Don't say good-bye to 1997 too fast. Take some of its mutual-fund lessons into the new year.
Yes, the new year is a perfect time for resolutions -- to focus on waistlines and bottom lines. But as you peek into your portfolio, take a look back for a moment. Don't forget the lessons we learned from one of the most instructive years in a decade. (When was the last time, after all, that the market obeyed the laws of gravity, if only for a while?) Here are some of the things I'm keeping in mind as I say hello to a new year:
Cash Isn't a Four-Letter Word
During the big bull run, managers who quietly stashed cash often were viewed with derision. But a cash cushion came in handy during the rough ride of the third quarter. And funds such as
Clipper, which hoarded a bit, came in for a much softer landing than their peers. This does not argue for market-timing. That's always a dangerous proposition for even the savviest of professionals, as
Brandywine's Foster Friess, who jumped in and out of cash at precisely the wrong times last year, knows all too well. But don't assume that cash is trash in a mutual fund's asset allocation.
It's easy to ignore the price tags of our mutual funds when they deliver double-digit returns year after year. But the third quarter, one of the worst on record for equity funds, offered us a taste of the bite that fees can take out of our bottom line. If you opened your third-quarter statements with a gasp, you might want to take a closer look at the fine print of the prospectuses, where a fund's expense ratio and management fees are outlined. You don't get a discount during market mayhem, and, yeah, it hurts more when the
is taking a dive. But a little pain may be what it takes to remind us to consider whether we're getting what we pay for.
Many traditional hedges during rough patches didn't offer much protection during last summer's selloff. Real-estate funds, for example, didn't perform as advertised. They were down 17.2%, on average, this year, according to
This was the big "should" that didn't. Value funds, those packed with bargain stocks,
have provided a little buffer on the down side. But they didn't prove very valuable to investors looking for cover. According to
, the average value fund lost 23% from July 17 through Oct. 8 -- more than the decline of the
during that volatile period. The painful lesson for many value managers: Yep, cheap stocks can get even cheaper.
Index Funds Can Battle the Bear
Another "should" that didn't: It has long been a defense of active managers that, sure, index funds do well while the bull is running hard, but they will tumble when it stumbles. Down times are supposed to be stock-pickers' markets. But the losses for S&P 500 index funds were less than those for almost every other fund category during the third quarter.
Focus? You Won't Always Like What You See
Focused funds, those that make big bets on a few stocks, have been one of the hottest trends in the fund world. That's because they can provide supercharged returns in high-flying markets. But what goes up can come down -- and hit hard. A few of the better-known ones showed that volatility often goes hand in hand with a concentrated approach.
CGM Capital Development lost 36% from the market's peak to bottom this year;
Oakmark Select was down 26% and
PBHG Large Cap 20 declined 29%.
During the last few years, chances are you were too busy counting your mutual-fund money to worry much about taxes. But 1997 offered the reminder that you can let Uncle Sam share some of the hurt of an up-and-down market. By selling a fund that lost money since you bought it (maybe an emerging-market fund or real-estate fund), you realize a loss to offset capital gains earned elsewhere in your portfolio.
We also learned that a fund can
money and still hit you with a big tax bill. This is a valuable lesson in checking on fund distributions. Because companies don't have to warn you of distributions in advance (in fact, many made early distributions last year without warning), you have to do a little homework. Check turnover and look to see if there's been a big decline in assets.
The Little Guy Holds On
Once again, we heard all the warnings from the blue suits on Wall Street that the blue-jeaned crowd on Main Street would bail right at the bottom. And yes, there was a flight to quality when the day was darkest last summer; and, yes, there were net outflows from stock mutual funds in August, but the money poured back in during September. And when many traders were turning somersaults to yell "sell," the little guy and gal held on. Now those experts who say the investing world is populated by uneducated investors who have never seen a bear market can't any longer. We've seen one and survived it.
Pass the Alka-Seltzer
Although individual investors proved to have great staying power, many of us learned that we might need to fine-tune our asset allocations. A 100% stock portfolio maybe felt great when the market was climbing, but when it started sliding, so, too, did our stomachs. Sure, if you want to make money in the long term, you have to be prepared to lose money in the short term. But if you were losing sleep and seeing red as your funds started dipping into the red, you should consider in a calmer moment whether your risk tolerance really is what you thought it was.
What about you? What did you learn this year?
Email me, and we'll post a sample of your comments.
Brenda Buttner's column, Under the Hood, appears every Thursday. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks or funds.