Q. I have been investing exclusively in mutual funds for the last 15 years. I have also been involved almost exclusively with the Fidelity family of funds. Fidelity's website has a program called "fund evaluator" which uses different criteria for selecting mutual funds from their family as well as the total universe of mutual funds. I am currently using stock funds, year-to-date returns, 3-year returns, and Morningstar ratings as my criteria. What would you suggest as the specific criteria to use to evaluate funds? Also, with constant market rotation, what sectors should I focus on in the months ahead, as I do get involved in Fidelities sector funds?

---T.G., by e-mail

  

A. Advances in java programming and database management have brought a lot of new screening and ranking capability to web users in the last two years, including the Fidelity site. Morningstars' own website, however, offers a greater variety of variables for screening so I think the first thing you should do is visit their site and use their Fund Selector. (http://screen.morningstar.com/FundSelector.html)

I also think you should avoid sector funds. The reason for this is very simple: sector funds are more volatile than broader portfolio funds and we should be working to reduce, not increase, the volatility of our investments. The greater the volatility of our investments, the greater the odds that our long term return will be reduced by what technical types call "variance drag."

Basically, the greater the volatility of your portfolio, the greater the odds that you will one day be hit by a really nasty decline. Recovery from a nasty decline is difficult. Suppose, for instance, that you own a fund that has great potential. But it also has a bad year and declines by 50 percent. Just to get back to your original value, the fund now has to DOUBLE.

That's variance drag.

After that, I wouldn't take Morningstar fund ratings too seriously. Sectors that are doing well tend to have more 4 and 5 star ratings than sectors that are doing poorly. As a result, if you search by screening for ratings, the resulting list will be loaded with the market sector of the month. In a recent examination, for instance, I found that Morningstar rated 34.3 percent of all domestic large-growth stock as 4 or 5 star funds and only 8.7 percent as 1 or 2 star funds. Among domestic large value funds, however, the ratings were reversed. Only 17.6 percent were rated 4 or 5 stars while 20.7 percent were rated 1 or 2 stars.

In the last three years, growth funds did better than value funds. The situation, however, reversed last fall. Since then, value funds have done better than growth funds. If you screened by Morningstar ratings, you'd tend to be over committed to growth funds over value funds.

  

Q. How would a retiree protect himself and his family financially if the US Credit Bubble burst, there was a "hard landing," and the value of the dollar dropped dramatically vis-à-vis foreign currencies like the Euro?

---R.Y., Rochester, NY

  

A.   Here's a list of reasonable steps:

•           Have no debt.

•           Have a diversified investment portfolio that included investments                in TIPS (Treasury Inflation Protected Securities and/or iSavings                Bonds.) The inflation protection will work to offset the loss of                purchasing power due to higher priced imports.

•           Have no impending major replacements or repairs on your house,                household goods, or car(s).

•           Make certain that your house, appliances, and car(s) are as energy                efficient as possible.  

•           If you live in an area where it would be efficient, consider                investing in photovoltaic electric power for your home. It's not                cost-effective today but it could become cost effective in a hurry                if energy prices continue to rise.

•           Be prepared to move down a step on "the processing chain" by being                ready to do more for yourself by, say, cooking and eating more                meals at home, etc.

•           Remember that retirees, more than others, are well positioned to                cope with such changes because most retirees start to reduce their                consumption of goods and services within a few years of retirement.                Young families, on the other hand, face a need to increase their                consumption simply to fulfill the commitment of raising a family.