Ride the Market With a Portfolio That Fits Right
Is your mutual fund manager as capable of keeping his head during a crisis as you are? For millions of individual investors, who shrugged off Monday’s 554-point plunge and helped stage Tuesday’s recovery by buying more shares, the question is pivotal.
“There are two factors on the fund side that you don’t have to worry about when you invest on your own,” says Catherine Voss Sanders, publisher of Morningstar Investor, a monthly newsletter published by the Chicago-based mutual fund research and information service Morningstar Investments.
“One is the fund manager, who may be making decisions that may or may not coincide with what you might want to do,” she said. “And the other is all these other shareholders, who will be making decisions that may or may not coincide with what you might want to do.”
So, you might want to wait through market reversals. But if Monday’s market activity caused churning and burning in both your portfolio and your stomach, you may be realizing that your investments don’t suit your personality.
What questions should you ask when trying to determine whether you and your fund--regardless of whether you own your funds through an ordinary investment account or through a retirement plan--are compatible?
Q: How much cash does my fund hold? And is that likely to be enough to handle redemptions if other investors sell in a panic?
Investor service representatives can generally tell you how much of your fund’s assets are held in cash at the end of any given month. (These figures generally are not kept on a daily basis.)
During the 1987 stock market crash--the largest one-day price decline in history--mutual funds experienced net outflows amounting to about 4.5% of assets over a two-week period.
If history repeats itself, a fund that holds less than 5% of its assets in cash risks having to sell investments to meet the cash demands of its investors. That could cause the fund to suffer steeper losses than otherwise necessary.
(On Tuesday, many fund companies reported that they did not see any noteworthy selling in the wake of Monday’s big drop. They did see an increase in calls for information, and some reported higher than usual buying activity.)
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Q: Is my fund willing and able to increase its cash position?
If you’re feeling negative about the market’s prospects, you might seek a fund that habitually increases its cash holdings when it feels the markets prospects are bleak, says Sheldon Jacobs, editor of the No-Load Fund Investor, a newsletter based in Irvington-on-Hudson, N.Y. There are a handful of funds that went into Monday with as much as 20% of their assets in cash, he added. Predictably, they suffered smaller losses than the funds that were fully invested.
But a fund with a big cash position will underperform its peers when market performance is strong.
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Q: How long has my fund manager been at the helm of this fund? Has he or she weathered any other market crashes?
Over the last decade, there has been a three-fold increase in the number of mutual funds, and a 10-fold increase in the amount of assets invested in equity funds, according to the Investment Company Institute in Washington, D.C.
Naturally, that means that some fund managers would have missed both the 1987 crash, and the bear market of the 1970s.
Should you care? Maybe. Knowing how a fund manager handled previous market reversals can be instructive. However, there’s no reason to believe that a new manager with fortitude couldn’t handle a crash well.
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Q: Just how volatile is my fund?
Market professionals measure volatility using Beta, a mathematical measurement of how a fund’s performance deviates from the performance of a market index, such as the Standard & Poor’s 500. A Beta rating of 1 indicates that the fund is roughly as volatile--subject to similar swings, both up and down--as the market index as a whole. If the fund’s Beta exceeds 1, it’s more volatile than the market; if it’s lower, it’s less volatile.
There are other ways to measure a fund’s volatility, including Morningstar’s risk ratings, which attempt to measure downside risk--or your chance of suffering a loss.
Investors can also get a volatility picture by asking their fund’s investor service representative for the fund’s year-by-year, or quarter-by-quarter, performance. This information can often be found on fund company Web sites.
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Q: If I can’t handle the market swings, how quickly can I get out?
One of the things most investors miss when they read through prospectuses is that many funds have a provision that allows them to delay sending checks to investors if a market crash spurs “unusual” selling activity.
In addition, certain funds won’t accept phone transfers, says John Woerth, a spokesman for Vanguard.
The fund’s rules are spelled out in its prospectus, unless you are investing through a tax-favored retirement plan such as a 401(k). For 401(k) plans, the rules are dictated by the retirement plan administrator.
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Q: If I sell or transfer fund shares, what will be the tax impact?
The answer usually depends on how you hold your shares. About one-quarter of all fund assets are held in retirement plans, such as 401(k)s and IRAs. These investors can transfer money between different fund accounts without triggering a taxable sale.
However, those who own their shares outside of a tax-favored retirement plan or a variable annuity, which works in much the same way, would have to pay tax on any gain. The tax rate would depend on how long they’d held the fund shares. Generally, the longer you’ve held your shares, the lower your capital gains tax rate.
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Kathy M. Kristof is a syndicated financial columnist and author of “Kathy Kristof’s Complete Book of Dollars and Sense.” She welcomes comments and suggestions, but regrets she cannot respond personally to every inquiry. Write to her in care of the Business Section, Los Angeles Times, Times Mirror Square, Los Angeles, CA 90053, or e-mail kathy.kristof@latimes.com
