When deciding where to invest your money, you need to always take into account your investment goals and objectives. Different types of investments carry varying degrees of risks and potential return.
CD
A bank CD is a very safe investment. The CD is FDIC insured up to $100,000, so there truly is minimal risk. The only downside is that you cannot withdraw that money in the CD for a specific amount of time or else you'll receive a penalty. Bank CDs generally only pay up to 5% interest.
Bonds
A bond is essentially a loan you make to a company or a government. Bonds have varying degrees of risk, from essentially risk-free treasuries to junk bonds. The higher the risk of the bond, the higher the return will generally be.
Stocks
Stocks are investments in companies. Depending on the company, the risk of the investment can be high or low. Obviously, buying stock in Johnson and Johnson is a lot less risky than a new internet startup company. In general, the stock market returns on average about 10% a year, though the actual return of any given stock will vary significantly.
Mutual Funds
A mutual fund typically invests in over 100 stocks, so it's an instant way to diversify your portfolio. However, the mutual fund generally charges a fee, which is about 1% of your assets per year. Because of this fee, most mutual funds do not outperform the market; a monkey blindly picking 100 stocks but not charging you a fee could easily outperform most mutual funds.
Real Estate
Real estate is a popular investment. The most obvious real estate investment you'll make is when you purchase your home. Your home can go up or down in value when you sell it; it depends on the housing market in your area.
Friday, January 4, 2008
Tips For Choosing High-Performance Mutual Fund
Most people who invest in mutual funds don't know what they are doing. They take advice from someone at a bank or perhaps a friend and plunk down money into a fund. Sometimes this strategy works, but most of the time, it doesn't.
When you invest your money in a mutual fund, you are trusting someone to invest in the stock market for you. Because of this, you want to be sure this person knows what he or she is doing. Also, you want to make sure that this person is not charging you too much to manage your money for you. Mutual funds fees are "hidden," in the sense that they do not charge you an upfront fee but rather a percentage of the amount of money in your account. If this percentage is too high, you would do better just blindly picking stocks yourself.
Here are five helpful tips for choosing the right mutual funds.
1. Keep the fees low. Generally, expense fees should not be much higher than 1% if it is just a basic domestic equity fund. You should never invest money in a fund that also charges a "load," which is an additional fee that is ridiculous to pay. Never invest in funds that charge loads; those funds are for suckers.
2. Check the asset base. Mutual fund managers only know of so many good investments. When they have too much money to manage, they begin investing in stocks they don't like much but need to invest in anyway or else they'll just have money laying around. There's little reason to invest in a fund with over $5 billion in assets. It's best if it's under $2 billion generally.
3. Consider an index fund. This is a fund that tracks a stock index, such as the S&P 500. For these funds, the manager just buys whatever stocks happen to be in the index. Since this is not much work, the fees are much lower. Even though this method is simple, it has proven to perform better than most mutual funds. Some high performance index funds include FSMKX (Fidelity S&P 500) and VIMSX (Vanguard S&P 400 Midcap.
4. Evaluate the fund's strategy. If you have a long term outlook, look for a more aggressive fund that invests in small-cap stocks, international stocks, and riskier stocks in general. High risk tends to result in high performance in the long run. If you are more risk-averse, consider an S&P 500 index fund.
5. Keep the fees low. Did I mention this already? Well, I'll mention it again. This is where most people mess up. Make sure you are not paying a load or paying too much in fees to the mutual fund.
More information about mutual funds can be found at Research Mutual Funds.
When you invest your money in a mutual fund, you are trusting someone to invest in the stock market for you. Because of this, you want to be sure this person knows what he or she is doing. Also, you want to make sure that this person is not charging you too much to manage your money for you. Mutual funds fees are "hidden," in the sense that they do not charge you an upfront fee but rather a percentage of the amount of money in your account. If this percentage is too high, you would do better just blindly picking stocks yourself.
Here are five helpful tips for choosing the right mutual funds.
1. Keep the fees low. Generally, expense fees should not be much higher than 1% if it is just a basic domestic equity fund. You should never invest money in a fund that also charges a "load," which is an additional fee that is ridiculous to pay. Never invest in funds that charge loads; those funds are for suckers.
