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How to Play It “Safe” With Conservative Mutual Funds


How to Play It “Safe” With Conservative Mutual Funds

The following is the tenth of a series of weekly articles in which Sheryl will provide overviews of investment options that offer alternatives to bank accounts. Last week's article covered index funds. As with any investment that's not an insured deposit account, there are risks. Some may feel that these risks are worth it for the chance of higher yields. The focus of these articles will be on conservative investments that may appeal to some savers who want a chance of higher yields and minimal risk.

Some investors aren’t interested in being a homerun champion. They are perfectly content hitting a single, getting on base and just being in the game. For sure they want to win, but they are going to do so without theatrics.

These folks are ideally suited for conservative mutual funds. "There might be a few ways to define a conservative mutual fund, but in my mind, a conservative mutual fund is one that has a significant concentration in fixed income to possibly help minimize risk, and with low turnover that can help minimize trading costs,’ says Kenneth Kim, chief financial strategist at EQIS Capital.

There is typically more emphasis on capital preservation, risk reduction and reliable streams of income. Funds often include large, blue chip dividend paying companies, high credit quality bonds, interest bearing securities and cash equivalents, explains Charlie Smith, founder and manager of the Fort Pitt Capital Total Return Fund.

Here’s a look at some of the places you can go conservative.

Bond Funds

Even when you go conservative there are many options. A bond fund for example, is a grouping of bonds and therefore it is assumed to have the same characteristics as a group of individual bonds would have. However, when interest rates eventually rise, bond prices will decline, as surely as a see-saw works when a greater weight is placed on one side, explains Selwyn Gerber, founding member of RVW Investing.

For individual bonds a rise in interest rates affects value temporarily, because value gets closer and closer to the face amount as the maturity date approaches, and upon maturity, the full par value is redeemed. However, bond funds do not have a maturity date per se, so there is no date by which they can recover to face value. Know too, he says, that in addition, the actual bonds held in the fund may not match the fund description of the bond fund or the expectation of the investor. "Managers have wide discretion about what they actually invest in, as was discovered in the 2008 crash by many bond fund investors," says Gerber.

If you’re interested in investing in bond funds, know the average maturity dates of bonds in the fund, the grades of bonds being purchased in terms of S&P rating, the annual costs of the fund and loads at the time of purchase, advises Gerber.

Growth and Income Funds

There are large company funds that hold many dividend paying stocks. Often these funds will invest in companies that are household names like Coke, Pepsi and Procter & Gamble. Dividend paying stocks tend to be not as volatile as their non-dividend paying growth stocks and may be perceived as being more conservative than stocks taken against the broader index, points out Leonard Wright, a CPA financial planner.

For example, he says, ExxonMobile currently has a dividend rate at over 3%. But it went from $105 down to $90 a share in about 105 days. "So there is risk. But when one looks over the long term, this is not a big deal. For instance about 15 years ago Exxon was about $20 per share. At nearly five times that value today, the dividend on that share price is about 15% -- not bad for a low yielding environment."

Balanced Funds

You can have your cake and eat it too. Balanced funds combine stocks and bonds usually with a 60/40 stock/bond split in the portfolio. "The theory is, and it is a pretty good theory, that stocks and bonds tend to balance each other out. When one category is up, the other is down and vice versa. Adding bonds also reduces the volatility of the funds," says Jeff Bogart, president of Sila Wealth Advisory.

Traditionally, these funds are invested in large domestic companies for both their stock and bond issues.

Low Volatility Funds

"This sounds like a free lunch, but there are no free lunches in life, or investments," says Bogart.

Low volatility funds can be invested in large, medium or small companies, domestically and or internationally. Though differing in name and construction, there is one common theme linking many of these strategies is a focus on stocks with low past volatility. In theory this type of investment should underperform the market.

What You Need to Know

For sure there’s something to be said for "safety. What are some other advantages of investing in conservative mutual funds? While much depends on your mix of investments, "You can expect returns of 3-6% before fees," says Kyle O’Dell.

