Stormy Weather — Current Market Tips for Mutual-fund Investors

By Dianna Doreen
Writer, mPower

In This Story Investor Profiles Equity's In Style Drift vs. Discipline Riding out the Storm

Before the hi-tech market drop this spring, the Nasdaq doubled in value during a period lasting roughly from September 1999 through early March 2000.

Many investors have grown weary of market fluctuations. Roller coasters are fun, but most people don't want to live on one. Yet, that's what retirement investors have been told to do: ride it out for the long term. Here are some tips for choosing funds you can hang on to comfortably.

minute: read this article at a glance.

According to figures released in the Employee Benefit Research Institute's (EBRI) February 2000 Issue Brief, 401(k)-plan participation grew 26 percent between 1996 and 1998.

As the bull market in equities has bounded along, 401(k)-plan participation has grown. And, according to a collaborative study on asset allocation done by EBRI and the Investment Company Institute (ICI), half of all 401(k)-plan assets were invested into stock funds in 1998.

Finding out that equity investments are popular is not a new thing. And, for retirement investors, stock funds offer the highest potential return over the long term. But, with more 401(k)-plan participation, investors may want to ensure that the stock funds they choose are the best picks for furthering their overall investment objective — retirement.

Has the recent bull market, as well as the proliferation of available mutual funds — the number of which stands now at over 10,000 — influenced how 401(k) participants invest?

Investor Profiles

"Historically, investors have gotten between a 10 percent and 12 percent return on their large-cap funds," said Bobby Chen, an mPower financial analyst whose specialty is in the technology and equity markets. "But, the new average of the last five years has added 5 percent more to that return."

And, Chen maintains, investors accustomed to returns of 15 percent to 17 percent may have had more than their performance expectations skewed. They may have also altered their investing style.

Chen says investors might run into trouble when they forget their risk tolerance and original goals for investing.

He explains: "For someone investing for retirement, typically, asset allocation over time would determine this investor's return. But, with a bull market, investors are chasing returns, and subsequently their investing style has gotten a lot riskier than they might have pursued in the past."

Chen lists some criteria that investors planning for retirement should look at when determining asset allocation:

• Current investment goals
• Time horizon
• Risk tolerance
• Size of their portfolio

Asset allocation that is intended as a long-term, overall investment strategy, is usually designed to provide several things beyond performance. Top among these is diversification, which is a major selling point for mutual funds in the first place. But, it's equity-fund performance, namely from large-cap and aggressive-growth funds, that has piqued mutual-fund investor interest.

"With a bull market, investors are chasing returns, and subsequently their investing style has gotten a lot riskier than they might have pursued in the past." — Bobby Chen, analyst, mPower.

Equity's In

On June 26, 2000, AMG Data Services released their May 2000 figures on mutual-fund inflows. The AMG data reveals that in May, 79 percent of mutual-fund inflows went to large-cap and aggressive-growth funds.

"Large-cap" refers to market capitalization (market cap), or the price of a share of the company's stock times the number of outstanding shares. AMG defines large-cap companies as those with market capitalizations equal to or over $1 billion. AMG's medium-cap companies have market capitalizations between $109 million and $5 billion, and small-cap companies are defined as having market capitalizations of $1 billion or under.

Mutual funds will often target a specific market cap in order to achieve a primary objective, such as "growth" and "aggressive growth." Typically, growth and aggressive-growth funds will invest in different kinds of stocks, with aggressive-growth funds choosing riskier companies with higher potential return.

Barron's Dictionary of Finance and Investment Terms, fifth edition, defines blue chip as companies that are "nationally known ... (with) a long record of profit growth and dividend payment, and a reputation for quality management, products, and services."

Most blue-chip companies are large-cap, by definition, but not all large-cap companies have a long record of profit growth or dividend payments.

Retirement-planning investors shouldn't assume that "large-cap" funds hold "blue-chip" companies.

The Internet and technology industry's astonishing boom time has created many large-cap companies, but blue chips have weathered market storms over the long haul. Due to their investment objectives, however, mutual-fund portfolio managers don't necessarily invest in blue chips.

The performance of aggressive-growth and growth equity funds can make a retirement portfolio bloom. But, some well-performing funds might not meet the other investment needs of 401(k) participants — investment needs based on an overall retirement-planning strategy that takes goals, risk tolerance, time horizon, and further individual considerations into account.

