Security in Numbers

By Philip J. Beavers, CFP,
WEAC's Member Benefits Specialist

February 1998

Financial Planning Seminars
Achieving Financial Independence

Mutual funds pool the money of many investors

In a mutual fund, the dollars of many investors are pooled together and invested in a number of stocks, bonds, and other securities. You buy shares in a large portfolio of securities, thus acquiring a degree of diversification even with a small initial investment. You will also be buying the services of professional investment managers at a relatively low cost. With mutual funds, no investment is guaranteed. There-fore, as potential for reward increases, so does the risk of loss.

How many funds should you own?

At last count, there were 10,322 stock and bond mutual funds with a total value over $4.3 trillion. Fifteen percent of fund-owning households now own seven or more mutual funds, according to the Investment Company Institute. A study conducted by Morningstar, Inc., suggested that the diversification and the risk/reward profile levels off after about 10 funds. Most financial experts suggest that five or six funds would provide adequate diversification. I would suggest six to eight funds with no more than one fund in the same asset class and investing style would be adequate. The key is to achieve an adequate diversification without overloading your portfolio or losing track. Obviously, as the size of your investment portfolio grows, the need for more diversification increases.

How do you choose a mutual fund?

• Since your objective should be to build a diversified fund portfolio, avoid funds which limit themselves to a single industry sector, or a particular foreign country or region.
• If you make your own fund decisions, avoid funds that have a sales charge. Avoid funds that charge an up-front or back-end commission or a large 12-b1 distribution fee.
• Avoid funds with high fund expenses. Pay no more than 1.00% a year for a fixed income fund, 1.25% a year for a domestic stock fund, or 1.50% for a global or international stock fund.
• Avoid funds whose current managers have been at the helm for less than three years, unless you know that the manager has a proven track record elsewhere.
• Avoid funds that have regularly generated poor results compared with other funds with the same investment objective over one, three, and five years.
• Stay with well-known fund companies, including American Century, Fidelity, Janus, Neuberg-Bergman, T. Rowe-Price, Scudder, Strong, Warburg Pincus, and Vanguard.

How do I select, de-select or evaluate performance of funds?

Every Friday the Wall Street Journal publishes benchmarks and performance yardsticks for mutual fund investors. The Wall Street Journal identifies fund investment objectives and displays performance numbers year to date; past four weeks; one, three, and five years; as well as expenses. You can check your funds to see how they compare to other funds with similar objectives. It is a very simple process to look up your fund, compare the performance against the average performance of funds in the same asset class. Most investors should be satisfied if the one, three, and five-year performance of their fund is better than the average performance of funds in the same class.

Below is an abbreviated mutual fund performance yardstick chart as published in the January 2, 1998, Wall Street Journal. I have selected seven investment objective categories with the one, three, and five-year performance numbers. After each category I have indicated a Vanguard Fund with a similar investment objective that might be worth considering. I have chosen Vanguard Funds for this illustration since they are the lowest cost provider of mutual funds. I have limited the illustration to only seven fund categories and only one Vanguard Fund in each category due to limited space. By spending some time with a Friday Wall Street Journal, the mutual fund investor could expand the fund categories and find other good-performing funds in each of the categories.

Posted February 5, 1998