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Mutual funds are not what they used to be

- Alan Lavine and Gail Liberman

So many people tell us that they are mental midgets when it comes to the complicated world of investing. But actually, simplicity is the key to some of the best investment strategies.

Here's the bottom line to understand about investing. Stocks are riskier than bonds. Bonds are riskier than bank CDs or Treasury bills. On the other hand, stocks have performed the best over the long term--say 10 or 20 years. So if you have that long to invest, it pays to own some stocks or stock mutual funds--even now.

You can cut your risk in stocks by also owning bonds, CDs, money funds or Treasury bills. Those who want to get fancy can invest part of their stock holdings in international stocks or international stock funds, real estate and gold or gold funds.

We suggest keeping it simple. You might not hit a home run, but then again, you also wouldn't have felt the extreme pain of the past 2 1/2 years, when the stock market nose dived -30 percent.

Kenneth Fisher, a Woodside, Calif.-based money manager and author of "The Wall Street Waltz" and "100 Minds That Made The Market," puts it best. He says the best decision is a simple one.

"To a large extent people take a rearward view after they have experienced losses and say they should have diversified more," Fisher says. "Then they make the mistake of looking at top performing investments of the past." But, he says, you have to look to the future for the best mix of investments.

Here are some potential ideas for the future.

  • The easy way to invest in stocks and bonds is to own index mutual funds. These are low-cost investments that own stocks or bonds that make up an index that measures the market. You might put 60 percent of your money in a mutual fund that tracks the S&P 500 stock market index. This means you own stocks in 500 of the largest and most profitable companies in the world. Then put 40 percent in an index bond fund that tracks the Lehman Brothers Aggregate Bond index.

  • Consider a balanced fund. Someone who owns a balanced fund with 60 percent in stocks and the rest in bonds is weathering the storm of the last 2 1/2 years nicely. On average, balanced fund investors are down just -7 percent this year ending in June compared with the S&P 500's -13 percent drop over the same period. Historically, a 60 percent stock and 40 percent bond mix has grown at an 8 percent annual rate since 1926, according to Ibbotson Associates, Chicago.

  • Consider an all weather stock fund. This is a single mutual fund that has a mix of different investments. The Permanent Portfolio Fund invests a fixed percentage in stocks, bonds, cash real estate and precious metals. Over the past three years, this simple all-in-one fund has grown at a 7 percent annual rate. By contrast, the S&P 500 has lost -8 percent annually. Over the past 10 years, the Permanent Portfolio fund has grown 5.8 percent annually.

    There also are more aggressive all weather funds. These funds make small changes in their mix of stocks and bonds depending upon the outlook for the financial markets. They promise higher returns in up markets, but they're also riskier. The Fidelity Asset Manager hasn't lost a penny over the past three years ending in June 2002. Meanwhile the Vanguard Asset Allocation fund has lost -2 percent annually over the same period.

    Longer term, however, the Fidelity Asset Manager and Vanguard Asset Allocation Fund have outperformed the Permanent Portfolio fund. The reason: Fidelity and Vanguard's managers put more into stocks when they believe the market is favorable. By contrast, the Permanent Portfolio always keeps a fixed percentage in stocks.

    It's always a good idea to spread your risks. But don't overdo it. If you over diversify your investments in reaction to the poor performance of your stock mutual funds, you risk missing out on nice returns when the stock market finally rebounds.


    Alan Lavine and Gail Liberman are husband and wife columnist and authors of The Complete Idiot's Guide To Making Money With Mutual Funds, (Alpha Books).

    To read more columns, please visit the column archive.

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