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Small and undervalued stocks deliver best long term returns

- Alan Lavine and Gail Liberman

If you had to invest in just one type of mutual fund for the long term, which should it be?

The answer: Under valued small company stock funds. Financial research has shown that based on seven decades of investment returns, small company stocks and undervalued stocks have outperformed large company stocks.

Over the past 15 years, small company stock funds have outperformed the S&P 500 by 3 percentage points in annual return.

Past performance is no indication of future results. Don't expect a mutual fund that invests in cheap small companies to do well year in and year out. Large company stocks and small company stocks take turns outperforming each other.

But if you buy and hold a well-managed fund in your retirement account for 20 to 30 years, you can expect to do well.

Paul Merriman, publisher of FundAdvice.com, recommends investors diversify among all types of stock funds--large, small, growth, value and international. However, he suggests putting more money in small company and value funds. He likes index funds that track the undervalued and small company stock markets. The best places to invest:

  • Those who invest directly should stick with Vanguard Group index funds. Index funds are lower-cost than actively managed stock funds. Plus, you don't pay a sales commission when you deal with Vanguard.

  • Investors who hire money managers should seek the Dimensional Fund Advisors stable of index funds. Their index funds have outperformed Vanguard's index funds because Dimension's funds invest more heavily in small and undervalued stocks.

    Prefer actively managed small company value funds?

    Best bets, according to Morningstar Inc., Chicago: N/I Numeric Investors Small Cap Value Fund and Schneider Small Cap Value Fund. Both funds carry the highest five-star Morningstar ratings.


    Spouses Gail Liberman and Alan Lavine are syndicated columnists. Their latest book is "Rags to Retirement (Alpha Books)." You can e-mail them at MWliblav@aol.com.

    To read more columns, please visit the column archive.

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