Although we don’t expect interest rates to change much the rest of this year, they have almost no place to go but up, so we’re planning for interest rates to be higher by this time next year. That being said, you should place any new investments
intended for bonds into Short-Term Bonds or Short-Term municipal bonds in your taxable accounts if you are in tax brackets above 25%. There’s not a lot of difference in the performance of bond funds of similar styles, especially with short term funds, so we suggest you stay with the ones offered by your fund family or brokerage if there is one available. If you don’t have that option, we have a couple of choices that should work well for you.
The fall in interest rates over the last several years has been good for Intermediate Bonds and Mortgage Securities (Intermediate Government Bond Funds). Keep a close eye on this portion of your portfolio when interest rates start to move up, because it will happen sooner rather than later. While it’s still reasonable to hold some money in these funds, it’s not to early to move some of your bond assets into short term bonds to get a head start on rising rates.
A better way to generate income on some of the assets in your portfolio is with Real Estate Funds. These funds now have yields similar to Intermediate Bonds, and have been an excellent place to be during the last 5 years. For now, they still look like a place to achieve good total returns with a reasonable yield.
While Growth Funds have performed better than Value Funds in 2003 you can see from the Stock Mutual Fund table, that even the best Large Cap Growth Funds have lost money in the last three years. In fact, most of these funds have lost money over the past five years, although a few managers have been good enough to preserve your principal during this time period. These results illustrate the fact that there are times in the economic cycle that one style performs better than the other does. Since Value Funds have been the place to be for the last three years, it was only a matter of time before Growth Funds started to do well.
Even though Large Cap Growth Funds have outperformed Large Cap Value Funds this year, we still feel that you should add Large Cap Funds to your portfolio in the order Value, Blend, and Growth. This is especially true in taxable accounts with the recent reduction in the tax rate on stock dividends since Large Cap Value funds have the highest yield of any stock fund eligible for this new tax break. With this in mind, we have included yield rather than Alpha (which is similar for all of the included funds) for this category.
While analyzing Mid Cap Stock Funds we discovered that their performance over the last 5 years was between the results of Large Cap and Small Cap funds. In addition, these funds seem to be less volatile than their Large Cap and Small Cap counterparts, which makes one of these a good choice if you are getting started with your “first” mutual fund. That being said, we didn’t find many Mid Cap funds that we would consider adding to our portfolio, but there were a few.
We continue to believe that money managers have a better opportunity to add value to a portfolio of small company stocks than they do with large company stocks. This is one area of the stock market where we feel actively managed Mutual Funds have an advantage over passive Index Funds.
Investment companies that specialize in small companies have done a better job than the big fund families in this area. The only problem with these funds is that many of them, like those managed by Wasatch, are closed to new investors. This means that some of the best performers over the past 3 years are not one of our choices. Your first Small Cap Fund should be chosen from the Blend category, but soon after that consider adding both a Small Cap Value and a Small Cap Growth fund.
When you look at the Stock Mutual Fund tables you will notice that if you are looking for Growth stocks, Small Cap funds are the way to go. Even though these funds had a difficult time when the stock market started falling three years ago, you’ll see that some managers were able to weather the storm quite well. In fact, for the best managers, the 5-year returns have been comparable with those of Small Cap Value Funds.
Small Cap Value funds have been the top performing stock category over that past five years, and even though they haven’t kept pace with Small Cap Growth funds this year, they are still doing quite well overall. Any of these funds should fit well in your portfolio.
Technology funds have been on a roll in 2003, but they are still almost 35% behind where they were three years ago. There are several important points to consider regarding these highly volatile funds. Don’t put more than 10% of your portfolio in these funds, don’t be afraid to take your profits, and don’t be overly concerned about the tax consequences of selling these funds.
Many of us learned the hard way that we would have been better off paying 35% tax on our hefty technology fund profits in 2000, than taking a big loss in 2001 or 2002. One way to take taxes out of the equation with funds that you might want to trade more often is to only buy technology funds in your retirement accounts.
International Funds are another category where the quality of fund management has had a big impact on fund results. While these funds have under performed domestic funds on average, some managers have done considerably better, so we feel a small allocation to one of these funds is worthwhile.
Whether you are fully invested in the stock and bond markets or not, it may be time for you to adjust your portfolio. Review our asset allocations to see how well your investments match up with these targets. If you gave up on the markets some time in the last couple of years, its time to get your feet wet again. If you are a little timid, start by dollar cost averaging your way back in. This year may not provide the kind of returns we saw in the late 1990’s, but it should earn you more than keeping your portfolio in Money Market Funds. And if you make some insightful investment choices, you should come out ahead of the crowd. Now that would be a good thing. Wouldn’t it?
A list of our Favorite Mutual Funds was updated in July with information through June 2003.
Asset Allocation for 2nd Quarter 2003
As we said in our fund review, interest rates have almost no place to go but up, so we are planning for interest rates to be higher by this time next year. That being said, you should place any new investments intended for bonds into Short-Term Bonds or Short-Term Municipal Bonds in your taxable accounts if you are in tax brackets above 25%. There is not a lot of difference in the performance of bond funds of similar styles, especially with short term funds, so we suggest you stay with the ones offered by your fund family or brokerage if there is one available. If you do not have that option, we have a couple of choices that should work well for you.
While it is still reasonable to hold some money in Intermediate Bond Funds, it is not too early to move some of your bond assets into Short Term Bonds to get a head start on rising rates. If you need more income than these funds will generate, we suggest you move some of that money into Real Estate Funds which have similar yields to Intermediate Bonds, but are more likely to hold their value as interest rates rise.