2. Check the asset base. Mutual fund managers only know of so many good investments. When they have too much money to manage, they begin investing in stocks they don't like much but need to invest in anyway or else they'll just have money laying around. There's little reason to invest in a fund with over $5 billion in assets. It's best if it's under $2 billion generally.
3. Consider an index fund. This is a fund that tracks a stock index, such as the S&P 500. For these funds, the manager just buys whatever stocks happen to be in the index. Since this is not much work, the fees are much lower. Even though this method is simple, it has proven to perform better than most mutual funds. Some high performance index funds include FSMKX (Fidelity S&P 500) and VIMSX (Vanguard S&P 400 Midcap.
4. Evaluate the fund's strategy. If you have a long term outlook, look for a more aggressive fund that invests in small-cap stocks, international stocks, and riskier stocks in general. High risk tends to result in high performance in the long run. If you are more risk-averse, consider an S&P 500 index fund.
5. Keep the fees low. Did I mention this already? Well, I'll mention it again. This is where most people mess up. Make sure you are not paying a load or paying too much in fees to the mutual fund.
More information about mutual funds can be found at Research Mutual Funds.
Sunday, December 30, 2007
Identified five big mutual fund drawbacks
"Mutual fund investors should be offended by the amount of taxes and fees they have to pay," says O'Shaughnessy. "Mutual funds may seem like no-brainer investments but they can compromise your long-term savings potential. All the money you spend on fees and short-term capital gains taxes could have remained invested and compounding."
O'Shaughnessy has identified five big mutual fund drawbacks:
High expense ratios. Investors pay a fee for the privilege of owning shares. That fee goes to the fund's manager. But instead of a flat amount, the fee is based on your assets in the fund. The more money you have invested, the higher your fee.
Undisclosed transaction costs. This is the fee that a mutual fund pays to its broker to buy and sell stocks. The fee is not found in a fund's prospectus and is deducted from the fund's returns. The higher the fund's portfolio turnover rate, the higher its transaction costs.
No control. You have no say over what stocks the fund owns. Some stocks may be ideal for you while others are not.
Little knowledge. Because you don't know what specific assets a mutual fund owns on a daily basis, you could wind up owning the same stocks in several different funds. Or the types of stocks the fund buys now may differ from the ones it set out to buy when you originally invested.
Significant tax hits. In addition to the capital gains taxes you pay when your fund manager actively trades stocks, you also face "embedded capital gains." These can occur when a fund you recently bought sells a stock it has held for many years. Your tax hit on that trade will be equal to someone who has the same amount invested but owned the fund for many years and profited from that stock's long run-up in price.
What's the average mutual fund investor to do? Alternatives are emerging that provide individuals with more control over their investments and taxes. The Web-based services in this new "personal fund" sector offer stock portfolios that are tailored to an individual investor's personal financial goals.
Instead of buying mutual fund shares, investors in personal funds buy an entire portfolio of stocks for a relatively low minimum investment. By owning the stocks in a personal fund, you control your capital gains taxes by choosing when to buy and sell stocks. You also know at all times the stocks you own.
The low cost of ownership and individual control of tax responsibilities offer individuals significant advantages over mutual funds and other popular investment vehicles. As such, Forrester Research, an e-commerce research firm in Cambridge, Mass., predicted that more than $1 trillion will be invested in personalized funds rather than mutual funds over the next 10 years.
"The days when mutual fund investors have to eat what they are served are over," says O'Shaughnessy of Netfolio.com. "Personal funds make it possible for every individual investor to own a professionally selected stock portfolio that is reasonably priced and designed for their needs and goals."
O'Shaughnessy has identified five big mutual fund drawbacks:
High expense ratios. Investors pay a fee for the privilege of owning shares. That fee goes to the fund's manager. But instead of a flat amount, the fee is based on your assets in the fund. The more money you have invested, the higher your fee.
Undisclosed transaction costs. This is the fee that a mutual fund pays to its broker to buy and sell stocks. The fee is not found in a fund's prospectus and is deducted from the fund's returns. The higher the fund's portfolio turnover rate, the higher its transaction costs.
No control. You have no say over what stocks the fund owns. Some stocks may be ideal for you while others are not.
