Putting the Portfolio on Autopilot
Tired of trying to figure out this hairy market?
There’s an easier way: You can put your investment portfolio on autopilot.
Rather than trying to pick the best stocks or mutual funds, some financial advisors say, investors may be able to do at least as well over time by opting for funds that simplify the investing process--and allow you to largely tune it out.
Autopilot-type funds typically fall into one of four categories: index funds that simply copy major market indexes; asset-allocation or “lifestyle” funds, some of which automatically change their investment mix as you age; “funds of funds” that mix mutual funds for you in a single fund portfolio; and balanced funds that always maintain some mix of stocks and bonds.
Though an autopilot portfolio isn’t insulated from the market’s gyrations, the ride can be smoother.
Just don’t take the term autopilot literally, advisors warn. Like a motorist using cruise control, you have to occasionally monitor what’s going on.
“These funds have no pizazz, but they do what an investment is supposed to do--which is not to provide prestige or excitement but to get you to your goals,” said Meir Statman, finance professor at Santa Clara University.
“Of course, the reason so many people don’t use this strategy is the same reason they buy a Lexus when a Toyota will do.”
The autopilot approach may seem drab, Statman said, but it actually can be psychologically rewarding.
“These funds not only minimize costs but also the pain of regret that so many other investors go through when their active fund disappoints,” he said. “The more you put it on autopilot, the more you can blame God. You can spend time living and push investing into the periphery, the equivalent of brushing your teeth.”
Index Funds
Index funds, which hold many or all of the stocks constituting a benchmark, such as the blue-chip Standard & Poor’s 500, are the most familiar autopilot vehicles to many investors. With an expanding array of sector, style and foreign index funds available, investors can create as diverse an index portfolio as they like.
Or, advisors say, they can keep it simple by using just three funds: a “total” U.S. stock market fund linked to the Wilshire 5,000 index; a fund that tracks a foreign stock benchmark such as Morgan Stanley’s international index; and a fixed-income fund tied, for example, to the Lehman Bros. bond index.
The bulk of your portfolio would be in the U.S. index fund. Then, advisors typically suggest a 20% to 30% international stock allocation, though many investors are reluctant to invest that heavily abroad.
A 10% allocation to foreign stocks is better than nothing, Statman said. His view is that “there’s no reason to think that U.S. markets will outperform the world” or that the historically high correlation in recent years between domestic and major foreign markets will continue.
Recommended bond index fund weightings generally fall in the same 20% to 30% range, though they may be higher for older investors.
Russ Kinnel, head of fund research at fund tracker Morningstar Inc., said investors should seek the most broadly diversified index funds with cheap expense ratios and low annual portfolio turnovers to help limit risk and boost tax-efficiency as well as performance.
Lifestyle and Asset-Allocation Funds
For investors who don’t want to do much if any portfolio mixing themselves--let alone having to change the mix over time--many of the large fund families such as Vanguard Group, T. Rowe Price Associates and Fidelity Investments offer lifestyle or life-cycle funds.
“For someone who doesn’t want to have to choose, a balanced or lifestyle fund can be a good way to go,” said Shlomo Benartzi, a professor at UCLA’s Anderson School.
With such funds, the asset mix is tailored to the investor’s general time horizon and temperament and is changed automatically as the investor ages--usually becoming more conservative over time.
Fidelity, for example, offers the Freedom 2020 Fund, designed for investors retiring around that year.
But such a cookie-cutter approach isn’t for everyone.
“Lifestyle funds will automatically change your allocation based on a retirement date of 65, which might not necessarily be your target,” noted Kurt Brouwer, an investment advisor based in Tiburon, Calif.
Added Kinnel: “The fund’s mix might be right for a lot of people but not for you.”
Vanguard LifeStrategy Growth, for instance, holds about 15% of assets in bonds, a figure that might be too high to suit some young, growth-oriented investors, he said.
