Money Matters: In some ways, investing is like cooking

By Dana R. Consler The Daily Record Newswire Mid-year is an excellent time to look at recent mutual fund performance and focus on what the numbers reveal. Mutual funds are how most Americans invest, either directly or through 401(k) and 403(b) plans at work. Sadly, many investors do not fully understand the funds they own (the ingredients), how to mix them together (the recipe) or how to evaluate their performance (how long to cook). The table below shows performance for the five-year period ended June 30 from Lipper. All returns are annually compounded and net of all fund fees and expenses. Five years includes the severe bear market from October 2007 to March 2009 and the tremendous bull market of the last 27 months. Over this period the growth style beat the value style and small and mid cap stocks have outperformed large-cap stocks. Large Cap Core funds 2.4% Mid Cap Core funds 4.7% Small Cap Core funds 4.0% Multi Cap Core funds 3.0% S & P 500 Index funds 2.4% S & P 500 Index 2.9% Here you see the average results for four categories of stock funds compared to the S&P 500 Index itself, a proxy for the broad U. S. stock market. These categories are for large, mid and small capitalization core funds and multi cap core funds. Core funds are those that blend together the growth and value styles of stock picking. Multi cap core funds buy a mix of small, mid and large company stocks. The fifth category is S&P 500 index funds, which try to replicate the index return by owning all 500 stocks in the index. Index funds are passively managed because they don't try to beat the stock market. All other types of mutual funds are actively managed; beating the stock market is their objective. Rule #1: You should never allocate all your money to either the growth or value styles because they go in and out of favor. For the previous five-year period, June 30, 2001 to June 30, 2006, the value style outperformed growth, just the opposite of the most recent five years. Rule #2: Neither should you invest all your money in only large, mid or small capitalization stocks. These two rules hold true whether you're talking about stock mutual funds or money managers. Eating only pizza, chocolate and beer might taste good for a while, but would become unhealthy. It's no different in structuring stock portfolios to perform well. Diversity across the growth and value styles and all capitalization ranges to avoid indigestion. Rule #3: Five years is the shortest time frame you should consider when evaluating investment performance. Ignore media ads or tables of top-performing funds over the last quarter or year. Even three years is too short. Five years covers a stock market cycle and includes both up and down market years. As a long-term investor you should focus on long-term performance, not what's been hot lately. The average large company fund lagged the broad stock market for the last five years. See Rule #2. Investors owning a better diversified blend of stocks of all sizes have an excellent chance of beating the stock market over the long term. Remember, these results are for only the average performing funds of each type. Rule # 4: Active management in the hands of smart managers will beat the market. Note that the average small, mid cap and multi cap managers beat the S&P 500 index and the average index fund over the last five years. Imagine how well you could have done with funds or money managers that were above average! A mix of the growth and value styles and large, medium and small stocks is necessary for investment success. This diversification of styles and capitalizations will reduce portfolio risk, lead to more consistent performance and increase your chances of out-performing the stock market long term. Add international stocks as well for even better diversification. If you follow my four rules, successful investing really is like good cooking. Mix the correct ingredients in the recipe properly, cook for the right amount of time and you will enjoy a tasty meal. ---------- Dana Consler is executive vice president of Karpus Investment Management. Consler can be reached at (585) 586-4680 or email dana@karpus.com. Published: Tue, Jul 19, 2011