Another advantage is that these funds can continue to generate streams of income, while preserving capital in volatile markets. "This is especially useful if you depend on periodic withdrawals from your portfolio in retirement and you are concerned about draining your funds sooner than anticipated if there is a bad year in the market," says Smith.

However, there can be some confusion about conservative mutual funds. "Most people buy these funds because they want a predictable rate of return without much risk, but at the end of the day, when the stock market drops, the stock market drops. If the fund has large cap stocks, the mutual fund will probably drop in value when we have our next market correction," says O’Dell.

If interest rates rise, investors in conservative mutual funds with a lot of fixed income might be surprised to see their value fall 10, 20 or even 30%

Simply put, just because a fund has a capital preservation strategy doesn’t make it immune to capital loss. "There are situations when seemingly safe investments, such as investment grade bonds and large cap stocks, can lose value," says Smith.

If interest rates rise, investors in conservative mutual funds with a lot of fixed income might be surprised to see their value fall 10, 20 or even 30%, warns Kim.

Before you invest there’s a checklist of sorts, "What are the overall fees? How does the investment objective align with your particular financial goals? What are the underlying investments? What are the risk metrics of the funds?" points out Diane Bourdo, president of The Humphreys Group.

Evaluate how the fund performed against the benchmark and its peers over the prior 10 years, or whichever period is longest, if less than 10 years. "As boring as this may sound, read the prospectus and see what you’re buying. These have changed over the years and are quite useful. A summary prospectus is quite fascinating to read,’ says Wright.

Remember, points out Ed Vargo, founder of Burning River Advisory Group, "Conservative is in the eye of the beholder. Depending on the age and risk tolerance of the client, a conservative mutual fund might consist entirely of bonds (for older clients) or could be a 60-40 mix of stocks and bonds (for younger clients). There is no way to label a mutual fund ‘conservative’ without having some context."

Editor's Note: To learn more about mutual fund investing, please refer to the following resources: Bogleheads investment philosophy and Clark's Investment Guide.

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Comments
Anonymous
Anonymous   |     |   Comment #1
If you need the money within 5 years there is no "conservative" equity or bond mutual fund that is appropriate to put one's funds in. For long-term investment goals, it all depends on one's risk tolerance. Besides, in most cases a portfolio of a few diversified index exchange traded funds (ETFs) would be preferable over actively managed mutual funds regarding fees, and likely performance. The Vanguard Total Stock Market Index ETF (VTI) and Vanguard Total Bond Market Index ETF (BND) are two of the index ETFs currently in vogue for long-term investors.
Anonymous
Anonymous   |     |   Comment #2
You wrote:
" If interest rates rise, investors in conservative mutual funds with a lot of fixed income might be surprised to see their value fall 10, 20 or even 30% "
NO THANKS for any of the funds suggested above.
Anonymous
Anonymous   |     |   Comment #3
When evaluating the potential risks in the bond market, it is critical to remember why bonds are an integral part of a well-thought-out asset allocation plan:to diversify the risk inherent in the equity markets. The U.S. bond market has never experienced a –20% return. The worst 12-month period for U.S. bonds since 1926 (the 12 months ended September 1974) saw a decline of –13.9%,while the worst 12-month period for U.S. stocks (the 12 months ended June 1932) returned –67.6%.