Some asset-allocation funds don’t change their mix as shareholders age but rather commit to a specific investment style and are supposed to stick with it. Typically, such funds label themselves as either aggressive, moderate or conservative in their investing, achieving their mix with stocks, bonds and money-market securities.
But Kinnel said investors should make sure “they’re really getting something on autopilot” if that’s what they want in an asset-allocation fund.
Markman Moderate Allocation Fund soared 36% in 1999--then fell 26% last year as manager Robert Markman bet heavily on large-cap growth-stock funds, Kinnel said.
“ ‘Moderate’ might not be the word some shareholders are using to describe it these days,” he said. “But this shouldn’t be an issue if you stick with a style-conscious shop like a Putnam Investments or a T. Rowe Price.”
Funds of Funds
Like many asset-allocation funds, the Markman offerings are “funds of funds,” meaning they invest in funds from various families, rather than in individual stocks or bonds.
Jeffrey Mortimer, who manages Charles Schwab Corp.’s funds of funds--MarketManager Growth, Balanced, International and Small-Cap--calls them “one-stop shopping for people who are tired of asking, ‘How do I stop getting hit by a bus?’ ”
In choosing funds for his portfolios, Mortimer interviews fund managers to check on their style, holdings and market views. Then he tweaks his mix of funds based partly on his expectations for the economy and other trends, trying to catch tail winds.
Schwab’s International fund of funds, for instance, added Tweedy, Browne Global Value to its portfolio about a year ago. “On recent past performance alone, that fund didn’t look so great, but we saw that it was turning into their kind of market,” Mortimer said. “They had excelled back in the ‘90s whenever value was in favor.”
Three of Mortimer’s funds of funds are in the top quartile of their peer groups, based on trailing three-year returns, according to Morningstar, though the small-cap fund has been less impressive.
Balanced Funds
For many investors in 401(k) retirement plans, a balanced fund may be the simplest way to go on autopilot.
Balanced funds, sometimes called hybrid funds, generally hold a mix of stocks, bonds and cash. Their bond and cash weightings may account for between 30% and 50% of assets, with stocks making up the balance. That makes them comparable to many moderate or conservative asset-allocation funds but less racy than growth-oriented funds.
The idea is that you leave the stocks-versus-bonds decision to a professional, but you’re always assured of having some bond cushion in the fund.
Popular balanced funds include Janus Balanced, Dodge & Cox Balanced and Oakmark Equity & Income.
Balanced funds are gaining popularity amid this year’s stock slump. As with pure bond funds, balanced funds have attracted net new cash even as investors have pulled back from stock funds in recent months, according to the mutual fund industry’s main trade group.
And according to a survey by the consulting firm Hewitt Associates, about 20% of new 401(k) dollars during February went into balanced funds, a spike from earlier months. About 8% of 401(k) dollars are allocated to balanced funds, according to Hewitt. (By contrast, lifestyle funds apparently have yet to catch on to the same degree: They hold just 4% of 401(k) assets.)
No matter what type of autopilot fund individuals choose, they can “put inertia to their advantage” by also using an automatic investment program, Benartzi said.
But that concept--for example, having $100 a month deposited automatically in the fund you choose--can be limiting because it can keep investors from boosting their savings rate significantly over time.
Benartzi suggests increasing investments at the time of each annual pay raise. An investor saving 3% of his paycheck in a 401(k) program, for example, might bump that up by 1 percentage point each year to move toward his or her goals.
Despite the streamlined approach, autopilot investors shouldn’t simply shove their quarterly fund statements into a drawer without looking at them.
“If you’re saving for retirement in 30 years, that’s one thing,” Kinnel said. “But if you’re putting kids through college in eight years or looking to buy a summer home in 10 years, then your portfolio is going to require more maintenance. You’ll want to check in from time to time and perhaps adjust the mix as you get closer.”
Indeed, market performance can throw even autopilot portfolios off course. In the 1990s, many investors saw the equity portions of their portfolios surge along with the major stock indexes.