Little knowledge. Because you don't know what specific assets a mutual fund owns on a daily basis, you could wind up owning the same stocks in several different funds. Or the types of stocks the fund buys now may differ from the ones it set out to buy when you originally invested.
Significant tax hits. In addition to the capital gains taxes you pay when your fund manager actively trades stocks, you also face "embedded capital gains." These can occur when a fund you recently bought sells a stock it has held for many years. Your tax hit on that trade will be equal to someone who has the same amount invested but owned the fund for many years and profited from that stock's long run-up in price.
What's the average mutual fund investor to do? Alternatives are emerging that provide individuals with more control over their investments and taxes. The Web-based services in this new "personal fund" sector offer stock portfolios that are tailored to an individual investor's personal financial goals.
Instead of buying mutual fund shares, investors in personal funds buy an entire portfolio of stocks for a relatively low minimum investment. By owning the stocks in a personal fund, you control your capital gains taxes by choosing when to buy and sell stocks. You also know at all times the stocks you own.
The low cost of ownership and individual control of tax responsibilities offer individuals significant advantages over mutual funds and other popular investment vehicles. As such, Forrester Research, an e-commerce research firm in Cambridge, Mass., predicted that more than $1 trillion will be invested in personalized funds rather than mutual funds over the next 10 years.
"The days when mutual fund investors have to eat what they are served are over," says O'Shaughnessy of Netfolio.com. "Personal funds make it possible for every individual investor to own a professionally selected stock portfolio that is reasonably priced and designed for their needs and goals."
Friday, December 28, 2007
Tips Investment in Mutual Safe and Profitable #2
Here are some tips to make your investment in mutual fund safe and profitable:
For their regular operations, the funds charge fees and expenses to the investors. As an investor, you have to bear the costs of advertising, research and fund manager’s fees. If the costs of funds are high, it should give better results than the low-cost funds. A small difference in costs over a period of time can become a big difference in returns. Use a mutual fund calculator to calculate how the costs of various mutual funds accumulate, reducing your returns.
Check out the impact of the fund on your tax liability: According to the law, you have to pay capital gains tax if the fund sells any stock to make a profit which cannot be offset against a loss and distributes it to the shareholders. This holds true even if the performance of the fund has been poor. To minimize paying the tax, talk to the fund when it is about to distribute the profit. You can also find out the information from their websites.
Consider the duration of operation and size of the fund: Find out how long the fund has been in operation and the corpus of funds managed by it. New or small funds can yield excellent gains in the short-term. Since these funds invest in a few successful stocks, it can reflect in the fund’s performance. When these funds start growing and invest in more stocks, the impact of each stock on the fund’s performance lessens. This makes repeating the initial spectacular performance difficult. Take a look at how the fund has performed over a long time (minimum period of 5 years) and how it has handled the fluctuations in the stock market.
Determine the volatility of fund: Though it is true that past performance of the fund need not determine the future, you can gauge how volatile the fund has been. High volatility funds carry high investment risk. If your aim is to invest money for your college education in a year time, do not choose these funds. They will not only fail to meet your needs but may also cause loss of capital. The prospectus and annual report for the fund will give you an idea of the fund’s volatility. If the fund has generated spectacular returns for a few years and then dismal returns for the next few years, then it is a highly volatile fund.
Take into consideration the risks taken by the fund to generate the return: All mutual funds carry some amount of risk. Even the funds that invest in the bonds and other debt instruments that are low-risk still have to face the risk of change in interest rates. Funds generating higher returns are more likely to take risks that you may not be comfortable with and may not match your financial goals. E.g. fund that invests mainly in technology stocks or small company stocks take higher risk. If you are investing in the fund for a short-term goal like going on a vacation, these risky funds may not meet it. To decide on the best fund, plan out your long-term strategy and decide your appetite for risk.
Question any changes in the fund’s operations: Many changes can happen in the mutual fund industry. The old fund manager may leave or the strategy may leave. The fund can merge with other fund. Find out the reason behind this. Changes like these can affect the future performance of the fund.
Find out the services offered and fees charged by fund: Find out the services offered by the fund and the fees charged by it. These details are mentioned in the offer document. Certain funds offer toll-free telephone numbers, check-writing facilities and automatic investment programs. Find out the ease with which you can trade in shares of the fund. Determine if the fund charges you for trading in shares. The funds like international funds or small companies funds need extra research from experts and hence charge higher.
