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For more on making smart and profitable mutual fund investments, pick up a copy of Kiplinger's Mutual Funds 2004. This fact-and-idea-packed guide includes ranking and comprehensive data on more than 2,500 funds -- and solid advice on how to use that data. |
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February 4, 2004  Email this  Print this
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FUNDS
One-Stop Investing
by Bob Frick Joe Bronson admits to being a nervous investor. And when he quit his corporate job to strike out on his own as a real estate consultant, the last thing he needed was to worry about the money in his 401(k) plan. In that plan he had six funds, including ones for income and for foreign and U.S. stocks. The diversification was good, he knew, but the complexity of his fund portfolio made him apprehensive. The solution Bronson arrived at was to roll his money into an IRA and to bundle all his types of investments into a single, highly diversified fund: T. Rowe Price Retirement 2040. The nicest thing, says the Chicago suburbanite, is that "I won't have to think about it much." And that suits the 30-year-old Bronson and his wife, Kathryn Price Bronson, just fine. As years go by, he won't have to worry about tuning his portfolio to become more conservative as he nears retirement, because the fund is designed to do just that.
One-stop investments such as Bronson's have been growing in popularity for about a decade. For T. Rowe Price, the first fund family to start such funds, the idea that investors would want funds that mixed investment types for them came from focus groups in the late 1980s. T. Rowe Price learned that people understand that having a diversified portfolio is a good thing. But they don't really understand what diversification means -- that, or they don't want to take the time or bother to attain it. Funds such as Price's Retirement series take care of diversification for you.
Diversifying among different types of investments -- also called asset allocation -- is one of the most important investment strategies. One study by Ibbotson Associates showed that more than 90% of a professional investor's performance comes not from picking individual securities, but from simply investing in different types of securities, such as large-company U.S. stocks, small-company U.S. stocks, foreign stocks and U.S. bonds.
Diversification also decreases volatility -- the degree to which a portfolio rises and falls in price -- because different types of investments seldom rise or fall totally in sync. For example, in 2000, Standard & Poor's 500-stock index (made up of stocks of the largest U.S. companies) lost 9%, but the S&P Midcap 400, which tracks medium-size U.S. companies, jumped 17%. The addition of some bonds can also smooth out a portfolio's ups and downs, as their performance over the past few years underscores. When one asset type rises as the other falls, the effect is to dampen the overall price swing.
One-stop funds can be broken into two categories. "Lifecycle" funds, such as the one Bronson invests in, grow more conservative over time by changing their asset mix. "Lifestyle" funds are also well-diversified, but the proportions of different investments do not change over time. Instead, they are matched to an investor's goals and temperament. Together these two types of funds have grown in assets from around $7 billion in 1997 to more than $35 billion today.
Ride the cycle
Wise investors tune their portfolio to be more conservative -- meaning that the percentage of bonds rises while that of stocks falls -- as they grow older. Lifecycle funds make those changes for you, as well as providing well-diversified portfolios, so they are the ultimate in simplicity.
If this notion appeals to you, the next question becomes, which funds seem equipped to do the best job? This comes down not just to what investments go into the funds, but also to their proportions and the fees you pay.
Given those parameters, our nod goes to two sets of lifecycle funds: the T. Rowe Price Retirement funds, and the brand-new Vanguard Target Retirement funds.
The Vanguard funds, introduced at the end of 2003, are made up of Vanguard index funds -- funds that simply mirror different segments of the market. Most index funds have excellent track records compared with actively managed funds, and Vanguard is the king of indexing due to the variety of index funds it offers and the skimpy fees it charges.
The Target Retirement funds combine U.S.-stock, foreign-stock and bond indexes (Vanguard Total Stock Market Index fund, which covers the U.S. market and is heavily weighted toward the S&P 500; Vanguard European Stock Index fund; Vanguard Pacific Stock Index fund; and Vanguard Total Bond Market Index fund) with a money-market fund and a dash of Vanguard's Inflation-Protected Securities fund for extra stability.
The funds range in aggressiveness from the Target Retirement Income fund (20% stocks, 75% bonds and 5% in a money-market fund), for investors who are already retired, to the Target Retirement 2045 fund, which is 90% stocks and 10% bonds. The other funds in this group are Target Retirement 2035, 2025, 2015 and 2005.
Without a track record, predicting the returns of these funds is tricky. However, Vanguard has shown with other fund combinations that it can capture returns similar to those of the S&P 500 with less volatility than the benchmark. The S&P 500 over the past ten, 15 and 20 years has returned an annualized 10%, 12% and 13%, respectively. All returns here are to November 30.
A huge plus for Vanguard's Target Retirement funds are their low expenses, which are in the 0.21% to 0.23% annual range -- more than a full percentage point less than the 1.5% fee levied by the average stock fund. Consider the impact of this on a $100,000 portfolio that earns 10% per year before fees. Compared with someone who owns a fund that charges the average expense ratio, an investor in a fund charging 0.23% would earn an additional $25,000 over ten years.
