Forget your typical 401k fund plan — even with professional management, mutual funds can be quite risky. This may be due to the type of strategy, portfolio concentration or simply bad bets.
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As you can see, if your fund drops by 50%, you need to make a heck of a lot more than 50% in profits to become whole!
So with this in mind, mitigating losses are just as important for investors as picking winners. So what are some of bad mutual funds to avoid in your 401k? Let’s take a look at five:
Vanguard Long-Term Treasury Admiral (VUSUX)
Bond funds seem fairly safe – especially when they are chock-full of government securities. What could go wrong?
Well, the bond market has been in the bull-phase for over three decades. In other words, it seems reasonable that there may be a reversal. Moreover, interest rates are at historic lows – and are now starting to get volatile. To top it off, if inflation seeps back into the U.S. economy, then the prices on government bonds will suffer as a result. The impact will be hardest on longer-term securities and related mutual funds.
With this in mind, investors need to be wary of funds like the Vanguard Long-Term Treasury Admiral (MUTF: VUSUX). True, it has a competitive expense ratio at 0.12% and a good management team. But this will mean little if there is a sustained increase in interest rates. Keep in mind that the Vanguard fund has an average maturity of about 13 years. This means that a 1% increase in rates will reduce the portfolio by a whopping 13%.
In fact, this scenario is not far-fetched. Keep in mind that high interest rates wreaked havoc on bond funds throughout much of the 1970s. Protect yourself, and dump VUSUX before you get burned.
Fidelity Freedom Income (FFFAX)
Retirement planning is often complex, requiring careful changes in asset allocation. To help things out, some mutual funds have launched so-called “retirement” funds that handle the details for you.
But be wary. These funds can often be costly and too cautious. The result could be that you fail to reach your retirement goals.
An interesting retirement fund is Fidelity Freedom Income (MUTF: FFFAX). The problem is that no more than 20% of the portfolio can be in equities. While this may appear to be safe, it almost certainly limits your upside. And as the average lifespan continues to increase, there is a realistic fear that a retiree may run out of funds – or if you have expectations of travel or a plush retirement, that your nest egg will not grow fast enough to support your dream.
Prudential Jennison Natural Resources (JNRRX)
For the last decade, commodities have been a tremendous investment. The result is that investors continue to pour large sums into natural resource funds, and that more 401k plans have started offering these options to investors.
While it is a good idea to have exposure to hard assets, there should be some restraint. The fact is that commodities can be quite volatile, as seen in 2008. Also, they have been prone to long-term bear markets. This was the case from 1980 to 2000.
So take a look at the Prudential Jennison Natural Resources Fund (MUTF: JNRRX), a serious fund with $6.4 billion in assets as just one example of a fund of this kind. The return for the past year came to 34.74% — thanks to roughly 50% of its assets in energy and the rest are in mining. Not bad. However, the fund has certainly been a wild ride. In 2008, it lost 52.95% of its value.
The ride down can be just as fast as the ride up in funds like JNRXX. If you own any natural resource funds, you may what to reconsider your holdings before the bottom falls out.
Calvert Income B (CBINX)
The expense ratio is the percentage of the overall costs for a mutual fund. On its face, it looks relatively small. But if it reaches 2% or higher, it can certainly eat into returns. The impact is often the most significant for bond funds, which tend to have lower returns (at least compared to equity funds).
An example is the Calvert Income Fund (MUTF: CBINX), which focuses on intermediate-term bonds. What about it’s expense ratio? It is a hefty 2.10%.
As for returns, they were 4.81% over the past year. But the average annual return was 2.34% over the past three years. Actually, in 2008, there was a 12.71% loss.
When you do the math over the long term on a high-expense fund like Calvert Income, you find that your actual returns aren’t nearly as healthy as they should be thanks to the fees. CBINX is far from the only offender – check your 401k funds to ensure you’re not in one of these high-expense funds.
Putnam Global Health Care A (PHSTX)
Another danger zone for investors is specialized funds. That is, they will focus on a particular industry or even country. The problem is that the volatility can be wrenching. If anything, it can be extremely difficult to time the ups and downs in these funds.
The Putnam Global Health Care (MUTF: PHSTX) is an example. With $1.1 billion in assets, the fund focuses on healthcare companies that have strong growth prospects.
Unfortunately, it has been mostly dead money for the past ten years. During this time, the average annual return was only 1.69%.