Determine the impact of diversification on your portfolio:
The success of your investments will be decided by the money you have distributed among various asset classes: stocks, bonds, and cash. While investing in the mutual fund, determine how investing that fund will impact the overall diversification of your portfolio. Try to keep your portfolio diversified and balanced to reduce the level of risk.
For their regular operations, the funds charge fees and expenses to the investors. As an investor, you have to bear the costs of advertising, research and fund manager’s fees. If the costs of funds are high, it should give better results than the low-cost funds. A small difference in costs over a period of time can become a big difference in returns. Use a mutual fund calculator to calculate how the costs of various mutual funds accumulate, reducing your returns.
Check out the impact of the fund on your tax liability: According to the law, you have to pay capital gains tax if the fund sells any stock to make a profit which cannot be offset against a loss and distributes it to the shareholders. This holds true even if the performance of the fund has been poor. To minimize paying the tax, talk to the fund when it is about to distribute the profit. You can also find out the information from their websites.
Consider the duration of operation and size of the fund: Find out how long the fund has been in operation and the corpus of funds managed by it. New or small funds can yield excellent gains in the short-term. Since these funds invest in a few successful stocks, it can reflect in the fund’s performance. When these funds start growing and invest in more stocks, the impact of each stock on the fund’s performance lessens. This makes repeating the initial spectacular performance difficult. Take a look at how the fund has performed over a long time (minimum period of 5 years) and how it has handled the fluctuations in the stock market.
Determine the volatility of fund: Though it is true that past performance of the fund need not determine the future, you can gauge how volatile the fund has been. High volatility funds carry high investment risk. If your aim is to invest money for your college education in a year time, do not choose these funds. They will not only fail to meet your needs but may also cause loss of capital. The prospectus and annual report for the fund will give you an idea of the fund’s volatility. If the fund has generated spectacular returns for a few years and then dismal returns for the next few years, then it is a highly volatile fund.
Take into consideration the risks taken by the fund to generate the return: All mutual funds carry some amount of risk. Even the funds that invest in the bonds and other debt instruments that are low-risk still have to face the risk of change in interest rates. Funds generating higher returns are more likely to take risks that you may not be comfortable with and may not match your financial goals. E.g. fund that invests mainly in technology stocks or small company stocks take higher risk. If you are investing in the fund for a short-term goal like going on a vacation, these risky funds may not meet it. To decide on the best fund, plan out your long-term strategy and decide your appetite for risk.
Question any changes in the fund’s operations: Many changes can happen in the mutual fund industry. The old fund manager may leave or the strategy may leave. The fund can merge with other fund. Find out the reason behind this. Changes like these can affect the future performance of the fund.
Find out the services offered and fees charged by fund: Find out the services offered by the fund and the fees charged by it. These details are mentioned in the offer document. Certain funds offer toll-free telephone numbers, check-writing facilities and automatic investment programs. Find out the ease with which you can trade in shares of the fund. Determine if the fund charges you for trading in shares. The funds like international funds or small companies funds need extra research from experts and hence charge higher.
Determine the impact of diversification on your portfolio:
The success of your investments will be decided by the money you have distributed among various asset classes: stocks, bonds, and cash. While investing in the mutual fund, determine how investing that fund will impact the overall diversification of your portfolio. Try to keep your portfolio diversified and balanced to reduce the level of risk.
Mutual Fund Investment Tips #1
A Mutual fund is a form of collective investment that pools money from many investors and invests the money in stocks, bonds, short-term money market instruments, and / or other securities. In a mutual fund, the fund manager trades the fund's underlying securities, realizing capital gains or loss, and collects the dividend or interest income. The investment proceeds are then passed along to the individual investors.
