Use `fun money,' try for oomph, even if less than 100% a year

Your Funds

Dollars & Sense

January 16, 2000|By Charles Jaffe

RECENTLY, I received a bevy of letters asking for a list of funds that gained 100 percent in 1999. A few other readers opted for a more conservative, long-term view, preferring to see funds that have gained 300 percent over the last three years.

Apparently, what went haywire with the arrival of 2000 was investor expectations.

I don't give out financial candy like hot-funds lists. That said, you're probably expecting the rest of this column to be a sermon preaching patience and caution.

But you don't need that kind of reminder. Instead, let's examine why expectations are wacky and consider the right way to actually join in the madness.

Well over 100 mutual funds finished 1999 with returns of more than 100 percent. In the preceding 25 years, the highest number of funds to top the century mark in a year was eight in 1998. Heck, four times that many funds (32) had gains above 200 percent in 1999.

Most members of the Century Club were focused in a few investment areas (Internet and tech companies, small-cap, and/or international stocks), but a lot of funds that constitute "core holdings" -- the growth-and- income funds of the world -- put up impressive 30 percent-plus numbers, too.

That's what's making some investors slap-happy.

Fund industry pundits say this is a fluke, that investors should banish the hope it can be duplicated.

Of course, these stubborn soothsayers have been wrong before, like for most of the 1990s. Industry leaders have been crying bear (as in bear market), advocating prudence and dampening expectations. Had you listened to the "fund experts" at the start of the 1990s, you might have missed much of the greatest bull markets in history.

While you've been warned for years against surfing the performance charts, most notably in this column, it's OK to take a chance on "the next great fund," so long as you keep things in perspective.

Taking a flier with a bit of your money, the small portion allocated for high-risk investments, is a lot different than moving your core holdings from solid funds into hot tickets. In fact, most of 1999's big winners were funds designed to add oomph to a portfolio, rather than to be its foundation.

Using some "fun money" to try for some oomph is OK, so long as your entire savings and investment plans are not based on capturing huge returns.

"People shouldn't lose sight of the fact that the goal is not to get the funds that went up 300 percent over the last three years, but to buy the funds that go up 300 percent over the next three years," says Mark Riepe of the Schwab Center for Investment Research. "Finding those funds is nearly impossible. If you want to carve out a little of your portfolio to try, that's fine, just don't deviate from a diversified base of holdings to protect you."

If you are looking at the year-end performance charts and searching for something on which to roll the dice, add three questions to your normal selection process:

How much of my money would I have put into this fund a year ago? This is important for all of the one-year, one-hit wonders in the Century Club. Truth be told, a year ago, the vast majority of investors might have gravitated toward technology, but they were hardly dumping big chunks of cash into Japan or some of the other markets that produced big returns.

If the investment made little or no sense to you a year ago, before the big returns, you could be letting your gut feelings be overwhelmed by the siren song of recent past performance.

What did the manager do to make this happen? If you believe the fund got hot mostly because it was the right time for the assets it buys, then consider the fact that every 24 hours the world turns over on someone who is sitting atop it. That time is coming for the 1999 Century Club members, too.

How are you going to feel if the joyride ends suddenly? Specialized funds, 1999's big winners, carry huge potential volatility.

A fund that can produce a 200 percent return when the Nasdaq composite is up 80-plus percent is likely to be pretty badly hurt when the Nasdaq gets crunched.

When you consider the potential downside of these funds, the need to limit these holdings to 15 percent or less of your portfolio becomes obvious. You may even decide to hold back further, because it won't feel like "fun money" if you lose it.

"I wouldn't risk my financial future on a bet that things really are different and that these kinds of returns will stick around indefinitely," says Clay Singleton, a vice president at Ibbotson Associates, the Chicago investment research firm, "and I wouldn't change my long-term expectations for the stock market. But in many financial plans there is room for taking a little bit of money and hoping to get lucky with it."

Charles A. Jaffe is mutual funds columnist at the Boston Globe. He can be reached by e-mail at or at the Boston Globe, Box 2378, Boston, Mass. 02107-2378.

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