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Note: This article was originally written in 2003. Please visit our Retirement Planning and Investing in Mutual Funds for up-to-date news and information.
Now that we have been brought up to speed on the numerous conservative and kind of stodgy ways to invest for the long term. We discussed bonds and certificates of deposits, and I believe I left you hanging right after the explanation on money market funds. The next step up would be the mutual fund itself.
Mutual Funds are incredibly wonderful creations designed for investors who want to be involved in a equities or stocks but do not have the ability or the time to pick a basket of stocks, research them, and buy them in such as manner as to be protected through diversity, or by merely spreading the risk over a variety of companies.
Mutual Funds come in numerous flavors designed for every investor's stomach for risk. But no matter what, this type of investing, which is highly preferred at the BlueCollarDollar, still requires some rudimentary skills to do it right.
Safe in the land of the mutual fund is often referred to as the index. These, also come in many varieties, all basically designed to do the same thing. Mimic the market that the fund has chosen to mimic. A fund might be chartered (which is a document that directs the investment stategy of the fund manager) to buy the S & P 500, a list of the 500 largest capitalization stocks. In which case, the mutual fund manager, would decide how much of each company the fund will buy (this called weighting and purchase some of each company). It might mimic the Wilshire 5000, or even the total market with some of everything, or a bluechip index, or the Dow 30. In any situation, the fund just follows along without much in the way of additional direction from the manager or his team. For this, there is usually little and sometimes, no charge. Rewards can be good for this type of investing, and Vanguard's John Bogle made himself legendary with his fund, now the largest in the land, even after some rough initial years. he is still out stumping for indexing even now. In a recent speech to New England Pension Consultant's Client Conference he advised his listeners that an all-index market fund was the best way to ensure diversity in any market. But stock picking has come back into fashion, and this is where the road takes many forks.
The next step from a fund designed to index the market is one that is designed to provide income. Now this sounds like a good idea. Investments need to provide income you would think, but these do it in such a way, that the risk is greatly lowered, and therefore, so is the reward. This is a protection move at best, and a fund that is really custom made for the investor who is at the end of their contribution life, and/or in retirement. The manager in this case invests in the preferred stock of companies who usually are rock solid. Preferred stockholders are satisfied first before common stockholders should there be any problems with the company, and the income comes from dividends paid for this loyalty. The stock prices for these types of investments do not follow the overall volatility of the market largely because the investor in this type of security doesn't want appreciation of their money, just income from it.
Balanced funds fit the bill for many types of investors whose risk level is not very high. These funds separate their investments into two categories, preferred stocks and income producing securities .
The BlueCollarDollar believes that if you pay a social security tax, you have invested in a bond fund. This slow moving, slow growth investment should be made part of your mutual fund portfolio, but in small doses if you are young, larger ones if you are older. It is mainly used as protection for your money. Interest rates will fluctuate on bonds adding just ever so much the hint of risk.
It's okay for a fund to hold some bonds for the short term, or even some cash (this is called defensive posturing), but there are plenty of opportunities for fund managers to stay better invested in stocks for protection than bonds.
Growth vs. Value
Growth funds invest in growth stocks. The BlueCollarDollar Glossary of Terms define growth stocks as:
Stock that has shown better-than-average growth in earnings, and is expected to continue to do so through discoveries of additional resources, development of new products or expanding markets. This has made "stock picking" very vogue.
Value managers invest in companies that have earnings, good price to earnings ratios (called P/E's), and whose price is somewhat depressed making it a ...good value!
In a bull market, which is a market whose upside numbers look very good, picking beaten down companies who have fundamentals and earnings and "value" is difficult.
Value has never meant much to most investors who sought growth through investments. Most folks want more than what value can offer, yet they are what is most closely looked at when inflation starts to rear it's ugly head.
The best way to look at these funds is through comparison.
Are value funds where you should be? Maybe. If you have found yourself caught in the hype of a market without limits and growth without boundaries, you might consider looking at some of the value plays in your mutual fund family. Remember that value managers try and find companies that have not done as well in the current or recent markets. These are usually low tech plays, sometimes even no-tech. Some of these companies were bought during depressed periods that have seen sudden resurgence, like in semi-conductors. That particular sector wasn't even a good charitable contribution, but some value managers jumped right in.
If you have seen incredible returns from your investing last year and you seem a little skeptical about what might happen this year as interest rates continue to rise, and inflation is continuing to become a word we use more often, value might be worth a look. If only for a short while, and certainly not for your whole investment strategy.
Next up...Growth and Aggressive Growth