Style Drift vs. Discipline

When a fund strays from its stated goal and investing criteria, it is said to have "style drift." If you have developed an asset allocation, and invested in funds based on their stated style, "style drift" in a fund could throw your asset allocation out of whack.

For example, if you've invested money in a fund that bills itself as a large-cap fund, but the managers have actually invested 50 percent of it in small-cap companies in a search for higher returns, this "drift" will affect your asset allocation.

Investors may actually want to stray, perhaps leaving money in a fund that is doing particularly well and ignoring the reasons why. However, trying to "time" your 401(k) with the market is probably not offering the best long-term returns for your retirement investment.

"Stock-fund investors ... have been sensitive to long-run trends in equity returns. Stock funds generally experienced inflows throughout the 1944 to 1970 and 1982 to 1995 periods when equity returns were relatively high, and they generally experienced outflows throughout the 1971 to 1982 period when equity returns were relatively low." — ICI, March 1996 Perspective, "Mutual Fund Shareholder Activity During U.S. Stock Market Cycles, 1944 to 1995."

Just as it's a mutual-fund manager's job to accomplish the fund's investment objective, it is your job to ensure that you've created, and are able to hold onto, the asset allocation that will best help you achieve your investing goals.

Riding out the Storm

Investors who want to shop for 401(k) mutual funds that fall within their investment strategy and goals, can make sure of this by reviewing:

• Fund objective
• Investment style
• Historical performance

Each of these is outlined in the fund prospectus. It is an often disregarded but essential read, because management discloses for shareholders how much a fund is allowed to hold in certain investments, like equities of developing countries and what a fund's market cap is.

Ultimately, investors picking mutual funds within a retirement-saving vehicle, like the 401(k), may want to scrutinize more than just the bottom line of a fund. Historical performance, as well as fund management's investing philosophy and objective, can help determine whether a fund fits an investor's personal retirement goals.

Regular asset allocation is a great tool for this process. How to design a hard-working asset allocation, specific to individual investor needs, will be covered in a Money Manager article appearing in August.

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.

Stormy Weather — Current Market Tips for Mutual-fund Investors

By Dianna Doreen
Writer, mPower

In This Story Investor Profiles Equity's In Style Drift vs. Discipline Riding out the Storm

Before the hi-tech market drop this spring, the Nasdaq doubled in value during a period lasting roughly from September 1999 through early March 2000.

Many investors have grown weary of market fluctuations. Roller coasters are fun, but most people don't want to live on one. Yet, that's what retirement investors have been told to do: ride it out for the long term. Here are some tips for choosing funds you can hang on to comfortably.

minute: read this article at a glance.

According to figures released in the Employee Benefit Research Institute's (EBRI) February 2000 Issue Brief, 401(k)-plan participation grew 26 percent between 1996 and 1998.

As the bull market in equities has bounded along, 401(k)-plan participation has grown. And, according to a collaborative study on asset allocation done by EBRI and the Investment Company Institute (ICI), half of all 401(k)-plan assets were invested into stock funds in 1998.

Finding out that equity investments are popular is not a new thing. And, for retirement investors, stock funds offer the highest potential return over the long term. But, with more 401(k)-plan participation, investors may want to ensure that the stock funds they choose are the best picks for furthering their overall investment objective — retirement.

Has the recent bull market, as well as the proliferation of available mutual funds — the number of which stands now at over 10,000 — influenced how 401(k) participants invest?

Investor Profiles

"Historically, investors have gotten between a 10 percent and 12 percent return on their large-cap funds," said Bobby Chen, an mPower financial analyst whose specialty is in the technology and equity markets. "But, the new average of the last five years has added 5 percent more to that return."

And, Chen maintains, investors accustomed to returns of 15 percent to 17 percent may have had more than their performance expectations skewed. They may have also altered their investing style.

Chen says investors might run into trouble when they forget their risk tolerance and original goals for investing.

He explains: "For someone investing for retirement, typically, asset allocation over time would determine this investor's return. But, with a bull market, investors are chasing returns, and subsequently their investing style has gotten a lot riskier than they might have pursued in the past."