Like any strategy, autopilot investing requires diligence, but it doesn’t have to be boring.
“If you believe in growth stocks and the importance of technology, you could buy shares of the Nasdaq 100 index with the idea that you’re going to wake up 10 years from now and see how they’re doing,” Brouwer said. “You just have to make an agreement with yourself that you’re going to stick with your plan unless your life changes.”
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Balanced Funds vs. S&P; 500 Index
Balanced mutual funds, also called “domestic hybrid” funds, always hold some mix of stocks, bonds and cash. The bond and cash part of a balanced fund’s portfolio will limit the fund’s returns in strong bull markets, but it also can limit losses when stocks tank--as they have over the last year. Here’s a look at the total return of the average balanced fund versus the return of the Standard & Poor’s 500 index each year since 1990 and in the first quarter of this year:
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Balanced: --5.2%
S&P; 500: --11.9%
Source: Morningstar Inc.
‘Autopilot’ Vehicles
If you want to put your investment portfolio on autopilot, there are hundreds of mutual funds that can help you do just that. Here is a look at the four major types of autopilot funds:
Index Funds
These seek to simply match the returns of a specific stock or bond index over time. Vanguard 500 Index, which tracks the blue-chip Standard & Poor’s 500, is the best-known, but there are funds tracking dozens of small-cap, mid-cap and international stock indexes.
California Investment S&P; MidCap Index, for instance, tracks the S&P; mid-cap 400 index. Funds tracking the broadest indexes, such as TIAA-CREF Equity Index, which aims to mimic the Russell 3,000, or Vanguard Total Stock Market Index, which tries to match the Wilshire 5,000, offer the most diversification.
According to Morningstar, there are 177 index funds in all.
Asset-Allocation Funds and ‘Lifestyle’ Funds
Asset-allocation funds promise to maintain a specific mix of investments--often labeling themselves either conservative, moderate or aggressive in their risk-taking. The idea is to relieve investors of the burden of deciding how best to invest for a certain level of risk.
“Lifestyle” or life-cycle funds are geared toward investors of a certain age or who have a specific time horizon, often a retirement target date. The funds generally become more conservative and income-oriented in their asset mix as the target date nears.
Examples include the Fidelity Freedom funds: 2000, 2010, 2020, 2030 and 2040.
There are 46 lifestyle funds available.
Funds of Funds
These portfolios seek to maximize diversification by owning shares of other mutual funds, chosen either from within the same family or from various families.
Examples include the T. Rowe Price Spectrum trio: Growth, International and Income, which hold various in-house funds in those sectors; and the Schwab MarketManager lineup: Balanced, Growth, International and Small Cap, comprising outside funds the Schwab manager likes.
There are 135 funds of funds.
Balanced Funds
Sometimes called hybrid funds, balanced funds always hold some mix of stocks, bonds and cash, usually weighted at the manager’s discretion. The funds offer a way to play the stock market over time but with the cushion of income-producing investments.
Among the 224 balanced funds available, strong performers in recent years have included Oakmark Equity & Income, Janus Balanced, Dodge & Cox Balanced, Gabelli Westwood Balanced and Invesco Balanced.
Where to Find Out More
For more information, these are some of the fund companies that offer autopilot vehicles:
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Fund company 800 phone Web site California Investment Trust 225-8778 www.caltrust.com Dodge & Cox 621-3979 www.dodgeandcox.com Fidelity Investments 544-8888 www.fidelity.com Gabelli-Westwood 937-8966 www.gabelli.com Invesco 525-8085 www.invesco.com Janus 525-8983 www.janus.com Oakmark 625-6275 www.oakmark.com Schwab 435-4000 www.schwab.com TIAA-CREF 223-1200 www.tiaa-cref.org T. Rowe Price 638-5660 www.troweprice.com Vanguard Group 662-7447 www.vanguard.com
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Sources: Times research, Morningstar Inc.