There are many mutual funds in the market. While choosing a mutual fund, you need to remember that if the fund had yielded superlative returns in the past, there is no guarantee that it would continue to do so in the future. This is especially true of new or small funds. The other factors that can affect the performance of your investment significantly are:
Sales charges, fees and other expenses levied by the fund
* Taxes to be paid on receipt of distribution
* Duration of operation and size
* Risks and volatility
* Alterationsin the operations
There are many mutual funds in the market. While choosing a mutual fund, you need to remember that if the fund had yielded superlative returns in the past, there is no guarantee that it would continue to do so in the future. This is especially true of new or small funds. The other factors that can affect the performance of your investment significantly are:
Sales charges, fees and other expenses levied by the fund
* Taxes to be paid on receipt of distribution
* Duration of operation and size
* Risks and volatility
* Alterationsin the operations
Thursday, December 27, 2007
Before You Buy Mutual Funds
Congratulations, you found a mutual fund you want to invest in! Buying a mutual fund may be the smartest financial decision of your life. But with over 10,000 mutual funds to choose from, you can be sure that there are a decent number of sour apples out there. To be safe, take a look at the items mentioned on this list before you invest in any mutual fund.
Mutual Fund: Prospectus
By law, you should receive a prospectus from the fund company before you invest in it. Many investors ignore the prospectus, but this is a must read. The mutual fund's objectives are displayed in the prospectus. It tells you the goals of the fund and how it intends to achieve them. You will also find information about the fund's past performance and fees.
Mutual Fund Families
Mutual Fund Glossary
Mutual Fund Fees
The fees are displayed in the prospectus as well as on many mutual fund research sites. Try to buy funds with low expense ratios and certainly avoid 12b-fees. I have yet to hear a valid argument on why you should ever buy a loaded fund. A loaded fund is a fund that carries front-end loads, back-end loads or deferred loads. These loads are basically sales charges. There are plenty of no-load funds to meet your objectives.
More on Mutual Fund Fees
12b-1 Fee Warning
Say "NO" to Loaded Mutual Funds
Mutual Fund: Objectives
Why are you buying this fund? Is it because you read about it in the paper or a neighbor told you about it? Don't get caught in the trap of chasing performance. Buy a fund because it meets an objective in your portfolio, not because it has done well recently. Asset allocation is the key to successful investing.
Psychology of Investing
Investment Psychology Books
When to Sell a Mutual Fund
Returns or Performance
Don't focus too much on returns. Any track record under 5 years is noise. Try to take a look at how a fund has done over longer periods of time and try to compare it to it peers or an index that represents the type of asset class the fund is in. It is not fair to compare a government bond fund with that private sector offer.
Chasing Investment Returns
Mutual Fund History
Mutual Fund: Risk
Take a look at the standard deviation of a fund. If Fund A did slightly better than Fund B, but took twice as much risk as Fund A, then Fund B would be the better choice. Other measures of risk include the Ulcer Index and the worst periods (ex. 1-month, 3-month, one year). Don't take any risk that you are not comfortable with and never take unnecessary risks.
Risk Tolerance Quiz
Risk Capacity Quiz
Index Funds
Mutual Fund: Management
What firm serves as the fund's adviser and who manages the fund? It might not be a bad idea to do some background checking to make sure it is a decent entity. The SEC is the official watchdog for mutual funds and has information about each fund and its manager. Also look out for recent manager changes. Though a new fund manager may be just as good or better, it is important to realize that all the fund statistics from before may not be relevant, especially in an actively managed fund.
What to Look for in a Fund Manager
Investing Professional Designations
Mutual Fund: Prospectus
By law, you should receive a prospectus from the fund company before you invest in it. Many investors ignore the prospectus, but this is a must read. The mutual fund's objectives are displayed in the prospectus. It tells you the goals of the fund and how it intends to achieve them. You will also find information about the fund's past performance and fees.
Mutual Fund Families
Mutual Fund Glossary
Mutual Fund Fees
The fees are displayed in the prospectus as well as on many mutual fund research sites. Try to buy funds with low expense ratios and certainly avoid 12b-fees. I have yet to hear a valid argument on why you should ever buy a loaded fund. A loaded fund is a fund that carries front-end loads, back-end loads or deferred loads. These loads are basically sales charges. There are plenty of no-load funds to meet your objectives.
More on Mutual Fund Fees
12b-1 Fee Warning
Say "NO" to Loaded Mutual Funds
Mutual Fund: Objectives
Why are you buying this fund? Is it because you read about it in the paper or a neighbor told you about it? Don't get caught in the trap of chasing performance. Buy a fund because it meets an objective in your portfolio, not because it has done well recently. Asset allocation is the key to successful investing.