The T. Rowe Price Retirement funds are inexpensive, too, though not quite in Vanguard's league. (T. Rowe Price charges 0.82% to 0.86%.) The Price funds have other things to recommend them. Their big virtue is the mix of assets. Other lifecycle funds generally wind their way down to just 20% in stocks for the fund suited for retirees. But the T. Rowe Price Retirement Income fund (suitable for people who are already retired) keeps 40% in stocks, and the other Retirement funds also have high percentages of investments in stocks compared with competitors. The fund company believes that 40% in stocks is the "sweet spot" for people who will likely live 20 to 30 years after retirement -- the capital appreciation historically provided by stocks will assure that older retirees do not run out of money -- and we tend to agree.
Another difference between the Vanguard and Price approaches is that Vanguard uses only index funds in its Target Retirement funds, whereas Price employs a mix of actively managed mutual funds. This is no knock on Price, whose funds are known for their solid returns and relatively low volatility. For example, the Retirement funds are anchored by the T. Rowe Price Growth Stock and T. Rowe Price Value funds, which returned an annualized 4% and 7% respectively over the past five rocky years, versus next to nothing for the S&P 500.
Reach goals with style
To some investors, adjusting the mix of stocks and bonds gradually isn't of paramount importance, but having a single fund for all their investment needs is. If this sounds like your style of investing, so-called lifestyle funds fit the bill.
These funds maintain a consistent mix of investments in three basic flavors: growth, which is mainly stocks; growth and income, which is roughly half stocks and half bonds; and income, which is mostly bonds. If you have an average risk tolerance, you might invest in growth funds when you are in your twenties through forties, then switch to the balanced funds in your fifties and go for income from your sixties on.
Though a host of fund families, including Fidelity and Charles Schwab, have lifestyle funds, here again we pick the Vanguard and T. Rowe Price offerings, for the same reasons we chose them for the lifecycle funds.
Instead of being a fund of funds, as is the case with its Retirement funds, each T. Rowe Price Personal Strategy fund is a well-diversified portfolio put together under the direction of Ned Notzon, who is the company's asset-mix guru. Notzon relies on T. Rowe Price fund managers to make the stock selections. For example, Greg McCrickard invests the small-company portion of the funds in the same way that he does the T. Rowe Price Small-Cap Stock fund.
The funds' returns are solid. The most aggressive fund, Personal Strategy Growth, keeps around 15% of its assets in cash and bonds and the rest in stocks. From 1995 to the present, it has had an annualized 10.4% return, versus 11.1% for the benchmark S&P 500, but with 30% less volatility. Personal Strategy Balanced fund, with about 65% in stocks, has returned an annualized 9.9% in that time, with half the S&P's volatility. Personal Strategy Income fund, with about 40% in stocks, has returned 9.2%, with 60% less volatility.
Vanguard LifeStrategy funds come in four flavors: growth, moderate growth, conservative growth, and income. Each fund is a combination of index funds, plus 25% in Vanguard Asset Allocation fund, which can vary from all stocks to all bonds, depending on what its managers think is the best investment profile at the time. That may make investors looking for a pure index-fund play nervous, but during its 15-year history, the Asset Allocation fund's annualized return was within a hairbreadth of that of the S&P 500 index, with 30% less volatility.
Overall, the Vanguard funds are more conservative (fewer stocks) and cost less than the T. Rowe Price funds -- a 0.28% annual fee versus 1%. From their start in 1995, Vanguard LifeStrategy Growth fund returned an annualized 9.3% with 20% less volatility than the S&P 500; LifeStrategy Moderate Growth returned 9.5% with 40% less volatility; Conservative Growth returned 9.1% with 60% less volatility; and Income returned 9%, with 80% less volatility.
Though it's not billed as part of Vanguard's lifestyle-funds offerings, Vanguard Star fund is cut from the same cloth and also deserves a look. This fund is assembled from 11 other actively managed Vanguard funds and is maintained to keep 63% in stocks, 25% in intermediate- and long-term bonds, and 12% in short-term bonds.
Its record is similar to Vanguard LifeStrategy Moderate Growth fund, with 40% less volatility than the S&P 500 and an annualized return of 10% over the past ten years. Though its annual fee is slightly higher, at 0.4%, time has shown that the total return of Vanguard Star will still be slightly higher than that of the Moderate Growth fund. This is due to the proven performance of several of its underlying funds, including Vanguard Windsor, which has edged the S&P 500's long-term record by about a percentage point.
The addition in 2001 of two solid foreign-stock funds, Vanguard's International Growth and International Value, which both beat the international-stock-fund average, make it even more attractive as a one-stop pick.
For more ideas and advice on making smart and profitable mutual fund investments, pick up our latest guide, Kiplinger's Mutual Funds 2004. | 
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