Chen lists some criteria that investors planning for retirement should look at when determining asset allocation:

• Current investment goals
• Time horizon
• Risk tolerance
• Size of their portfolio

Asset allocation that is intended as a long-term, overall investment strategy, is usually designed to provide several things beyond performance. Top among these is diversification, which is a major selling point for mutual funds in the first place. But, it's equity-fund performance, namely from large-cap and aggressive-growth funds, that has piqued mutual-fund investor interest.

"With a bull market, investors are chasing returns, and subsequently their investing style has gotten a lot riskier than they might have pursued in the past." — Bobby Chen, analyst, mPower.

Equity's In

On June 26, 2000, AMG Data Services released their May 2000 figures on mutual-fund inflows. The AMG data reveals that in May, 79 percent of mutual-fund inflows went to large-cap and aggressive-growth funds.

"Large-cap" refers to market capitalization (market cap), or the price of a share of the company's stock times the number of outstanding shares. AMG defines large-cap companies as those with market capitalizations equal to or over $1 billion. AMG's medium-cap companies have market capitalizations between $109 million and $5 billion, and small-cap companies are defined as having market capitalizations of $1 billion or under.

Mutual funds will often target a specific market cap in order to achieve a primary objective, such as "growth" and "aggressive growth." Typically, growth and aggressive-growth funds will invest in different kinds of stocks, with aggressive-growth funds choosing riskier companies with higher potential return.

Barron's Dictionary of Finance and Investment Terms, fifth edition, defines blue chip as companies that are "nationally known ... (with) a long record of profit growth and dividend payment, and a reputation for quality management, products, and services."

Most blue-chip companies are large-cap, by definition, but not all large-cap companies have a long record of profit growth or dividend payments.

Retirement-planning investors shouldn't assume that "large-cap" funds hold "blue-chip" companies.

The Internet and technology industry's astonishing boom time has created many large-cap companies, but blue chips have weathered market storms over the long haul. Due to their investment objectives, however, mutual-fund portfolio managers don't necessarily invest in blue chips.

The performance of aggressive-growth and growth equity funds can make a retirement portfolio bloom. But, some well-performing funds might not meet the other investment needs of 401(k) participants — investment needs based on an overall retirement-planning strategy that takes goals, risk tolerance, time horizon, and further individual considerations into account.

Style Drift vs. Discipline

When a fund strays from its stated goal and investing criteria, it is said to have "style drift." If you have developed an asset allocation, and invested in funds based on their stated style, "style drift" in a fund could throw your asset allocation out of whack.

For example, if you've invested money in a fund that bills itself as a large-cap fund, but the managers have actually invested 50 percent of it in small-cap companies in a search for higher returns, this "drift" will affect your asset allocation.

Investors may actually want to stray, perhaps leaving money in a fund that is doing particularly well and ignoring the reasons why. However, trying to "time" your 401(k) with the market is probably not offering the best long-term returns for your retirement investment.

"Stock-fund investors ... have been sensitive to long-run trends in equity returns. Stock funds generally experienced inflows throughout the 1944 to 1970 and 1982 to 1995 periods when equity returns were relatively high, and they generally experienced outflows throughout the 1971 to 1982 period when equity returns were relatively low." — ICI, March 1996 Perspective, "Mutual Fund Shareholder Activity During U.S. Stock Market Cycles, 1944 to 1995."

Just as it's a mutual-fund manager's job to accomplish the fund's investment objective, it is your job to ensure that you've created, and are able to hold onto, the asset allocation that will best help you achieve your investing goals.

Riding out the Storm

Investors who want to shop for 401(k) mutual funds that fall within their investment strategy and goals, can make sure of this by reviewing:

• Fund objective
• Investment style
• Historical performance

Each of these is outlined in the fund prospectus. It is an often disregarded but essential read, because management discloses for shareholders how much a fund is allowed to hold in certain investments, like equities of developing countries and what a fund's market cap is.

Ultimately, investors picking mutual funds within a retirement-saving vehicle, like the 401(k), may want to scrutinize more than just the bottom line of a fund. Historical performance, as well as fund management's investing philosophy and objective, can help determine whether a fund fits an investor's personal retirement goals.

Regular asset allocation is a great tool for this process. How to design a hard-working asset allocation, specific to individual investor needs, will be covered in a Money Manager article appearing in August.

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.