Most of the stock analysts and commentators (including
) keep talking about stock valuations being too high and point out they will probably fall to lower valuations under certain circumstances. But I haven't seen anyone address this situation regarding mutual funds. So is there any advice for both new and existing mutual fund investors? Harvey Talley
Some people will tell you that certain areas of the market are overvalued. Some won't.
It all depends on who is doing the talking. (On
, for example, we have a lot of different points of view.) For years some financial professionals have been crowing that the market is overvalued and ripe for a fall. But when it comes right down to it, who knows?
Without having to decide which pundit is right, there are a few things you can always remember when looking at your existing funds or picking new ones.
For starters, keep in mind that a mutual fund is just a basket of stocks. If the stocks in the fund are overvalued and begin to decline, then the mutual fund will follow suit. So, to get a handle on valuations and your mutual fund, you need to check out the standard valuation measures as they pertain to the stocks in your fund. Figures are available for the average price-to-earnings ratio and the average price-to-book value ratio for a mutual fund. (
site carries them.) These ratios will let you compare the valuation of a particular mutual fund to an index fund or one or more of its peers.
Some financial professionals care more about these measures than other pros do. Which brings me to my next point: It is important to know and understand the investment approach of your fund manager. A fund might have the word "value" in its name, but that doesn't tell you much about a manager's style. The approach of
Strong Schafer Value, for example, is different from the value style at
. Other funds, so-called "aggressive growth" or "momentum" funds, are generally less concerned with valuation -- or the price they have to pay for a stock -- than whether the price is going up.
If you personally are concerned with valuation, you may want to avoid momentum or aggressive growth managers. You may also want to avoid sector-specific portfolios where you think the sector is overvalued. A simple way to look at it: If something has rocketed, then it has the potential to head downward with the same force.
Small-cap funds certainly have lower valuations than large-cap growth funds. Then again, small-cap stocks have dramatically underperformed the large-caps. We don't really know when or if the world will turn around for small-caps and when large-cap growth names will no longer lead the market.
"I think one thing to do in a market such as this is try to diversify," says Tim Schlindwein of
, a financial adviser in Chicago. "If one buys a more broadly diversified portfolio that isn't just focusing on one area where all the action has been, you mitigate your exposure to that area of the market and still participate in the broad market's movement."
"Where I would be very cautious in the mutual fund arena is the focused funds," Schlindwein adds. A focused fund, with only about 20 or so stocks, or a sector fund is going have heavier weightings in certain areas and may not recover as quickly if that part of the market goes south. Of course, a focused or sector fund could have a place in a broader portfolio. That just goes back to spreading your bets around.
TSC Fund Forum aims to provide general fund information. Under no circumstances does the information in this column represent a recommendation to buy or sell funds or other securities.