Like black-eyed boxers, fund investors are looking for a good corner man, and Russ Kinnel is that guy.
It hasn't been pretty. Thanks to anemic economic growth and corporate profits, bonds are about to beat stocks for the second-straight year. The average U.S. stock fund is down more than 14% over the past year, worse than any calendar-year loss since 1980, according to Chicago research house Morningstar.
Even worse, tech and growth funds, last year's top sellers, are down almost 50% and 30%, respectively, over the same stretch. To sort through this mess, we called Kinnel, Morningstar's director of fund research.
TSC: What did we learn over the past two years?
Russ Kinnel: I think we learned how severe a valuation-sparked correction can be. I think we've also learned why diversification is so important. Sometimes people make the mistake of looking at the last few years and projecting that out. That never really works very well, and the past two years shows why you want to own a variety of stock and bond funds, not just those that worked recently.
TSC: How should someone analyze their portfolio to make sure it's diversified now?
Start by pulling together all your holdings, stocks and funds. You want to look at what styles you own, growth vs. value and large-cap vs. small-cap. Generally, you want a mix without being more than moderately overweighted anywhere. You also want to look at your portfolio's sector weightings. There have been enormous changes in how growth funds, for instance, are investing in tech stocks. Did your growth manager double down on tech or bail out? You want to judge your portfolio's diversification by sector and style by looking at it vs. the Wilshire 5000 Index.
TSC: A lot of investors could've saved themselves some pain if they'd had a big percentage of money in a diversified core stock fund. What's the anatomy of a core stock fund?
You do want to make sure you don't just own a bunch of sector or niche funds because that's an unstable structure. It's very likely you've left out funds that invest in the
Procter & Gambles
of the world that are a big part to the economy. A good core fund has a good percentage of its money, 40% to 50% say, in large-caps, and decent diversification among styles and sectors. It should also be a fund that is not making wild swings in its portfolio from time to time. If you build your portfolio around one or two key funds, you don't want them to go 80% into financials or bonds suddenly. You generally want moderate costs and turnover, too. The fund shouldn't necessarily have top-decile performance, but rather be consistently above-average.
TSC: How much of your stock portfolio should be in a core stock fund, and what are a couple of good choices?
In a core fund you can have anywhere between 15% and 50% of your stock assets. I wouldn't go to 50% unless it's a broad index fund. In terms of examples,
offers a number of very appealing options like the
Investment Company of America. It has a modest bias toward cheaper value stocks but is still very broad. Another is the
Vanguard 500 Index fund. There are other good options like the
Dodge & Cox Stock fund or
Fidelity Magellan, which is closed to new investors but still owned by millions
and available in 401(k) plans. It has a modest growth bias, but it has low costs and low turnover, too. It's also married to the big-cap market.
TSC: What's the case for investing in bond funds? And should most investors do so?
I think bonds and bond funds belong in most investors' portfolios for a few reasons. The first is that they have very low correlation with stocks, so it diversifies your portfolio. Second, even though stocks will probably beat bonds over the long haul, there will be periods before you retire when you'll have to tap your savings -- and bonds are perfect for that. Also, even though stocks generally beat bonds, the market's history is murky enough that you can't absolutely guarantee that stocks will beat bonds over the next 10 years. Warren Buffett says we're looking at returns of 5% or 6% a year for stocks. The problem is that if you are going to invest in bond funds today, you need to lower your expectations, too.
TSC: What are the criteria for a good core bond fund?
You want a core bond fund to be in the intermediate-term category and focus on mostly high-quality, investment-grade bonds. You also want a fund that has low costs and comes from a manager with a lot of expertise in bond investing. You also want to look at the portfolio to make sure it's pretty vanilla. You don't want to own a fund that stretches for extra return by investing in lower-quality or foreign bonds.
By and large I'd say stick with a name you can trust. There are some excellent bond shops like
has very good municipal bond funds.
TSC: When does someone know they need to at least consider hiring a financial adviser?
If you're looking at your portfolio and it's really just a random collection of funds that sounded good at the time, then it's time to pay for an adviser. And if you don't want to spend more than 10 minutes a year on it, get a good planner who's been in the business for at least 10 years and comes with good recommendations. More people are paying for advice because we're all now in charge of our retirement money. There aren't many pensions out there anymore, so you have to recognize that you shouldn't mess around with your finances.
Ian McDonald writes daily for TheStreet.com. In keeping with TSC's editorial policy, he doesn't own or short individual stocks. He also doesn't invest in hedge funds or other private investment partnerships. He invites you to send your feedback to
firstname.lastname@example.org, but he cannot give specific financial advice.