Investing fads come and go, with everyone talking this summer about future technologies and computer stocks. Amid all the market chatter–exchanged over cocktails, overheard on the train, whispered at museums–people who have never put a dime in the stock market start to think about taking the plunge.
But tips on hot sectors do not make sound advice for a first purchase. Constrained by a small budget or restrained by limited financial experience, the beginner needs an all-weather investment, say a broad mutual fund, instead of a risky, high-flying technology stock.
Choosing just one fund, though, can be a bewildering exercise. The $2.5 trillion industry encompasses more than 6,500 funds, ranging from tiny portfolios on a single industry to behemoths that cover all the bases, holding cash, bonds and stocks, both here and abroad.
To narrow the field, mutual fund specialists urge investors to address two questions: How long do you have before you need the money? And how willing are you to manage your portfolio as it grows? The less time you have, the more you need to be concerned about ups and downs in financial markets, and the more conservative you will want to be. The less interested you are in managing your investments, the more you could benefit from an outside adviser or an asset allocation fund, which will make important decisions for you.
Choosing the right mix of assets–cash, bonds or stocks–has proven to be more important to investing success than selecting the best asset in each category, study after study shows.
In any event, invested money should be slated for a purpose, whether retirement in 20 years or a home in three years.
“Your first decision is your time frame,” said Jack Bowers, editor of Fidelity Monitor, an investment newsletter on Fidelity mutual funds published from Rocklin, Calif. “If you need the money in less than three years, you need a different kind of fund than you would for a longer-term commitment.”
In fact, many investment advisers say to stay away from the stock market entirely unless you are willing to lock up your money for three, or perhaps five, years. If you have three years or less, Bowers recommends a short-term bond fund.
If you have more than three years to invest, several advisers suggested a balanced fund, which splits its holdings among all the major asset classes and serves as a mini-portfolio.
“Someone making a first investment in mutual funds needs to get a feel for the marketplace,” said Henry L. Schmelzer, president of the New England Funds in Boston. “They don’t want something too aggressive and risky, and I think a balanced fund is a nice way to go at it.”
Balanced funds come in numerous flavors, but the archetype invests 60 percent in equities and the remainder in high-quality bonds, usually of long maturity to achieve the highest yields. The bonds provide income and act as a buffer against swings in the stock market, while the stocks provide long-term growth.
For an investment of three to eight years, Bowers’ choice is Fidelity Puritan, a balanced fund that invests in stocks, bonds and cash, and that has some foreign holdings. “So it’s very thoroughly diversified,” he said, “and has shown an ability to produce fairly steady returns, even in choppy markets.”
Similar to balanced funds are asset allocation funds, which may make drastic moves in and out of stocks and bonds as conditions shift. A relatively new type of fund, often called life-stage or life-cycle, fits into this category.
Dreyfus splits its Lifetime Portfolios into three pools: growth, growth and income, and income. The growth fund is the most aggressive and has 80 percent of its assets in domestic and foreign stocks. The bond component increases from 20 percent in that portfolio to 50 percent in the growth and income portfolio. The income portfolio has roughly 68 percent in bonds and 10 percent in cash, with 22 percent in stocks.
The income fund is for those who need the money in three to five years, the growth and income version is tailored for 5 to 10 years, and the growth fund for at least 10 years, said Jim Foster, senior vice president of Mellon Equity Associates, the adviser on the Dreyfus funds.
Weiss, Peck & Greer, an institutional money manager in New York, plans to offer a similar series of funds this fall. Buyers will be pointed toward a fund based on their age. The Tomorrow Long-Term Retirement Fund is designed for people 35 or younger, the Medium-Term fund for those 36 to 50, and a Short-Term fund for older people.
Simplicity is the appeal of all these funds, though it’s worth noting that they are too new to have long-term records.
Anyone building a long-term portfolio on his own can do it brick by brick, perhaps first buying a stock fund and then adding other types of funds over the years. For truly long-term investors–those with at least eight years to invest–Bowers reached into his Fidelity bag and chose Fidelity Blue-Chip Growth, a stock fund that aims for long-term capital appreciation and emphasizes large, well-capitalized companies.
Stocks are the only asset that has provided returns significantly greater than taxes and inflation over the years, and time provides protection against stock market downturns.
The Blue Chip fund seeks to outperform the overall market by investing in fast-growing companies.
Gerald Perritt, a money manager in Chicago and the author of “Mutual Funds Made Easy,” recommended T. Rowe Price Spectrum Growth, which invests in other stock funds in the T. Rowe Price family.
“Price in my opinion ranks up there with the best of the fund families,” Perritt said, “and this way you get real diversification with your first purchase.”
Going with a large fund complex, like Fidelity or T. Rowe Price, makes it easy to add funds over time. Several discount brokers, notably Charles Schwab & Co., also allow access to a wide array of funds and funds from many companies.
“You may only have enough money for one fund now, but you’ll have more money in the future,” said A. Michael Lipper, president of Lipper Analytical Service. For a first stock fund, Lipper said, “I would choose one that wasn’t doing particularly well at the moment. Funds that are hot are the most likely to disappoint.”
And what of fears that the stock market is too high? “The market is always too high,” said Perritt. “Forget about where the market is. It’s always a good time to get started.”
