Aggregate Portfolio Risk More Important than Individual Mutual Fund Risk
The Securities and Exchange Commission as well as mutual fund watchdog groups are trying to make mutual fund companies better explain the risks of investing in mutual funds. But even if mutual fund companies bolster their explanations, they may be irrelevant.
Why? Most people own more than one mutual fund. Sure, an individual fund you own might return 45 percent in year one and -80 percent in year two. If an investor owned only that fund, such gyrations--and risk--would be hard to take. But investors often own three or more mutual funds, so if the gyrating fund has shown good, long-term performance, having it in your mutual fund portfolio may be well worth the risk.
Let's say you decided to build a diversified stock mutual fund portfolio in 1984. If you invested 45 percent of your mutual fund portfolio in a big company stock fund, 20 percent in a small company stock fund, 15 percent in an Asian fund, 15 percent in a European fund and 5 percent in an emerging market fund, your annual return would have been about 34 percent through1994. Sure, certain of your funds would have been hammered in certain time periods. This year, emerging markets funds, for example, were down 16.8 percent at the end of the third quarter. But your large company and small company funds would have offset the drops. Your overall performance would have been significantly better than just buying a fund that invests in blue-chip stocks, which would have returned about 28 percent a year at the end of the period.
If you own a diverse portfolio of funds, you can go even further afield, such as investing in theme- or country-specific funds, including those that invest in biotechnology, health, Malaysia or natural resources. The key is having a large percentage of your fund represented by a plain vanilla growth or growth and income fund, which is less volatile.
Bottom line: there are ways of increasing returns while managing the increased risks appropriately.
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