Investors sometimes ask me: “Wouldn’t it be better to get out of stocks entirely when the market is acting sick, as it is now?” That’s a tempting option. But the record shows that most folks who try to take an all-or-nothing approach to investing in stocks (or equity mutual funds) don’t succeed. After one brilliant timing move, you might think you’ve got “the system” all figured out. Sooner or later, though, you’ll fall into a pattern of buying and selling too soon (or too late). Horror of horrors, you’ll probably discover you would have fared better, over the long haul, if you had simply bought and held.
I’m not opposed to making modest adjustments in your overall portfolio allocation as market conditions change. I call it “trimming around the edges.” Beyond that, however, I believe most investors are better served by altering the types of stocks — and mutual funds — they own over the course of the market cycle, rather than getting 100% into, or out of, equities.
As we speak, it’s impossible to know whether the market will regain its April 2011 highs reasonably soon, or whether that peak will hold well into 2012 (or even longer). However, we do know that Europe’s festering sovereign-debt problems present a serious obstacle to economic growth around the globe. It makes sense, in a climate like this, to dial back the risk you’re taking with your stock mutual funds and ETFs.
Switch to Safer Vessels
One easy way to lower your fund risk is by switching from higher-volatility to lower-volatility funds. “Volatility” is a statistical measure of how much the price of an investment varies, up and down, from its long-term trendline. Financial analysts use several gauges of volatility, but my favorite is called standard deviation. You can look up the volatility of most funds on websites like Yahoo Finance and Morningstar.
Ideally, you’ll want to go with funds that sport better absolute returns than their peers over a three- to five-year period, at a lower standard deviation than other funds with the same investment objective. “High return, low risk” is your mantra.
Among the no-load (no sales charge) funds I’ve recommended, two in particular stand out for their high-return, low-risk profiles. You can trust these sturdy boats to carry you through almost any market storm:
FMI Large Cap
Large-cap “blend” (growth plus value) fund FMI Large Cap (MUTF:FMIHX) is my No. 1 pick for investors who don’t need current income and aren’t planning to touch their money for at least five years.
Performance has been superb, too, with FMIHX beating both the S&P 500 Index and 94% of its rivals over the past five years. But I’m most impressed with the fund’s steadiness: Its five-year standard deviation of 16.3% is lower than both the S&P (18.1%) and the average large-cap blend fund (18.7%). When a mutual fund can trounce the competition and take you on a smoother ride, you’ve got a winner!
Gabelli Equity Income
A close runner-up to FMI Large Cap in the performance derby, Gabelli Equity Income (MUTF:GABEX) has topped both the S&P 500 and 95% of its fellow large-cap value funds over the past five years. I recommend the Gabelli fund especially for investors nearing or in retirement, because it tosses off a higher cash yield (1.7% at last glance) than FMIHX.
Like FMI Large Cap, Gabelli Equity Income is a Steady Eddie, with a five-year standard deviation (17.6%) below both the S&P and the fund’s peer group (18.7%). My only beef is that GABEX charges higher management fees than, say, the Vanguard or T. Rowe Price equity-income funds. In recent years, though, the Gabelli fund’s clearly superior performance — after all fees — has kept the cost issue at bay.
What to Do Now
Buy FMIHX and GABEX any time the S&P 500 is quoted at 1,230 or less (the market’s first significant overhead resistance level, dating from late August and early September). Both funds are available fee-free through Fidelity Brokerage, Charles Schwab and TD Ameritrade.
New ETF Alternative
For investors who prefer exchange-traded funds, there’s an exciting new way to bring added safety to your portfolio:
PowerShares S&P 500 Low-Volatility Portfolio
Launched in May 2011, the PowerShares S&P 500 Low-Volatility Portfolio (NYSE:SPLV) owns the 100 lowest-volatility stocks in the S&P 500 index. SPLV boasts a juicy 3.3% yield, making the fund a perfect choice for retirees and other income investors. In addition, the fund’s low expense ratio — 25 cents a year per $100 invested — gives you a powerful edge over actively managed funds. Indeed, you might say SPLV is itself semi-actively managed, since the fund’s holdings are rebalanced quarterly. That way, you’ll always be in the steadiest stocks the market has to offer.
