Millions of mutual fund investors are staring at their account balances and wondering how they went so wrong.
Redemptions at Janus Soar
Building the Low-Maintenance Portfolio
Questioning the Buy-and-Hold Strategy
(Re)Building a Diversified Portfolio
The Junkie's Perfect Portfolio
Fact is, if you built a seemingly sensible portfolio of funds in the past five or 10 years, it was quite easy to end up with a tech-stuffed gaggle that's falling through the floor. When tech dusted the rest of the market in 1998 and 1999, pro and amateur investors alike chased the sizzling sector. A record gush of money flowed into tech funds and "diversified" growth-fund managers quietly put 40% and 50% of their money in tech stocks, too. Today
we detailed the steep losses these funds -- and their shareholders -- are still absorbing.
The upshot: Even a portfolio that seemed only moderately aggressive was actually positioned to fall -- and fall hard -- in this tech-led downturn. Let's look at one and then check out some simple alternatives you can use to cut your risk way down, without sacrificing competitive returns. I'm not telling you to buy these funds, I'm just trying to show you how easy it can be to get marketlike returns without a slew of risk.
Over the past few years, it seemed like everybody was buying
index funds, big-cap growth funds, focused growth funds that held only 20 or so stocks and tech funds. If we build a portfolio of the biggest, most popular funds in each style, it would include the
fund and the
T. Rowe Price Science & Technology
fund. Let's call it the Popular Portfolio. Yes, Magellan and Twenty are currently closed to new investors, but given their asset size, there is no shortage of folks with these funds, and funds like them, in their portfolios.
While this probably seemed like a moderately aggressive portfolio, it was actually pretty risky. If we look at the sector weightings of an equally weighted portfolio of these four funds we find that it would have more than half its money in the tech sector, according to
. Keep in mind, the telecommunications sector is a big part of the portfolio's "services" bet, so about 60 cents of every dollar in this portfolio is pegged to mercurial and currently sagging tech/telecom stocks.
This Popular Portfolio's tech bet was probably apparent when it sailed high in 1998 and 1999, but it's even more noticeable now. It's down almost 32% over the past 12 months through Feb. 28, according to Morningstar. That's about four times the loss of a portfolio invested just in the Vanguard 500 Index fund, where tech is about 19% of the portfolio.
Even more stark is a look at the Popular Portfolio's volatility. Yes, over the past 10 years its best 12-month return was 67.8%, but its worst 12-month loss topped 30%. That's three times the worst-case scenario for the Vanguard 500 fund. If we look at each portfolio's beta, a measure of its volatility compared with the S&P 500, we find that the Popular Portfolio was a much bumpier road, too. For reference, the S&P 500's beta is 1.0 and a higher beta implies more volatility.
But even for tech fans, it didn't have to be that bad. For aggressive investors, most portfolio models prescribe a diversified portfolio that limits its sector-fund bets to 10% or less of your assets. This adds up to a 28.6% tech bet, which might be a happy medium for even those stricken with tech fever. If we compare the returns and risks of a portfolio with 90% of its money in the Vanguard 500 Index fund and 10% in the average tech fund, we find often-higher returns and less risk than the Popular Portfolio.
Over the past 10 years, the Popular Portfolio would've posted a 17.4% average annual gain, compared with 15.9% for the other. But the Popular Portfolio would've fallen short this year, over the past 12 months and over the past five years.
Bringing bond and foreign-stock exposure would reduce risk even more. For instance, let's look at a portfolio with 80% of its money in the Vanguard 500 fund, 10% in the Vanguard Total Bond Market Index fund and 10% in the Tweedy, Browne Global Value fund. This fund would trail the Popular Portfolio over the past 10 years, but it would be down only 4.3% over the past year, compared with the Popular Portfolio's 31.8% fall.
This broader portfolio, which has a 21.3% tech weighting, still would've gained more than 45% in its best year, but its worst 12-month return was just 5%, according to Morningstar. Its beta or volatility along the way also was just 0.85%.
Well, there you have it. A few different ideas on how you might participate in up markets, without getting a healthy dose of account-statement shock.
Fund Junkie runs every Monday, Wednesday and Friday, as well as occasional dispatches. 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
email@example.com, but he cannot give specific financial advice.