Mutual fund madness.
The dizzying array of mutual funds available today can intimidate even sophisticated investors. Last year, 2,000 new mutual funds were introduced, bringing the total to more than 8,000 funds.
Don't despair, even if you're a novice investor. It's still possible start with as little as $100 and begin with just one fund, if that's all you can afford.
First you must sort through the terminology. The terms "load" and "no-load," which intimidated me when I first started investing, have become largely meaningless today.
The term "load" was once used to refer to a fund sold by a broker who got a commission. A "no-load" fund was sold directly, without a commission.
But that distinction has become blurred. Today, many load funds spread the broker's commission over a number of years. That means you pay it gradually rather than shelling out an up-front fee. And many former no-load groups, most notably Fidelity Investments, tack up-front loads onto their funds, even though they offer no advice.
So how should you choose between the two? For one thing, you can eliminate performance as part of your decision making process. Any number of studies have shown that there's no difference in performance between the two groups.
Morningstar Mutual Funds compared load and no-load funds in a study conducted in mid-1995. Not surprisingly, the study found that load funds had higher annual expenses - 1.62 percent of assets, compared with 1.11 percent for no-load funds.
Load funds, on average, also invested more aggressively. And, as expected, when performance was adjusted for the load, load funds trailed in performance in the early years. Here are the results, with the performance of the load funds adjusted to take the commission into account:
No-Load Load Funds Adjusted
1 year 14.05 8.77 3 year 10.90 8.83 5 year 10.78 9.83 10 year 12.13 12.14
It seems clear that no-load funds are a better option for investors who can do their own research. And that's not as difficult as you might think.
Start by putting together a list of funds, paying attention to the asset classes - or the types of securities - each fund buys and to its management style. Ignore what the fund calls itself.
Most investors should have at least one fund that invests in large U.S. companies. These stocks had a tremendous runup in the first half of this year when the Standard & Poor's Index of 500 stocks gained more than 20 percent.
If you have sufficient assets, you should divide them between a manager who uses a value approach to picking stocks and one who uses a growth approach.
Value managers look for undervalued securities. Growth managers look for companies on the fast track, hoping that earning growth will send stock prices soaring. These two management styles perform well in different investment environments.
But if you're just starting out as a mutual fund investor, you'll probably want to start with just one fund. Although investment pros say you need three to five funds to diversify properly, everyone must start somewhere.
Even the most intrepid fans of diversification, like Harold Evensky, an investment adviser in Coral Gables, Florida, admit that on occasion they'll recommend a one-fund portfolio.
"There are times when people really don't have the resources to set up a diversified portfolio," Evensky acknowledges. "To tell them they can't invest until they're rich is pretty lousy. We don't want them to just shove their money in the mattress."
There are three types of funds that experts recommend for beginners. The first is a balanced fund, which invests in both stocks and bonds, typically with 60 percent in stocks and 40 percent in bonds.
"We think people should own more than one fund," says A. Michael Lipper, president of Lipper Analytical Services Inc. "But if you think of your first fund as a starter kit, a balanced fund is a good option. It gives you exposure to both stock and bond markets. It's a good training wheel."
One of the oldest funds in this group, and the choice of Jonathan Pond, a Boston financial planner and author of The Money Book, is the Vanguard Wellington Fund.
The second type of fund to consider is an index fund that tracks the S&P 500. Index Funds have low expenses, because there's no need for management. That also makes them a good fund for beginners because there's no manager to monitor.
"With your first fund, you'll want to stake out the main directory - or to buy America - and that means the Standard & Poor's 500 index," Evensky says. "It gives direct ownership in the domestic equity market, and you're not depending on one manager whose style may change or may leave when you're not paying attention."
The third choice for a one-fund portfolio is a global asset allocation fund. The upside is that you get stocks, bonds, real estate, gold, and other securities around the world, providing a truly balanced portfolio. The downside is that virtually none has been able to make a good job of such a complex task.
The outstanding exception is SoGen International, a favorite of Evensky and many other investment professionals. A second possibility is USAA Investment Cornerstone. Although Cornerstone was set up in 1984 primarily as an inflation hedge, it has evolved into a well-rounded player investing in gold, real estate, and U.S. and foreign stocks and bonds.