Mutual Fund Trends & Research Newsletter

Contents:

-Overview
-Our Stock vs Bond vs Cash Recommendations
-Our 3rd Quarter Results
-New Recommendations for Funds/Categories
-Don't Rely on Opinions on the Markets: Focus on the Facts

Overview

Once again, as has been true regularly for the last several years, our Model Portfolio outperformed the S&P 500 and the average stock fund in the 3rd Qtr. (Details below). As comforting as that might be, it's hard to be satisfied with an overall negative 8.4% return on our Portfolio for the quarter even though that is only roughly half the loss of many investors.

As we have stated before, our objective is to be long-term winners. And we don't think you can do that without exposing yourself to some risk in the stock market. (In spite of the 2 1/2 year bear market, over the last 10 years, US stocks have still been the best investment category returning about 8%, beating out bonds at about 6%; foreign stocks have returned only about 4%, however.) So stocks should remain a large portion of a long-term portfolio, UNLESS of course, one decides that there is ample evidence that stocks cannot possibly do well over a significant upcoming period of time.

Of course, you can be "safer" by exiting the stock market altogether. We can pretty much be guaranteed a positive return by merely putting all our investments in a money market account. But is this the wise thing to do now?

It has been a relatively winning approach recently, at least over the last 5 years. During that time, an investment in the average domestic stock fund returned approximately -1.6% annualized, as compared to merely keeping it in Vanguard's Prime Money Market which would have returned about +4.75 (annual.).

But there are other choices than just stocks or a money market fund.

The primary other category to choose from is quality bonds which in most cases have handily beat the above two over the last 5 years with average annual. returns in the 5.75 to 6.75 range.

Our Stock vs Bond vs Cash Recommendations for the 4th Qtr

As we have discussed before, many long-term investors will choose to stick to their pre-bear market stock allocations in the hopes that future returns will gradually again favor a heavily weighted traditional stock investment portfolio.

Unfortunately, there are no guarantees this will happen or will happen any time soon. And unless you have nerves of steel, there is always the chance that your resolve may weaken if stocks continue falling. Proceeding with the faith that things will always favor the traditional stock investor has not panned out in the last 5 years, defying almost all predictions. People who modified/diversified their portfolios during this period have been able to hold on to much more of their balances as compared to people who didnt. And people who have been out of the stock market all together during the last 2.5 years have avoided losing money.

With this in mind, we will lower our stock allocation to 45% and increase our bond allocation to 55%

Class	Previous	New
Stocks	50%	45%
Bonds	50	55
Cash	0	0

3rd Qtr Results

Stock Model Portfolio

Summary: Our stock portfolio returned -16.4 during the qtr vs the average diversified stock fund return of -17.5 and S&P 500 return of -17.6 (the latter 2 figures are preliminary.)

Bond Model Portfolio

Fund	Morningstar "Interest Rate Sensitivity"	Previous Allocation	3rd Qtr Total Return	5 Yr Annual. Total Return
Vanguard Short Term Corporate	Low	20%	+2.33%	+6.25%
Vanguard Inflation Protected Securities	Low	30	+7.96	NA
PIMCO Total Return Instit.	Medium	20	+3.47	+8.14
Vanguard High Yield	Medium	20	-3.25	+1.64
American Century International Bond	Not Available	10	+3.56	+3.57

Note: All five year returns shown thru 10-1-02

Summary: Our bond portfolio returned +3.25 during the qtr vs 1.82 (preliminary) for the average taxable bond fund.

New Recommendations for Funds/Categories

One can continue to opt for typical growth, value, or blend stock funds under the assumption that these types of stocks have to rebound sooner or later. In light of current trends, however, we feel that several specialized categories of funds may have the best chance of restoring some positive returns to a portfolio. With that in mind, here is our recommended portfolio considering the current outlook: (We also have a long-term portfolio - see Newsletter 45; this will again be favored if and when the bear market is over.)

Stocks

Fund Category	Recommended Fund	Allocation	5 Yr Annual. Return for this Fund Category	5 Yr Annual. Return for this Particular Fund
Fidelity Contra	Large Blend	10%	-2.52%	+3.59%
Hussman Strategic Growth (Note: see below table)	Mid Cap Blend	10	+0.26	NA
Vanguard Emerging Markets Index	Emerging Markets	20	-9.91	-8.25
T. Rowe Price New Asia	Pacific/Asia ex-Japan	10	-8.57	-6.5 (approx.)
Fidelity Low Priced Stock	Small Cap Value	10	+1.68	+7.25
Vanguard REIT Index	Real Estate	20	+2.77	+3.56
Vanguard Energy	Natural Resources	20	+1.8 (approx.)	-2.70

Five yr returns thru 9-30-02
Note (1-5-04): When we initially published this, we erroneously stated that this fund was only for aggressive investors; however, thanks to input from journalist Eric Troseth, we now recognize that this fund is more conservative than most in its category because it reduces risk when appropriate by using hedging techniques.

Bonds

Fund Category	Recommended Fund	Allocation	5 Yr Annual. Return for this Fund Category	5 Yr Annual. Return for this Particular Fund
Inflation Protected Securities	Vanguard Inflation Protected Securities	25	NA	NA
Interm. Term	PIMCO Total Return Instit	30	+6.38	+8.14
Zero Coupon Bonds	American Century Target Mat 2010	20	NA	+9.9 (approx.)
International Bond	American Century International Bond	25	+4.28	+3.57

Five yr returns thru 9-30-02

Don't Rely on Opinions on the Direction of Markets: Focus on the Facts

Most people rely heavily on opinion, either their own or that provided by friends or "experts" regarding where the markets are headed. And opinions abound everywhere, especially in the media and newsletters like this one. But opinion, while it may originate from fact, is largely subject to the influence of psychology. In other words, opinions boil down to highly subjective judgments.

We think it best not have an strong opinion as to whether the current bear market will continue or reverse. While we believe that the current trend is the best indication of what will transpire in the months, and perhaps even the year or more ahead, we are watching for any new developments that will provide firm data that the downward trend has stopped and maybe even reversed.

Tom Madell, PhD

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