Psychology of Investing
Investment Psychology Books
When to Sell a Mutual Fund
Returns or Performance
Don't focus too much on returns. Any track record under 5 years is noise. Try to take a look at how a fund has done over longer periods of time and try to compare it to it peers or an index that represents the type of asset class the fund is in. It is not fair to compare a government bond fund with that private sector offer.
Chasing Investment Returns
Mutual Fund History
Mutual Fund: Risk
Take a look at the standard deviation of a fund. If Fund A did slightly better than Fund B, but took twice as much risk as Fund A, then Fund B would be the better choice. Other measures of risk include the Ulcer Index and the worst periods (ex. 1-month, 3-month, one year). Don't take any risk that you are not comfortable with and never take unnecessary risks.
Risk Tolerance Quiz
Risk Capacity Quiz
Index Funds
Mutual Fund: Management
What firm serves as the fund's adviser and who manages the fund? It might not be a bad idea to do some background checking to make sure it is a decent entity. The SEC is the official watchdog for mutual funds and has information about each fund and its manager. Also look out for recent manager changes. Though a new fund manager may be just as good or better, it is important to realize that all the fund statistics from before may not be relevant, especially in an actively managed fund.
What to Look for in a Fund Manager
Investing Professional Designations
Monday, December 24, 2007
CONTRUCTING AN ALL-WEATHER MUTUAL FUND PORTFOLIO
Equity mutual funds perform differently in different time periods as investment styles and sectors come in and go out of favor. While screening tools readily provide performance data and make the task of identifying top mutual funds relatively easy, there is more to constructing an all-weather portfolio than screening for the top funds.
This article describes methods of constructing an all-weather portfolio. Before getting into the nitty-gritty of constructing an all-weather portfolio, it helps to know how equity mutual funds are classified and how their performance is impacted by market conditions.
Classification by Market Capitalization & Style
Equity funds are commonly classified based on market capitalization of the companies in which they invest their assets and investment style.
Market capitalization is divided into three categories: large, medium, and small. Investment style likewise is divided into three categories: value, growth, and blend.
Combining both types of classifications, equity mutual funds typically fall into one of nine boxes on a 3 x 3 matrix. This classification system works well in analyzing diversified funds.
Classification by Sector & Industry Group
Instead of dividing the equity market by market capitalization and investment characteristics such as value or growth, an alternative way is to slice it by sectors. The Global Industry Classification System jointly developed by Standard & Poor’s and Morgan Stanley Capital International, for example, classifies the equity market into ten sectors, such as financials and information technology. Each sector in turn is divided into several industry groups. This classification system is particularly useful for analyzing sector funds that invest their assets in a given sector like information technology or industry group like computer hardware.
Impact of Business Cycle
The net asset value per share of a fund changes in response to the prices of stocks held in its portfolio. Generally speaking, stock prices are impacted by business conditions. The business cycle has various phases to it: Recovery, Boom, Slowdown, and Recession. Different parts of the stock market as seen from market capitalization, style, or sector perspectives perform differently in different phases of the business cycle.
Impact on Diversified Funds
Growth style funds, in general, fare well during expansion phases such as recovery and boom, and value style funds during contraction phases such as slowdown and recession. Likewise, from a capitalization perspective, small cap funds tend to perform better during expansion and large cap funds during contraction.
Looking at the most recent boom-bust cycle, Spectra Fund, a large cap-growth fund, was among the star performers during the 1997-1999 boom. Spectra gained 141% during the three-year period ending October 31, 1999. However, Spectra fared poorly during the 2000-2002 slowdown and lost 52% during the two-year period ending October 31, 2002.
In complete contrast, Hotchkis & Wiley Small Cap Value Fund, which failed to participate in the 1997-1999 boom, was among the top funds during the 2000-2002 slowdown. Following the 30% loss for the two-year period ending June 30, 2000, Hotchkis gained 88% during the two-year period ending June 30, 2002.
