Amid Rapid Market Evolution, Some Things Remain Constant

The world sure looked a lot different two years ago, when I started writing for The Times.

Diversification still mattered to mutual fund investors back then. So did concepts such as dividend income and downside risk. (In fact, the first column I wrote focused on stock funds with decent dividend yields.)

As for Internet funds, they were considered a gimmick. For that matter, the Internet itself was still viewed by some as a passing fad. And “value”-oriented fund managers such as Robert Sanborn and Bill Sams were among the most respected in their profession.

Today, how many investors care about a stock fund’s dividend yield? And what, me worry about market risk? Meanwhile, who among us hasn’t heard of Internet funds? Who here thinks the Internet is going away? And when’s the last time you invested money with a “deep value” stock fund like Sanborn’s Oakmark fund or Sams’ FPA Paramount?

Indeed, the lesson of the last two years has truly been that the more things change, the more things change. And it’s important to keep up with those changes. But ironically, the more things change, the more those things that don’t change grow in importance. After all, in an unpredictable world, the only thing you can control is that which you know to be certain.

For instance, you can debate in perpetuity whether growth stocks or value stocks will lead the market over the next five years. Making the right call on which style of investing is (or isn’t) in favor could add (or subtract) several percentage points of returns each year. For most of us, though, knowing which style of investing will be in favor--and when--is largely a crapshoot.

Yet, we know for certain that taxes on average shave roughly 2 percentage points of returns each year from our mutual fund investments. That doesn’t sound like much in an era when funds are returning 100%-plus annual gains.

But if you invested $10,000 today in a stock fund and it grew 12% a year for the next 40 years, you’d end up with $931,000 in the year 2040.

On the other hand, if you lose just 2 of those percentage points a year to taxes and end up with after-tax gains of just 10% a year, that $10,000 investment would grow to $453,000 over the next 40 years--half what a net 12% return would produce. (There’s the miracle of compounding.)

What else, besides taxes, should matter to fund investors?

* Expenses should matter to you. Expenses are even more certain than taxes, because funds let us know exactly how much we’ll be paying each year in sales commissions or annual management expenses. All other things being equal, why pay a 1.5% management fee if a similar fund charges 1%?

* The types of securities your funds own should matter to you. More important than the individual stocks that your fund owns is the type of stocks your fund invests in. You may not be able to predict whether growth will do better than value, or whether large-cap stocks will do better than small-cap. But at the very least, you should know the fund manager’s general style tilt--so you don’t end up with too much of one style, or not enough of another.

* Your fund’s top 10 holdings should matter. In recent weeks, we’ve talked a great deal of how “concentrated” most funds have gotten over the years. That is, many funds now invest in fewer stocks than they used to--and make bigger bets on each.

The average equity fund holds 143 stocks, according to the Chicago fund tracker Morningstar Inc. However, nearly $4 out of every $10 in a domestic stock fund is riding on the top 10 holdings in that fund. For some funds, it’s closer to $5 or $6 out of every $10.

That means it’s all the more important to know what your fund owns in its top 10 holdings.

The problem: Funds are required to disclose this information only twice a year. And often, by the time the holdings are disclosed, the fund may have made considerable adjustments to the list.

In recent years, however, an increasing number of funds have begun providing fund-tracking services like Morningstar monthly updates of their holdings.

If you go to https://www.morningstar.com and then type in the ticker symbol of your fund, the site will show its top 25 holdings--free.

* Overall sector weightings should matter. Sure, it’s important to know exactly what kind of fund you own--whether it’s a large-cap growth fund or a small-cap value. Nowadays, though, the most important question may be how much of a fund’s assets are held in technology stocks.

A fund’s tech weighting is often a quick way to tell whether it’s truly a value or growth portfolio--or a new-economy fund or an old. If, for instance, half or more of a fund’s assets are in tech, you know it’s likely to move more in sync with the new-economy Nasdaq than the old-economy Dow. (Sector weightings are also available on the Morningstar site.)

As for what doesn’t matter, that’s easy.

Morningstar’s overall “star” rating system is largely useless. Funds are too diverse to be compared against just one of four broad categories: domestic stock funds, international stock funds, taxable bond funds and municipal bond funds.

Also, such outmoded labels as “growth and income” or “equity-income” don’t matter anymore.

“What’s the difference between equity-income, growth and income, and growth funds?” asks Sheldon Jacobs, editor of the No-Load Fund Investor newsletter in Irvington-on-Hudson, N.Y. “There isn’t any. There used to be a difference when stocks paid dividends. There isn’t any anymore.”

Just as you can’t tell a book by its cover, you can’t tell a fund by these old labels.

*

On a personal note, this will be my last column for the paper. I’m trading in sunny Southern California for Washington, D.C.

I’ve learned a lot in the nearly two years I’ve worked here. And I attribute much of that education to the great questions you’ve asked--whether via e-mail, phone calls or letters. (Sorry I couldn’t respond to every one of your questions.)

Thanks for making this column a pleasure to write.