Lessons From the Fall: How to Ride Growth Funds Without Getting Bucked

Your growth-overdosed portfolio might be looking like it's ready to ride again after a rough patch, but let's check out a couple of ways to make your trails a tad happier.

Lessons Learned: 2000's Harsh Truths We Shouldn't Forget

The Halftime Club: Record Number of Funds Loses Half Their Value

It's Not Value or Growth, You Need Both

Popular Funds Left You With a Tech Hangover

False Profits: Are You Really in the Black?

Sector Addicts: Sector Funds Changing the Game and Not for the Better

Hocus Focus: The Downside of Focus Funds

If Now, Then How: Why Dollar-Cost Averaging Makes Sense

Cash Isn't King: Managers Don't Cash Out of Falling Markets

How to Build a Low-Maintenance Portfolio

Questioning the Buy-and-Hold Strategy

Bonds Have a Place in Most Portfolios

Foreign Funds Lower Risk, but Won't Do the Opposite of U.S. Stocks

Ask the average fund investor about the past couple of years and you'll get a riches-to-rags story. In 1999, more than 120 tech- and tech-stuffed growth funds rode that mercurial sector to triple-digit gains, according to Morningstar. Then the average tech- and large-cap growth fund rode the techy Nasdaq Composite down to 61% and 36% losses, respectively, for the year ending March 31. Despite those big losses, they still got the lion's share of investors' dollars over the past year.

Now comes the twist. The Nasdaq is up a whopping 36% over the past 20 trading sessions. Consequently, big-cap growth funds and tech funds are up an average of 18.6% and 39.3%, respectively, over the past month, according to Morningstar.

If you're one of the many folks out there who overcommitted to growth funds in general and the tech sector in particular during the past few years, you might be tempted to stick with those feast-or-famine types or even buy more shares. But as part of this week's Lessons From the Fall series, let's take a look at just how rough a ride you'd get from a portfolio of last year's bestsellers. Then we'll look at a couple of more diversified alternatives that would have posted similar gains, with below-average volatility.

Last year the five top-selling funds were all large-cap growth funds: (FDGRX)Fidelity Growth Company, (AGTHX)Growth Fund of America, (JAWWX)Janus Worldwide, (FDEGX)Fidelity Aggressive Growth and (ACEGX)Van Kampen Emerging Growth.

This handful took in almost 25 cents of every net dollar invested in stock funds last year, according to Boston fund consultancy Financial Research. On average, they gained 79% in 1999 and are down 26% over the past year, doubling their average peer's returns on the upside and losses on the downside, according to Morningstar. By no coincidence, an evenly weighted portfolio of the five funds has 38% of its money in tech, about double the S&P 500's tech stake.

The Bestseller Portfolio
20%	(FDGRX)Fidelity Growth Company
20%	(AGTHX)Growth Fund of America
20%	(JAWWX)Janus Worldwide*
20%	(FDEGX)Fidelity Aggressive Growth
20%	(ACEGX)Van Kampen Emerging Growth
Source: Financial Research Corp. *Currently closed to new investors.

These funds are still clinging to an S&P 500-beating 16.9% five-year annualized return and 12.3% three-year annualized gain. But many investors haven't owned shares for that long and the road to those returns was grueling. In the year ending March 31, this portfolio would be down 42.1%, or about double the S&P 500's loss. If you're not familiar with beta, it measures a portfolio's volatility vs. the S&P 500. A beta below 1.0 indicates less shakiness, while a beta above 1.0 implies sleepless nights. This gaggle of funds checks in with a five-year beta of 1.13, according to Morningstar.

Bestsellers vs. the Market
Volatility
	Bestseller Portfolio	S&P 500
Worst Year	-42.1%	-21.6%
5-Year Beta	1.13	1.0
Source: Morningstar.

For some of us, it's worth it to swing for the seats with this kind of growth-heavy portfolio. But for most investors, it's not really what they're after. There are a number of ways to build a portfolio with the thousands of funds out there, but let's just look at two for folks with at least a 10-year time horizon. The goal of both is to try to use no-load funds to build a portfolio that's diversified among sectors and market caps, with competitive returns, below-average expenses and below-market risk.

First, let's assume you don't have the time and inclination to monitor your stock fund portfolio more than quarterly or annually. In that case, here's a stab at a portfolio that might work for you: The Low Maintenance Stock Fund Portfolio.

The Low Maintenance Stock Fund Portfolio
80%	Core U.S. Stock	(VTSMX)Vanguard Total U.S. Stock Market Index
20%	Core Foreign Stock	(TBGVX)Tweedy, Browne Global Value

With just two funds you get broad access to the world's stock markets. The no-load (VTSMX)Vanguard Total U.S. Stock Market Index fund tracks the broad Wilshire 5000 index, and the no-load (TBGVX)Tweedy, Browne Global Value fund has demonstrated a knack for topping its peers with less volatility by shopping for undervalued stocks in foreign markets and hedging its currency exposure.

When we look under this portfolio's hood, we find that it gives you access to every sector of the market without making titanic bets on one area. Also, about a third of its money is in small- and mid-cap stocks, compared with about 25% for the Wilshire 5000. This might lead to a bit more volatility than sleepier large-caps, but will probably boost returns over time, too.