Impact on Sector Funds
Like diversified funds, certain sector funds tend to perform better during some phases of the business cycle. Sector funds that invest in economically sensitive sectors such as technology typically tend to perform better during expansion phases. Sector funds that invest in economically less sensitive sectors like consumer staples typically tend to perform better during contraction phases. As a result, a sector fund that performs best in one time-period may not perform as well in another time-period.
Among the 41 Fidelity sector funds, Fidelity Select Energy Services was the top fund in 2005 with a 54% gain. However in 2003, the same fund gained just 8% to be the worst performer.
Constructing an All-Weather Portfolio
Can one select the top fund by knowing what stage the business cycle is in? Unfortunately, things do not get that easy.
Getting the turning points of the business cycle right is less than a science. Although certain styles and sectors are expected to do better during particular stages of the business cycle, there is no certainty they will do so each time. Additionally, stock prices tend to anticipate and lead the business cycle. The performance of a fund therefore usually varies from one economic cycle to another.
So, rather than chase the top funds, a prudent course is to construct a robust, all-weather portfolio.
A) Constructing with Diversified Funds
One way to construct an all-weather portfolio is to use diversified funds that emphasize different types of market capitalizations and investment styles. To simplify the task, one may construct a portfolio using a large cap-growth fund, a large cap-value fund, a small cap-growth fund, and a small cap-value fund.
In evaluating funds in each category, focus on the long-term track record and see how the funds have fared in different market environments. Complement this by evaluating each fund on non-performance-based metrics such as manager tenure, price volatility or risk, mutual fund fees, and mutual fund fiduciary grade. Choose the best available fund in each category and build your portfolio with managers of a ‘dream team’ caliber.
Alternatively, if you want to restrict yourself to only one fund to start with, you may consider a total market index fund which spans all capitalizations and styles.
B) Constructing with Sector Funds Sector funds
can also be used to construct an all-weather portfolio. This approach offers the advantage of creating customized diversified portfolios by including sectors and industry groups which are likely to outperform the market indexes and excluding those which are likely to under-perform.
The reward potential can be enhanced by concentrating in a few sectors or industry groups. Diversification across several sectors and industry groups serves to mitigate risk. By optimizing the balance between concentration and diversification, one can achieve superior nominal and risk-adjusted returns.
The AlphaProfit Core model portfolio, http://www.alphaprofit.com/fidelity-select-model-portfolio-description.html exemplifies this approach. Over the 33 month period from September 30, 2003 to June 30, 2006, the AlphaProfit Core model portfolio gained 57% compared to 39% for Dow Jones Wilshire 5000 Total Market Index.
Key Points
1. There are no top mutual funds for all times and climes.
2. A prudent course is to build a robust, all-weather portfolio.
3. Diversified funds as well as sector funds can be used to construct an all-weather portfolio.
Notes: This report is for information purposes only. Nothing herein should be construed as an offer to buy or sell securities or to give individual investment advice. This report does not have regard to the specific investment objectives, financial situation, and particular needs of any specific person who may receive this report. The information contained in this report is obtained from various sources believed to be accurate and is provided without warranties of any kind.
This article describes methods of constructing an all-weather portfolio. Before getting into the nitty-gritty of constructing an all-weather portfolio, it helps to know how equity mutual funds are classified and how their performance is impacted by market conditions.
Classification by Market Capitalization & Style
Equity funds are commonly classified based on market capitalization of the companies in which they invest their assets and investment style.
Market capitalization is divided into three categories: large, medium, and small. Investment style likewise is divided into three categories: value, growth, and blend.
Combining both types of classifications, equity mutual funds typically fall into one of nine boxes on a 3 x 3 matrix. This classification system works well in analyzing diversified funds.
Classification by Sector & Industry Group
Instead of dividing the equity market by market capitalization and investment characteristics such as value or growth, an alternative way is to slice it by sectors. The Global Industry Classification System jointly developed by Standard & Poor’s and Morgan Stanley Capital International, for example, classifies the equity market into ten sectors, such as financials and information technology. Each sector in turn is divided into several industry groups. This classification system is particularly useful for analyzing sector funds that invest their assets in a given sector like information technology or industry group like computer hardware.
