Balance lessens panicky selling

The Baltimore Sun

Three of the mutual funds I own that invest mostly in stocks have been particularly easy to keep during market downturns, without any temptation to bail out.

It's no coincidence they also have been my most consistent moneymakers.

The funds are Dodge & Cox Balanced, Oakmark Equity and Income, and T. Rowe Price Capital Appreciation. All three invest in diversified portfolios of stocks and fixed-income securities (and particularly for the T. Rowe Price fund, securities convertible into common stock).

While the usual allocation hovers around 60 percent to 65 percent equities, fund managers can tweak the mix based on their take on market valuations and risks. You should never buy any fund without thoroughly understanding its strategy and risks.

I am writing about these funds because they exemplify a "balanced" or "moderate allocation" category worth considering.

Many financial advisers pooh-pooh these types of funds and argue investors are better off determining their own asset allocation with separate stock and bond funds. But the latest installment of a continuing study of investor behavior bolsters my view that investors rattled by the volatility of stocks are more likely to stay the course with these more conservative funds and, as a result, achieve better returns.

Dalbar Inc., a Boston financial services research firm, has been measuring the effects of investors' decisions to buy, sell and switch into and out of mutual funds since 1984. The key finding has been that the average investor earns significantly less than the return reported by their funds.

(For the 20 years ended Dec. 31, 2006, the average stock fund investor earned a paltry 4.3 average annual compounded return compared with 11.8 percent for the Standard & Poor's 500 index.)

"Investors are motivated by greed and fear, not by sound investment practices," said the 2007 Dalbar Quantitative Analysis of Investor Behavior study. "As markets rise, investors pour cash into mutual funds, and a selling frenzy begins after a decline."

Investors "should learn good practices before learning how to pick a fund," the study said.

Among good practices are staying invested and not selling low, the opposite of what panicky investors do. During the past 20 years, investors have mostly guessed wrong during market declines, selling their funds, only to see their stocks' prices go back up.

That is why I like less volatile balanced and moderate-allocation funds, or, as Dalbar calls them, asset-allocation funds (a category that includes life-cycle and target-retirement funds). By doing their own asset allocation, these funds encourage good behavior by investors, who are holding them an average of 5.2 years, compared with 4.3 years for stock funds.

These funds "have created a comfort zone for investors that protects them from their own errors" of selling in fear, the study said.

As extra protection, I prefer funds like my three that follow a strict risk-averse value discipline and don't chase after hot, pricey stocks.

Bigger losses are, of course, possible with these funds. In the third quarter of 2002, Capital Appreciation fell 7.9 percent, Dodge & Cox Balanced 8.9 percent, and Oakmark Equity and Income 8.6 percent - still considerably less than the 17.3 percent loss the S&P; 500 suffered that quarter.

Besides limiting volatility and losses, all three funds have outperformed the S&P; 500 over lengthy periods, including the past five and 10 years.

Humberto Cruz writes for Tribune Media Services.

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