Mutual Funds: The Risk Factor
Should I risk it? People who have virtually doubled their money in the stock market over the past three years are asking whether they should risk their gains to stay in. After all, the Dow industrials index hit its high last summer and is only haltingly making its way back. Emerging market funds, which were supposed to be the bet on the future, have taken a beating. The impact of the unexpected Asian economic crisis on corporate earnings remains a mystery. And which way will rates go? Deflation may push them down, but the economy is still rolling along at 4% annual growth. How is one supposed to assess risk in this confusing environment?
High risk, high gain; low risk, low gain--right? Maybe not. When it comes to mutual funds, at least, it's possible to have low risk and pretty high gain as well. An analysis by the BUSINESS WEEK Mutual Fund Scoreboard, which focuses on risks as well as returns, shows that there are dozens of funds that have lower than average risk but have generated returns of about 19% per year over the past five years. This compares with the five-year average of about 20% for the Standard & Poor's 500-stock index. Bottom line: There are some mutual funds that are consistently low-risk but deliver fairly high returns to investors.
But how? Well, first they forgo the excitement of IPOs. Small-cap growth stocks are suspect as well. And there aren't many international equities in these portfolios. The low-risk funds tend to be packed with big companies that are proven earnings generators. They also have a lot of financial institutions that do well when rates decline. All this adds up to less "oomph" in these funds when the market is up but less "ouch" when the market is falling.
This year is starting out with more economic and financial uncertainty than the previous three or four. The economy is running hot, while inflation is still falling. The "Asian Miracle" is on hold for the moment, but what will be the fallout? A congressional election in the fall could change the balance of power between the two parties in Washington, or not. Throw in El Nino, and risk management becomes the critical art.