funds. Still, high expenses aren't a given; Fidelity's Freedom 2040 fund has a total expense ratio of 1.0 percent, which is less than the average of 1.3 percent for comparable funds. By contrast, the Integrity Fund of Funds has an expense ratio of 1.6 percent.
If you want a no-sweat way to divide your money between stocks and bonds, you might like an asset allocation fund, which uses a flexible combination of stocks, bonds, and cash. "If you're not inclined to really watch your portfolio, these funds can be of great value," says Steven Brophy.
Leuthold Core Investment Fund divides its holdings mostly among US stocks, but also holds foreign stocks, bonds, and cash. It splits its selections almost evenly between companies in the service, manufacturing, and information segments. The fund has beaten the S&P 500 since 2000.
American Century Strategic Allocation: Aggressive Fund has outperformed many other funds focusing on US stocks and bonds. It combines a blend of growth and value mostly blue chip stocks, with a fairly conservative bond portfolio.
Keeping volatility to a minimum can help you stay calm during some of the market's ups and downs, says Dean Bahniuk. Beta measures how volatile a fund is compared with the overall market. The market, as represented by the S&P 500, has a beta of 1.0. A beta of less than 1.0 means the fund will have smaller ups and downs than the overall market.
A beta of more than 1.0 means the fund will gyrate more extremely than the overall market. "If you overlook the importance of the fund's beta during a good market, you may overload on highly volatile holdings that plunge in a bad market," says Bahniuk.
To keep beta in check, stick with mainstream vehicles. Be wary of sector funds, some of which tend to be more volatile than funds covering the broader market.
The Yacktman Fund, with a beta of 0.7, has ranked in the top 1 percent of mid-cap value funds over a 3-year time frame. It's one US equity fund whose assets have grownfrom $81 million in 2000 to $421 million in 2003. Its 3-year annualized return of 20.6 percent puts it way ahead of the crowd.
Another low-beta (0.7) domestic stock fund worth a look is RS Partners Fund, which focuses on small stocks. The fund has racked up an impressive track record while keeping volatility low relative to the market. The manager invests in mundane industries, such as coal and consumer staples, but also holds interests in health care, insurance, and industrial metals producers.
A final word of advice: Wade, rather than dive, into the market. "Bland, boring, dollar cost averaging is a great way to start moving in," says Bryan Place. "We're going to continue to see a lot of sideways activity in the market; there will still be ups and downs. Putting a certain amount in every month allows you to buy more shares when the market's down. It would be dangerous to think that the worst is behind us, and to suddenly move lump sums back into the market."
Like your high school pal who has morphed into a middle-aged gent, some mutual funds have also changed in recent years.
Some funds are much smaller, which can have benefits. "Smaller funds can be very nimble when it comes to making changes in their holdings, while larger funds can't move very quickly because of their sheer size," says Dean Bahniuk, an investment director with Oppenheimer & Co., in Washington, DC. Still, if you're cautious and looking for stability, bigger often is better, he says. "Smaller funds might post stellar performance, but they usually have difficulty repeating a blockbuster year."
Many funds are also undergoing style driftmoving from one investment strategy to another, notes Bryan Place, a financial adviser with Place Financial Advisors, in Manlius, NY. Minor style drift can be helpful when it allows a manager to respond to market changes. But if a growth fund begins to concentrate in one sector, such as technology, it may become unbalanced. Or if a small-cap fund starts buying medium and large-cap stocks, it may duplicate holdings in your mid-cap or large-cap fund.
"Another type of style drift involves holding cash, rather than being fully invested," says Place. "You don't want to pay managers to hold cash. Check your funds for style consistency."
Have you received any letters from your mutual fund company that you didn't bother reading? Companies notify shareholders of a change to the fund's mandate by mail. But many folks just toss the documents.
|12-month return||3-year annualized return||5-year annualized return|
|Franklin Rising Dividends Fund||13.1%||13.0%||10.5%|
|Fidelity Freedom 2020 Fund||17.8||6.4||5.9|
|Vanguard LifeStrategy Moderate Growth Fund||14.0||2.9||4.7|
|American Century Strategic Allocation: Aggressive Fund||16.1||5.9||6.4|
|Leuthold Core Investment Fund||34.0||6.8||9.6|
|RS Partners Fund||51.2||21.6||17.8|
|Standard & Poor||17.0||11.0||2.5|
Leslie Kane. How to get back into the market. Medical Economics Oct. 10, 2003;80:41.