Let me put in a word for balance. Don't sell all stocks and equity funds. Don't stuff your mattress with cash. Instead, turn indecision and confusion into an art form.
Own stocks and bonds. Let someone else make the selections. Invest in a balanced mutual fund--- now called a "hybrid" by Morningstar--- and 'fugetaboutit.'
My case for balance has three parts: history, risk, and potential.
Let's start with history. Anyone who thinks we're rational, risk/reward measuring investors should pick up a copy of the Mutual Fund Fact Book for 2002. The paperback book, published annually by the Investment Company Institute, provides a broad history of our investing habits. It shows, for instance, that we were so beat up by the 1973-1974 market crash that we had more money in bond funds than in equity funds from 1985 through 1991. During that period large equities returned 18.1 percent a year.
From 1992 through 2000, we poured money into equities. Net new cash to equity funds totaled a stunning $1.3 trillion. That was 10 times the $126 billion that went into bond funds during the same period. Our collective enthusiasm for equities was so strong that in 1999 and 2000 we sold $54 billion in bond funds and $44 billion in hybrid funds to raise cash.
What did we do with that $98 billion? We put it all on the fast horses. It was a warning: greed had the upper hand. Caution was nowhere in sight.
Mix stocks and bonds and risk is reduced. Over the last 15 years Morningstar figures show the average equity fund provided a return of 10.38 percent, annualized. Risk, as measured by volatility, was a standard deviation of 21.61 percent. Invest in the average balanced fund over the same period and your return was 8.80 percent. But your risk was half as much, 10.27 percent.
You got 85 percent of the return with less than half of the risk.
Equity zealots will argue that the higher long-term return on stocks is worth the additional risk. I disagree. To get the coveted long-term return on common stocks you have to survive the down periods. You can't be scared into selling out. You raise the odds of holding through thick and thin by reducing the volatility of your investments.
Finally, there is potential. While the average hybrid fund trails the average equity fund, a small number have been able to beat the average equity fund--- but with half the risk.
Using the Morningstar database, I found eight balanced funds that have superior records extending back 20 years. Four are no-load funds and four are broker distributed load funds. Whatever your choice of distribution channels, these funds show it is possible to reduce risk without reducing return.
Will this superiority continue in the future? No one knows. But even if these funds lose their edge and revert to merely average balanced funds, they'll provide a better mix of risk and reward than going 'whole hog' for equities.
|Finding A Good Balance|
|All figures are annualized returns and assume tax-deferred reinvestment of all dividend and capital gain distributions. Bold figures represent the best of the eight funds for each period; italic figures represent the worst performance of the eight funds for each period.|
|Fund||3 years||5 years||10 years||15 years||20 years|
|American Balanced A||7.19||10.25||11.77||11.31||13.80|
|American Income A||5.46||8.58||11.17||11.07||13.75|
|Dodge & Cox Balanced||9.97||11.72||13.28||12.34||14.73|
|Mairs & Powers Balanced||4.68||9.79||11.91||11.31||13.65|
|MFS Total Return A||6.17||9.13||11.15||10.76||13.88|
|Van Kampen Equity-Income A||8.58||11.61||13.69||11.75||14.37|
|Vanguard 500 Index (Benchmark)||-5.26||6.09||11.99||11.61||14.93|
|Source: Morningstar, period ending 5/31/02|