Mauled by mean mutual funds, what's the poor investor to do?

Your Funds

Dollars & Sense

February 02, 2003|By CHARES JAFFE

STEVE from Suquamish, Wash., is fed up with his mutual funds. They've lost too much money. He can't bear them any more.

"I'm through with mutual funds," he wrote in a recent e-mail. "What are the alternatives? What should I replace my funds with?"

Steve, who declined to give his last name, is far from alone in wanting to abandon funds, particularly stock mutual funds. Investors pulled more than $25 billion from stock funds during 2002. Money market funds, which have been posting wretched returns due to the historic decline in interest rates, also saw net outflows.

But Steve's question has two possible answers. And both are worth examining for the frustrated fund investor, a description that applies to almost everyone these days.

First, there is the literal interpretation of Steve's question. If he gives up on funds, where would he put his money? On the stock front, he could buy individual issues or construct a "folio," essentially a personalized mutual fund where the investor makes all management decisions. (See www.folioFN.com for information.) Exchange-traded funds - basically an index mutual fund that trades as if it were a stock - are another option, although Steve's "no funds" prohibition might knock them out. The same goes for variable annuities, which combine an insurance product with traditional mutual funds.

If Steve has enough money, he can pursue a "managed account," where a money manager essentially builds and manages a portfolio of stocks and bonds on his behalf. It'll act something like a mutual fund, even if it isn't.

On the bond side, Steve could move to individual bonds rather than bond funds. For the most common types of bonds, such as Treasuries, this can be a great alternative. Holding the paper allows an investor to know what their precise return will be.

But if Steve doesn't have much experience with bonds, he'll need to learn a lot before he takes on the tough sledding of junk or corporate bonds on his own.

Steve also could avoid the issue altogether and move into cash, as it hardly takes a chartered financial analyst's credential to buy a certificate of deposit.

"He can change everything he owns, but that doesn't mean he changes the problem," says Stephen M. Savage, editor of the No-Load Fund Analyst newsletter. "He's assigning blame for his poor performance to the structure of the investment vehicle, when that structure is pretty much irrelevant to the performance he has had."

A Standard & Poor's 500 index fund would have roughly the same performance as a folio based on the index, as well as the Standard & Poor's Depositary Receipt, which is an exchanged-traded fund nicknamed a "spider."

If Steve is fed up with last year's 20-plus percent loss in the traditional index fund, the identical loss in a folio or spider won't make him feel better.

Which brings up the second answer to Steve's how-to-replace-funds question: Getting rid of funds, as an investment type, is less important than changing the asset allocation to something more palatable.

"Someone who wants out has suffered a lot of pain in their current portfolio," says Roy Weitz, who runs FundAlarm.com, which helps investors decide when a fund deserves to be sold. "They don't need to throw out everything as much as they need to reconsider where their money is going."

While a panicky investor can move to the sidelines until he or she is confident in the market, specialists warn against it. The person who is nervous about a loss today is often just as worried they'll miss out on tomorrow's rebound; they pay the transaction costs for moving the money around but their long-term performance doesn't benefit from their moves.

Instead, nervous investors need to re-examine their holdings. Stock market losses are likely to have made portfolios more conservative, shrinking stock fund allocations so that someone who split their money 50-50 between stocks and bonds a year ago is now closer to 40 percent stocks and 60 percent bonds.

That more conservative approach may be appealing as the market struggles to rebound. But investors will find comfort more in their asset allocation than in the type of asset - fund, stock, bond. etc. - in which they invest.

"People shouldn't give up on funds," says Savage, "they should give up on chasing perceived performance promises that never panned out. They should be giving up on the poorly informed decisions they made a few years ago based on hope, and they should try to make sound decisions that make sense for the long haul. And they can do that with or without funds.

"If someone who is fed up with their funds today would feel a lot better if the next bull market started tomorrow, they need to realize that the problem is not with funds but with the market."

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

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