Impact of Business Cycle
The net asset value per share of a fund changes in response to the prices of stocks held in its portfolio. Generally speaking, stock prices are impacted by business conditions. The business cycle has various phases to it: Recovery, Boom, Slowdown, and Recession. Different parts of the stock market as seen from market capitalization, style, or sector perspectives perform differently in different phases of the business cycle.
Impact on Diversified Funds
Growth style funds, in general, fare well during expansion phases such as recovery and boom, and value style funds during contraction phases such as slowdown and recession. Likewise, from a capitalization perspective, small cap funds tend to perform better during expansion and large cap funds during contraction.
Looking at the most recent boom-bust cycle, Spectra Fund, a large cap-growth fund, was among the star performers during the 1997-1999 boom. Spectra gained 141% during the three-year period ending October 31, 1999. However, Spectra fared poorly during the 2000-2002 slowdown and lost 52% during the two-year period ending October 31, 2002.
In complete contrast, Hotchkis & Wiley Small Cap Value Fund, which failed to participate in the 1997-1999 boom, was among the top funds during the 2000-2002 slowdown. Following the 30% loss for the two-year period ending June 30, 2000, Hotchkis gained 88% during the two-year period ending June 30, 2002.
Impact on Sector Funds
Like diversified funds, certain sector funds tend to perform better during some phases of the business cycle. Sector funds that invest in economically sensitive sectors such as technology typically tend to perform better during expansion phases. Sector funds that invest in economically less sensitive sectors like consumer staples typically tend to perform better during contraction phases. As a result, a sector fund that performs best in one time-period may not perform as well in another time-period.
Among the 41 Fidelity sector funds, Fidelity Select Energy Services was the top fund in 2005 with a 54% gain. However in 2003, the same fund gained just 8% to be the worst performer.
Constructing an All-Weather Portfolio
Can one select the top fund by knowing what stage the business cycle is in? Unfortunately, things do not get that easy.
Getting the turning points of the business cycle right is less than a science. Although certain styles and sectors are expected to do better during particular stages of the business cycle, there is no certainty they will do so each time. Additionally, stock prices tend to anticipate and lead the business cycle. The performance of a fund therefore usually varies from one economic cycle to another.
So, rather than chase the top funds, a prudent course is to construct a robust, all-weather portfolio.
A) Constructing with Diversified Funds
One way to construct an all-weather portfolio is to use diversified funds that emphasize different types of market capitalizations and investment styles. To simplify the task, one may construct a portfolio using a large cap-growth fund, a large cap-value fund, a small cap-growth fund, and a small cap-value fund.
In evaluating funds in each category, focus on the long-term track record and see how the funds have fared in different market environments. Complement this by evaluating each fund on non-performance-based metrics such as manager tenure, price volatility or risk, mutual fund fees, and mutual fund fiduciary grade. Choose the best available fund in each category and build your portfolio with managers of a ‘dream team’ caliber.
Alternatively, if you want to restrict yourself to only one fund to start with, you may consider a total market index fund which spans all capitalizations and styles.
B) Constructing with Sector Funds Sector funds
can also be used to construct an all-weather portfolio. This approach offers the advantage of creating customized diversified portfolios by including sectors and industry groups which are likely to outperform the market indexes and excluding those which are likely to under-perform.
The reward potential can be enhanced by concentrating in a few sectors or industry groups. Diversification across several sectors and industry groups serves to mitigate risk. By optimizing the balance between concentration and diversification, one can achieve superior nominal and risk-adjusted returns.
The AlphaProfit Core model portfolio, http://www.alphaprofit.com/fidelity-select-model-portfolio-description.html exemplifies this approach. Over the 33 month period from September 30, 2003 to June 30, 2006, the AlphaProfit Core model portfolio gained 57% compared to 39% for Dow Jones Wilshire 5000 Total Market Index.
Key Points
1. There are no top mutual funds for all times and climes.
2. A prudent course is to build a robust, all-weather portfolio.
3. Diversified funds as well as sector funds can be used to construct an all-weather portfolio.
Notes: This report is for information purposes only. Nothing herein should be construed as an offer to buy or sell securities or to give individual investment advice. This report does not have regard to the specific investment objectives, financial situation, and particular needs of any specific person who may receive this report. The information contained in this report is obtained from various sources believed to be accurate and is provided without warranties of any kind.
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