Crystal Ball on the Fritz? Try These Funds.
Market forecasters have steered you wrong all year, but so what? With a smart plan and the right mutual funds, you control your own fate.
(MONEY Magazine) – To listen to market prognosticators, there were two things you could count on in 2005: The U.S. dollar would fall and long-term interest rates would rise. For mutual fund investors, then, the path was clear: Load up on international stock funds and choose short-term bond funds over long-term.
Alas, the seers got it exactly backward. Instead of continuing the slide that began in 2002, the dollar jumped 11% vs. the euro between January and June. And while yields on 10-year Treasury bonds did inch up the first few months of the year, they finished the first half around 4%, or about a quarter of a point below where they started. Result: Contrary to the experts' predictions, foreign-stock funds lagged their U.S. equity counterparts, and long-term bond funds did better than their "sure thing" competition.
A case of stocks and bonds behaving badly? Actually, no. Just another example of markets doing what they do best--confounding the consensus opinion. Many investors, unfortunately, followed the gurus' guidance. It's tough to resist when a persuasive authority figure on television or in the newspaper is telling you how to make gobs of money. "People know better," says Thomas Muldowney, a financial planner in Rockford, Ill. "But we still see lots of investors chasing short-term trends, hoping for higher returns." The past six months were simply another reminder of where that usually leads.
So what approach should you follow? Assuming you're starting with a diversified portfolio (and you are, aren't you?), this is a time to stay on plan and make smart mid-course adjustments, not to stampede after the next big thing.
Before you do anything else, make sure you understand what role each fund plays in your portfolio. If your holdings are sprinkled with funds that you own only because you hoped they were going to be hot, hot, hot at some point, think about replacing them with choices from the MONEY 50, our list of recommended funds. (You'll find the complete list, with performance data, on page 120.) None of the 50 aim for shoot-the-lights-out returns, since that approach inevitably burns out. Instead, they won our endorsement because their low costs and high consistency make them ideal building blocks for a diversified portfolio in which one fund's strengths offset another's weaknesses. While the 50 have shared the markets' lackluster returns this year, they continue to stand out over long stretches, with the vast majority bettering their peers for the past three and five years.
Here's what you should do now.
» REASSESS YOUR MIX Over the past two years, small companies have outperformed the big boys by more than 40%, while value stocks have outrun growth shares by nearly 2 to 1. That means you could now easily have more money than you intended in funds that specialize in small shares and value-oriented stocks. It's time to bring things back into balance.
Growth and value shares tend to have a seesaw relationship, with value outperforming for several years and then growth taking the lead. Large and small stocks display a similar dynamic. So the very fact that value and small shares have been so dominant in recent years suggests that it could be time for growth funds and large-stock funds to take the lead.
Remember, though, the point isn't to revamp your holdings on the basis of yet another prediction that may or may not pan out. Rather, it's to position your portfolio so you're not overly dependent on the performance of just one or two sectors. Thus if a lot of your money is tied up in value funds, for example, you should restore your portfolio's balance by selling some of those shares and investing the proceeds in growth funds such as MONEY 50 choices Fidelity Capital Appreciation (FDCAX; 800-343-3548) and T. Rowe Price Blue Chip Growth (TRBCX; 800-638-5660). Similarly, if you're heavy on small-cap funds, you can consider adding MONEY 50 selections such as the big-cap growth fund Jensen (JENSX; 800-992-4144) or Nicholas II (NCTWX; 800-227-5987), a specialist in mid-size companies. For advice on how to divvy up your holdings among different types of funds based on your financial goals, check out the Asset Allocator tool on our website at money.com.
» PLAY IT SMART IN BONDS Given our yawning federal budget deficit, long-term interest rates appear much more likely to climb than to fall in the future. Economists polled each month by the Blue Chip Economic Indicators newsletter believe the bellwether 10-year Treasury will do exactly that, averaging 4.4% this year and climbing next year to 4.9%. (Rising interest rates translate into falling prices for bonds, especially those with maturities of 10 years or longer.)
Of course, these same economists were also calling for higher rates last year. So you don't want to abandon bonds altogether just because the sages might be right this time. Indeed, you should always have some bond funds in your portfolio to help offset stock market downturns.
The key is adopting the right strategy--and choosing the best funds to pull it off. The best approach: Stick to short-term or intermediate-term bond funds since they deliver yields comparable to those on long-term issues while holding their value better in the face of rising rates. MONEY 50 choices such as the Vanguard Short-Term Bond Index (VBISX; 800-851-4999) and the Dodge & Cox Income Fund (DODIX; 800-621-3979) fit the bill.
» DON'T FLEE FOREIGN FUNDS Yes, international stock funds are showing losses this year. But going with an all-U.S. portfolio now could just be making the opposite mistake of the one that investors made by piling into internationals at the beginning of the year. It's a safe bet that U.S. stocks won't always be the world's best, and you'll want some exposure abroad for diversification. The easiest way to get it is to invest in one or more of the MONEY 50 international selections, such as Vanguard International Growth (VWIGX; 800-851-4999) and Artisan International (ARTIX; 800-344-1770).
» GET REAL ABOUT REAL ESTATE FUNDS Like many property markets around the country, real estate funds have been sizzling. They're up more than 6% in the first half of 2005 and 36% over the past 12 months. As a result, if you own real estate funds, chances are you have more of your portfolio locked up in them than the 10% or so that financial planners usually recommend. Take some profits and spread the proceeds among less overheated parts of your portfolio.
The point is not that everyone "knows" there's a real estate bubble (just as everyone "knew" interest rates would rise in early 2005). Instead, you should simply stick to the amount you planned to keep in real estate funds. Departing from a prudent strategy in the hope that you'll squeeze a few extra points out of your hot performers is just as dumb as letting yourself be swayed by market seers. True foresight means sticking to a plan built around low-cost, consistent funds like the MONEY 50. In the long run, that'll position you for prosperity, whatever appears in the Street's crystal ball.
It's Been a Bad Year for Seers
Bond yields were supposed to rise. They fell.
The dollar was supposed to fall. It rose.
The sectors that had led the market took a bath.
NOTES:  Russell 1000 Value index.  Russell 2000 index.  Through May. SOURCE: Morningstar.