https://personal.vanguard.com/pdf/s807.pdf
Anonymous
Anonymous   |     |   Comment #6
You can say that again.  I am more interested in a return of my money than a return on my money.
gregk
gregk   |     |   Comment #4
This series has been a good review, useful, and informative, - but probably a definite (and perhaps large) majority of readers here have no tolerance for ANY "capital risk" in making their deployment choices, and thus will immediately pass over ALL of the alternatives presented.  Many of us have anxious visions of potential market meltdowns that could deplete a significant percentage of any funds committed to variable type investments, and while not happy about it, will stubbornly tolerate very low returns (even for long periods) to know that at least the (nominal) dollar we commit now will be there in full to withdraw when the time comes to do so.  The "return rate" or "inflation" risk over time attached to this kind of mindset and behavior is a well known given, but many of us feel we can ride out any value depletion of our assets in that respect, and fear most of all the "big event" that otherwise might evaporate large amounts of what we've painstakingly accumulated for future needs (and to pass along for our heirs).  We're skeptics of happy talk and market mania, - and while very cognizant of the historical record of solid gains in stocks, bonds, and real estate, etc. over the long term. (and even shared in them ourselves when in different circumstances) wonder if the historical conditions that produced them may be in process of converting to something much more ominous or at least more volatile, - and would like to shield ourselves from any maelstrom (though perhaps our "sidelines" strategy won't leave us unaffected by that in some respects either).  All in all though, I myself am committed to CD's and bank deposits exclusively now, not as a paranoid approach but simply as a prudent one in my stage of life.  The American character and economy, while sometimes blind and reckless is also very dynamic and creative, which may lead wealth creation and consumption to take off again here in a new turn up of the spiral (I recall the excitement of being a participant in that during previous cycles).  But I'm dubious.  Many the forces in play seem to have arguably turned pathological (if not quite sinister) in their orientation and thus likely eventually very dysfunctional (elaboration would be required to make this argument persuasive, - but I'm going to leave at just an inchoate impression for now) if not redirected, -  and once a certain inertia sets in any redirection or turnaround becomes more difficult and unlikely before breakdown (and hopefully subsequent renewal).

In any case, give me a good 5 year 3% CD now, and I'd be very happy (PenFed in 2025?) hehe.
gregk
gregk   |     |   Comment #5
(PenFed in 2015?) that is.
Anonymous
Anonymous   |     |   Comment #7
At this stage I also am content with CD's. I do see CD's have been going up slowly at a few credit unions for the last year. The boom and busts of the last 40-50 years have been every 5 to 7 years. At the beginning of this recession it was stated in many articles that I read that they were going to control the interest rates so that it would be a much slower and hopefully sustainable recovery. It was stated in several articles that it was hard on the citizens with the boom and busts and it would be hard on many with a slower recovery but in the low run it it works it will be best for all if it proved sustainable.
Each of the recoveries have taken longer and have had lower interest rates for CD's when it was over. 
Anonymous
Anonymous   |     |   Comment #8
The mutual bond funds are interest rates sensitive, inflation sensitive, political climate sensitive, S&P ratings sensitive and number of other factors.
If you have guts, buy individual municipal bonds, mutual of ETF bond funds are very risky.
Anonymous
Anonymous   |     |   Comment #10
The funny thing is that all you "safe" investors are the ones who are risking so much by putting money into accounts that earn tiny little rates of 1-2%.........Stop looking at "annual returns" and "APY".......Those were created by con artists in both private and government sector to give over your money and earn these lousy rates. They must laugh at you cowards when they open an account at 1%........You people are easy marks.
Anonymous
Anonymous   |     |   Comment #11
Even when you factor in major crashes.......The stock market still earns great returns when compared to bank accounts and CD's. So stop being little mice afraid of your own shadow and take a little risk. You are getting nothing from bank accounts anyway.
Anonymous
Anonymous   |     |   Comment #12
Tell that to those retirees who live in fear of going through another collapse on the scale of 2008 when global stock markets lost 40% to 60% of their value. Many don’t have the time left to watch their investments get back to where they were. They are not "cowards" by any means. Just realistic.
Anonymous
Anonymous   |     |   Comment #13
Your analysis is typical nonsense. You make a bunch of negative, insulting statements without knowing one thing about the audience. This is a familiar hustle that doesn't work with folks in their 60's and 70's sitting on a pile of hard-earned cash. You'd be surprised how many folks on this site have million dollar piles!
Anonymous
Anonymous   |     |   Comment #14
Comment #13 was a reply to #10 and #11
Anonymous
Anonymous   |     |   Comment #15
Thank you for the clarification.