Under the Hood
	Portfolio	S&P 500
Financials	19.4%	17.9%
Technology	18.2	19.1
Health	14.1	13.5
Services	13.9	11.9
Industrial Cyclicals	11.7	11.4
Consumer Staples	8.3	6.7
Energy	4.9	7.5
Retail	4.8	6.7
Utilities	2.5	3.5
Consumer Durables	2.2	1.8
Expenses
Avg. Expense Ratio	0.44%	1.38%*
Volatility
Worst Year	-19.1%	-21.6%
5-Year Beta	0.9	1.0
*Average fund's expense ratio. Source: Morningstar.

This two-fund portfolio also boasts an average annual expense ratio of just 0.44%, compared with the fund world's 1.38% average, according to Morningstar. Finally, a look at its worst one-year loss and its beta over the past five years shows less volatility than the S&P 500.

Admittedly, if this portfolio were a car it would be a Ford Taurus, not a Porsche. But it lost less than the S&P 500 in the first quarter and over the ugly 12 months ending March 31. It also beat the index over the past three years and trailed it by only one percentage point over the past five years. Finally, this portfolio doesn't need daily monitoring and would require only modest rebalancing at the end of each year to keep your asset allocation on target.

Low Maintenance vs. the S&P

Source: Morningstar

But what if you're actually intrigued by funds and how they can fit together? If you're not content to chug along with an index fund and you don't mind a bit more work, you might consider something like A Fund Junkie's Portfolio. This isn't my portfolio -- though I'd take it in a second -- and I'm not suggesting you buy any of the funds included in these models. But if you're curious about how indexed- and actively managed funds with growth and value styles and broad or sector-specific focuses might fit together, here's a look.

A Fund Junkie's Stock-Fund Portfolio
35%	Core U.S. Stock	(VTSMX)Vanguard Total U.S. Stock Market Index
15	Core Foreign Stock	(TBGVX)Tweedy, Browne Global Value
10	Growth	(GABGX)Gabelli Growth
5	Growth	(RPMGX)T Rowe Price Mid-Cap Growth
10	Value	(LMVTX)Legg Mason Value
5	Value	(OAKMX)Oakmark
10	Small-Cap	(MGSEX)Managers Special Equity
10	Sector	(TVFQX)Firsthand Technology Value
		(FSPHX)Fidelity Select Health Care
		(FSFSX)Invesco Financial Services

The plan here is to blend solid core stock funds, like those in the low-maintenance portfolio, with a select group of funds with gifted managers at the helm. Here we're talking about folks like Howard Ward ((GABGX)Gabelli Growth), Bill Miller ((LMVTX)Legg Mason Value), Bill Nygren ((OAKMX)Oakmark) and Kevin Landis ((TVFQX)Firsthand Technology Value).

In this portfolio, the core funds give you broad, cheap access to the market, while with the diversified and sector-specific funds, all actively managed, you top the market. Like all actively managed funds, these will have good and bad years, but these folks have been right more than they've been wrong. Overall, the diversity of the actively managed funds' styles, combined with the staid core funds, should keep the portfolio from being too dependent on any company, sector or strategy.

Under the Hood
	Portfolio	S&P 500
Financials	21.5%	17.9%
Technology	20.4	19.1
Services	16.6	11.9
Health	15.8	13.5
Industrial Cyclicals	9.3	11.4
Consumer Staples	5.4	6.7
Retail	4.9	6.7
Energy	2.8	7.5
Consumer Durables	2.2	1.8
Utilities	1.3	3.5
Expenses
Avg. Expense Ratio	0.96%	1.38%*
Volatility
Worst Year	-16.6%	-21.6%
Five-Year Beta	0.94	1.0
*Average fund's expense ratio. Source: Morningstar.

An X-ray of this portfolio shows some solid DNA. It is diversified among sectors, but its modest overweightings in the financial and technology sectors position it to fare well whether value or growth stocks are in favor. The portfolio's 0.96% average expense ratio is below average and its 16.6% loss over its worst 12-month stretch is five percentage points below the S&P 500's.

With its moderate approach, you probably expected the portfolio to lose less than the S&P 500 over the past year, but its index/active management blend also helped it top the index over the past three- and five-year periods.

The Junkie vs. the S&P
	A Fund Junkie's Portfolio	S&P 500
First-Quarter Return	-11%	-11.9%
1-Year Return	-16.6	-21.6
3-Year Return	7	3.1
5-Year Return	16.1	14.2
Source: Morningstar.

Of course, this portfolio requires a bit more work. When you own 10 funds, many of which are charting distinct courses, you need to keep an eye on them. And rebalancing at the end of the year can be a bit of a headache. That said, its above-market returns and below-market risks might make it worth your while.

The bottom line, of course, is that there's nothing wrong with including aggressive tech and growth funds in your portfolio. But if you blend them with less racy value and index fare, you'll still get a boost in frothy times like 1999 or the past month, without suffering as badly when the Nasdaq's siren song stops.

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