Money 70: Funds for the long run
Investing is a marathon. Use our Money 70 funds to run a safe, steady race.
NEW YORK (Money Magazine) -- If ever there was a time when it paid to be diversified, it was last year. As the market got rocky amid an old-fashioned credit crunch, many blue chip U.S. stock funds took a beating.
Even some of the nation's best-known investors - like Bill Miller of Legg Mason Value and Bill Nygren of Oakmark Select - suffered losses due to troubles in the financial and housing sectors caused by the subprime mortgage mess.
But if you held your domestic stock funds within a well-diversified portfolio that included bonds and other types of equities, you didn't feel much pain. Indeed, if you invested in foreign equity funds in 2007, you probably earned double-digit gains, up for losses you suffered among your domestic funds.
The key is, you needed to be patient and balanced. A long-term view and a diversified asset mix - that's exactly what the Money 70, our list of recommended mutual and exchange-traded funds, is all about.
When assessing funds, we don't focus on short-term performance swings, because history shows that funds that are hot in one period are often stone cold the next.
Nor do we try to spot the coming year's chart toppers, as other lists do.
In addition to being an exercise in futility, that's not the purpose of the Money 70.
What we're offering you is a menu of high-quality funds and ETFs that you can use as building blocks in constructing a prudent, well-balanced portfolio. We hope these funds will help you reach your long-term goals - which, by the way, don't include bragging rights around the watercooler.
In selecting the Money 70, we focus on criteria with lasting value. For example, we make sure that all of our funds charge fees lower than their category average. Why? Since fees reduce total returns, funds with low costs are likely to outperform those that levy steep expenses. This is such a simple concept it's amazing that high-fee funds can still exist.
We also look for funds with strong records for putting shareholders first, as measured by Morningstar's stewardship grades. These ratings evaluate such factors as a fund group's corporate culture, regulatory history and board independence. The way we figure it, while you can't control how good your returns will be, you can at least stick with stock pickers who've been good to their investors.
On top of that, we look for funds with a consistent strategy and experienced managers.
Of course, we also consider performance - but over the long term. We prefer funds with better-than-average returns over five years, although we make some exceptions, as we'll explain.
These standards don't always prevent our funds from stumbling. Over the long run, however, the majority of the Money 70 funds have performed admirably. Even in last year's difficult market, 57% of the actively managed funds on our roster delivered returns that rank in the top half of their category; and over the past five years, 73% outperformed their category average.
There's one more thing: The Money 70 is designed to help you construct all aspects of your portfolio. For your core holdings, you might consider one of the 25 index funds or ETFs on our list. If you're willing to take a few more chances, check out the 43 actively managed stock funds we like. And if you simply don't want the hassle of building your own portfolio, you can choose either of two sets of target-date portfolios, which give you a preset mix of funds that automatically becomes more conservative as you near retirement.
Though we believe in buy-and-hold investing, we did make a few alterations to our list.
Actively managed funds: We removed Fidelity Dividend Growth and Madison Mosaic Investors. Neither kept pace with other large-cap funds in their category (they ranked in the bottom 10% of their peer group over the past five years).
But it's not about raw performance. If a fund lags its category for a long enough time, you have to question whether it's fulfilling its role in your portfolio.
If you own these funds in your 401(k) or IRA, where selling won't trigger an immediate tax bill, we recommend you shift into a better choice: FMI Large Cap. This low-cost fund also invests in blue-chip stocks. The managers' risk-averse approach kept the fund out of troubled financial stocks recently, which helped it rank in the top 24% of its peers over the past three years.
More important, FMI's consistent investing style makes it a better portfolio building block over time. A few other funds on our list have also lagged their peers.
Among them: American Funds American Mutual, Matrix Advisors Value, Jensen, FAM Value and FPA Perennial. These funds have something in common: They take a lower-risk approach than others in their categories. This means they might lag during stretches when the market is soaring - like the five-year-old bull market.
But they hold up well in downturns. So their five-year results, which don't reflect the 2000-02 bear market, may understate their long-term potential. Especially in light of today's shaky economy, these funds still make sound choices. Taking a low-risk approach was not what held back Weitz Hickory and Muhlenkamp, two other laggards on our list. These go-anywhere funds were torpedoed by big stakes in subprime lender Countrywide and other financial and real-estate- related stocks.
But Wally Weitz and Ron Muhlenkamp are contrarians with a tradition of wild performance swings - their chart-topping years are followed by periods in the cellar and vice versa. Their 10-year returns are still strong. It's worth hanging on to these multicap funds since history suggests they'll soar again.
Meanwhile, we are adding Third Avenue International Value to the roster. Run by Amit Wadhwaney, the fund focuses on overlooked small and midsize foreign stocks, an often forgotten category, but one that provides needed diversification and that hasn't been represented before on the Money 70. To keep its assets at a manageable level, the fund had been closed to new investors for years, which is a strong sign of stewardship.
But it reopened recently when Wadhwaney began spotting more opportunities in the wake of the upheavals in the global financial markets. Because the fund looks for small, undervalued shares in overseas markets, it probably doesn't invest in stocks your other foreign funds do. For all these reasons, we think International Value, a low-cost fund run by a respected fund family, is a solid new addition to the list.
Index funds and ETFs: While it's hard to tell which actively managed funds will outperform in any given category, that's not the case with index funds. Since these portfolios just mimic a market index, it's simply a matter of arithmetic that the lowest- cost funds are likely to beat out more expensive peers that track the same benchmarks.
With this in mind, we revisited all of our index funds and ETFs. We noticed that Vanguard recently introduced ETF versions of Vanguard Short-Term Bond and Vanguard Total Bond Market, which are both on the Money 70 index fund roster. With fees of only 0.11%, Vanguard's ETFs are cheaper than two similar ETFs on our list: iShares 1-3 Year Treasury (0.15%) and iShares Lehman Aggregate Bond (0.20%).
Moreover, Vanguard Short- Term Bond ETF offers a broader range of fixed-income issues than iShares 1-3 Year Treasury.
So we are replacing the iShares ETFs with their Vanguard counterparts. Vanguard also launched an ETF that tracks the Morgan Stanley Capital International EAFE index, a benchmark for developed stock markets in Europe, Asia and Australia.
Vanguard Europe Pacific sports a 0.15% expense ratio, which is significantly lower than the 0.34% fee for iShares MSCI EAFE, so we are swapping these ETFs as well.
We are also adding the Vanguard FTSE All- World ex-U.S. This new ETF tracks both developed and emerging markets, including Canada, which enables investors to buy the whole world outside the U.S. with a single ETF. Finally, we are dropping iPath Dow Jones-AIG Commodity Index.
This is actually not a fund but an exchange-traded note, or ETN - a structure designed to minimize taxes. ETNs recently came under the scrutiny of the IRS, which might disallow their favorable tax treatment. If that happens, it could be trouble for investors in taxable accounts.
For an alternative in the Money 70, try T. Rowe Price New Era, a mutual fund that buys mainly natural-resources stocks, or iShares S&P GSSI Natural Resources Index, an ETF that owns energy and commodity shares. Whether you opt for ETFs, index funds or actively managed portfolios, you can be assured of some important advantages with the Money 70.
You will pay reasonable fees, and the fund managers are unlikely to betray your trust and will stay consistent in their strategies. In an uncertain world, those advantages will give your portfolio a big head start toward your long-term investing goals.