Jan 30, 2004

Newsletter #81

Mutual Fund Research Newsletter

http://funds-newsletter.com
© 2004 Tom Madell, Ph.D.

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Dear Subscriber:

With Jan. 2004 now history, once again the majority (16 out of 25) of our 1st Qtr. 2004 stock and bond fund picks posted Dec. 30th are beating the funds we use as their respective benchmarks year-to-date. And not a single one of our funds is showing a negative return for the young year!

Note: Benchmark funds for these comparisons are the Vanguard 500 Index and the Vanguard Total Bond Market Index, both tough indexes to beat due to their low expenses.

Sticking near the percentages for those fund categories shown at the above link, our advice to remain 60% invested in stock funds and 35% in bond funds has been a good strategy so far this year. Both stocks and bonds have performed fairly well with stocks, however, doing somewhat better. Although the year is still early, we think that a similar pattern will likely continue.

Continued thanks for your confidence in us and in letting others who might value our service know about us, including other websites that might be interested in showing our link to their readers.

Sincerely,

Tom Madell, PhD
Publisher

Contents:

-Main Article
-Fidelity Funds, Rising Interest Rates, and more

Are You Putting Too Much Faith in Your Fund Manager and Your Tolerance for Downturns?

When handling my own investments, it seems natural to try to achieve the best returns possible, or even more potentially crucial, to make sure I avoid long-term losses. But, in reality, most fund investors, it seems, are relying largely on their fund managers to do these things for them. How so? As one of your fellow readers astutely points out: "Fund managers are responsible, and compensated, for being fully invested in promising companies." He goes on to observe that most people just don't have the time or knowledge to further oversee their investments, thus predisposing them to sometimes suffer thru long downturns when they occur, such as during 2000 to early 2003, without any real "defense" against these losses.

The above is certainly true: Most people don't feel up to the task when it comes to making changes in their portfolio; their understanding of the changing factors that either help or hinder fund performance is too minimal to give them much confidence in doing that. Given this fact, most people tend toward a type of buy and hold by default.

But here's one place where psychology comes in: Research shows that buying is more active when people are the most confident - and that confidence is largely determined by past returns. Thus, investors tend to buy more when "the lights are green." And likewise, while most people like to think that they will maintain "buy and hold" no matter what, when things within the market have become bad enough, they are much more likely to abandon that discipline and sell - that is, they begin acting to "protect" themselves when the lights are already red rather than beginning after the lights have turned yellow.

So, my point is that the outcome achieved by most investors is nowhere near as good as "genuine" buy and hold; their actions promote a degradation of what they could get with an even (or better still, a reduced) flow of buying during the "green" periods and no, or minimal, selling (or better still, somewhat increased buying) during the "red" periods.

If you count on your fund manager to protect you from a long downdraft, you probaby don't recognize that only you can fully take charge of the bad things that can happen to investors. And relying on your own fortitude to ride out long periods of fund category underperformance may go against the fears we almost all have of losing far more than we can afford to. (If you were one of those who entirely sat thru the aforementioned bear market without selling a single thing when prices were low, then you are certainly a rare exception to the rule!)

It would be highly unrealistic for anyone to think that they can change the sometimes flawed, yet recurrent fundamental ways that most fund investors invest. All that one can hope to do is perhaps capture the attention of a small number of people and hopefully help them to avoid the risks of unconsciously following the above patterns. So that's why the true experts say you will generally do better by buying more when funds are beaten down, selling a little when you have made some big profits, and otherwise, doing nothing, even in the face of extreme selloffs.

More Questions and Answers

The answers to the following questions will hopefully help you further evaluate the current investment climate and the information found on this site.

Q. Will you at some time include more Fidelity funds in your recommended portfolio's. A lot of people use Fidelity for their investments including myself.

A. I have perhaps not been as entirely clear on our overall approach to advising readers as I should have been, although I have tried many times to make the following point: You can get the most out of my recommendations by investing in the categories of funds I recommend, not necessarily the exact funds I discuss or those in my Model Portfolios.

My research is primarily about which areas within the stock and bond markets seem to be best suited for doing well over the next year or even several years. The specific funds I suggest are not based on an exhaustive search of all funds and families, but rather those funds that I myself have come to learn about and value. Many also tend to be some of the lowest cost funds available.

So, I suggest that if for whatever reason you are tied to a particular fund family (such as for example, these funds are featured in your 401k), you focus mainly on the fund categories I recommend and look for similar category funds within your choices available.

Our most recent stock category preferences suggest making one's largest allocations to Large Growth and Foreign stock funds. Fidelity has at least several such funds that have performed relatively well recently, including Fidelity Blue Chip Growth Fund, Fidelity Large Cap Stock Fund, Fidelity International Growth & Income, and Fidelity Diversified International. Although I have occasionally and still do recommended some of Fidelity's funds, such as Low Price Stock and Contrafund, I am not equipped to do exhaustive searches for funds - each reader should choose within his own limits.

If you don't already invest in a fund family that I recommend, perhaps you might want consider starting your own new acct. in that fund as your own financial situation allows. A reader recently told me he only invests in Vanguard, but I urged him that he might want to consider Fid. Low Price Stock for his small cap funds: now he is quite glad he did go to that fund. (Unfortunately if you arent a current investor, the fund just closed to new investors.) I frequently have had to make such jumps because even big families such as Vanguard or Fidelity dont have the type of fund that my research suggest will do well.

Q. Rising Rates If you look at the recent history of the prime rate, you will see that rates dropped severely from 2001-2002. If just the inverse happened in 2004-2005 (from 4% to 9%, a 5% rise) bond funds with a duration of 5 years would lose 25%? If this happened... at what point would your system indicate reallocation ?

A. The chance of rates rising 5% in 1 yr. are almost 0; the rate drop you speak of was over several years. If rates go up even 1 or 2%, I would think it would create a big problem for the Republican administration this election year. They will do all they have within their power to keep rates close to steady.

As far as my "system", it is hard to say in advance because I consider many variables (and I'm not sure I really would characterize my work as being a type of "system"). But as rates showed a rise for a period of say over 6 mos, and returns started dropping over that period, I would start to see signs that the positive trend we've basically been in are reversing. And once a full year of a negative trend was in place, I would definitely be turning quite negative. So, my work would not likely enable you to get out before losing some of your gains, assuming you didnt just get in this year. I do not believe it possible to jump in and out quickly since there are too many false starts to the downside which might reverse after you tried to get out and it proved to be only a temporary setback.

Q. Why this site? Today, I became a free subscriber to your newsletter. I also read on your site your plea for more free subscribers. Can u tell me how more free subscribers can help to keep your letter alive and well?

A. I guess the point of your question is if I don't make money when someone subscribes, then what difference should it make. The answer is that there is a reason for everything that someone does - my reason for publishing is 1) to get some satisfaction that my knowledge is helpful to others & 2) if so, to see what opportunities my writing might lead to. If there is, however, what I sense to be too little interest in what I spending a lot of hrs. working on, I likely won't continue. But lately my no. of readers has been approaching 100 people per day or 3000 per mo., which shows that more people seem to be not only finding this site, but finding it worthwhile.

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