The Value of Asset Allocation

By Brenda Watson Newmann
Managing Editor, mPower

Mutual funds can have any of a wide range of stated investment objectives, from aggressive growth to short-term government bonds. Once you know what your investment goals are, and how to allocate your investments to have the best chance of reaching those goals, it's time to look at specific funds.

Choosing a managed fund is somewhat more complicated. You cannot judge a managed fund by stated investment objective alone! It is important to research the historical performance of the fund, as well as how long the current manager has been in charge, in order to know whether he or she is responsible for that performance.

All funds are required to publish information on how they have performed over the last one-, five- and 10-year periods (or back to when they started, if they are less than 10 years old). They should also compare that performance against a market index.

They also must publish a list of their holdings. It is a good idea to review this to determine whether, for example, the small-cap value fund you are looking at really does hold predominantly small-cap value stocks.

You also want to determine the fund's most significant risks, to see if they overlap those of other investments you have. For example, if you already have international holdings and you invest in a large-cap growth fund, you want to be sure that the companies in the fund don't have extensive international operations as well, in order to limit the amount of international risk in your portfolio as a whole.

(International investing is widely recognized as adding value to a portfolio — the point here is that you want to make sure your overall portfolio doesn't contain too much of any one kind of risk.)

Determine the Investing Style of the Funds That Look Interesting

You need to be sure that a fund will continue to invest in its advertised style. A good way to begin is to call the phone number listed on the fund's prospectus and ask whether the fund plans to stick to its capitalization and valuation range, as well as its investing style.

Index funds are designed to closely track an index, and generally have lower fees than actively managed funds. With index funds, on the whole, what you see is what you get.

"Style drift" is what happens when a fund moves away from its stated investment style. This can happen for a number of reasons. The companies the fund invests in may have a large increase in their capitalization that moves them from small-cap to mid-cap, or mid-cap to large-cap. This could be the case in fast-growing sectors like technology. Or, in a period of rising interest rates, managers of a long-term bond fund might start trying to add value by buying more shorter-term bonds, changing the nature of the fund.

The information provided here is intended to help you understand the general issue and does not constitute any tax, investment or legal advice. Consult your financial, tax or legal advisor regarding your own unique situation and your company's benefits representative for rules specific to your plan.

The Value of Asset Allocation

By Brenda Watson Newmann
Managing Editor, mPower

Mutual funds can have any of a wide range of stated investment objectives, from aggressive growth to short-term government bonds. Once you know what your investment goals are, and how to allocate your investments to have the best chance of reaching those goals, it's time to look at specific funds.

Choosing a managed fund is somewhat more complicated. You cannot judge a managed fund by stated investment objective alone! It is important to research the historical performance of the fund, as well as how long the current manager has been in charge, in order to know whether he or she is responsible for that performance.

All funds are required to publish information on how they have performed over the last one-, five- and 10-year periods (or back to when they started, if they are less than 10 years old). They should also compare that performance against a market index.

They also must publish a list of their holdings. It is a good idea to review this to determine whether, for example, the small-cap value fund you are looking at really does hold predominantly small-cap value stocks.

You also want to determine the fund's most significant risks, to see if they overlap those of other investments you have. For example, if you already have international holdings and you invest in a large-cap growth fund, you want to be sure that the companies in the fund don't have extensive international operations as well, in order to limit the amount of international risk in your portfolio as a whole.

(International investing is widely recognized as adding value to a portfolio — the point here is that you want to make sure your overall portfolio doesn't contain too much of any one kind of risk.)

Determine the Investing Style of the Funds That Look Interesting

You need to be sure that a fund will continue to invest in its advertised style. A good way to begin is to call the phone number listed on the fund's prospectus and ask whether the fund plans to stick to its capitalization and valuation range, as well as its investing style.

Index funds are designed to closely track an index, and generally have lower fees than actively managed funds. With index funds, on the whole, what you see is what you get.

"Style drift" is what happens when a fund moves away from its stated investment style. This can happen for a number of reasons. The companies the fund invests in may have a large increase in their capitalization that moves them from small-cap to mid-cap, or mid-cap to large-cap. This could be the case in fast-growing sectors like technology. Or, in a period of rising interest rates, managers of a long-term bond fund might start trying to add value by buying more shorter-term bonds, changing the nature of the fund.

The information provided here is intended to help you understand the general issue and does not constitute any tax, investment or legal advice. Consult your financial, tax or legal advisor regarding your own unique situation and your company's benefits representative for rules specific to your plan.