4:29 AM
Vinay Singh
(Money magazine) -- This is the second part of Money magazine's series on How to make your money safer.
While mutual funds are managed by professionals, these pros are also human beings who make mistakes and come with varying degrees of skill. Time to put them to the test.
Step one: Minimize risks caused by fund managers
Start by screening for funds that beat their average category peers over the past three, five, and 10 years.
Great runs can't always be repeated, but "managers that underperform tend to continue to underperform," says Litman Gregory analyst Jack Chee.
You want funds with a proven track record over long periods. But you must also check to see that the fund's current managers are responsible for that record, so eliminate portfolios with manager tenures of less than 10 years.
To make sure these long stretches of outperformance aren't hiding lousy patches, look for funds that also have beaten their peers in down years.
For instance, ProFunds Ultra-Nasdaq 100 (UOPIX), which seeks to deliver twice the daily performance of the 100 biggest stocks in the Nasdaq index, has beaten 80% or more of its peers over the past three, five, and 10 years. Yet this volatile fund lost around 70% of its value in 2002 and in 2008 -- not ideal for a risk-averse investor.
Step two: Minimize risks caused by the funds
Fund managers have to get paid, and that introduces yet another risk: fee drag.
Fund expenses come straight out of your returns. And while annual fees of 1.5% can sting in a year when your fund posts scant returns, it's the compounding effect of those costs that really eats into your long-term gains.
That's why we demand lower than average fees from all the funds in the MONEY 70, our recommended list of mutual and exchange-traded funds.
Step three: Look for funds that make the most of risk
Finally, "a good screen takes into account how much return you get relative to risk," says Lane Jones, chief investment officer at Evensky & Katz, a wealth management firm.
The fact is, even Steady Eddie funds bounce up and down, exposing you to some risk. That's unavoidable. At the end of the day, though, what you want are stock funds that will compensate you the most for each degree of volatility that they expose you to.
You can screen for this type of efficient risk taking by relying on something called the Sharpe ratio -- a technical measure, developed by the Nobel Prize-winning economist William Sharpe, that compares an investment's returns to its standard deviation. The higher a fund's ratio, the more attractive it is.
Low-risk funds: The results
These seven Steady-Eddie funds have delivered over time.
Buffalo Growth (): Looks for U.S. businesses with global diversification to reduce risk.
- Expense ratio: 0.99%
- 5-year rank*: 22
- Sharpe ratio: 0.80
Fidelity Growth Co. (FDGRX): Its manager beat over 90% of his peers in the past 3, 5, 10, and 15 years.**
- Expense ratio: 0.84%
- 5-year rank: 6
- Sharpe: 1.02
FPA Capital (FPPTX): Seeks stocks with strong balance sheets and low valuations.**
- Expense ratio: 0.84%
- 5-year rank: 9
- Sharpe: 0.75
Harbor Capital Appreciation (HCAIX): A focus on high-quality growth stocks helped it weather recent bears.
- Expense ratio: 1.05%
- 5-year rank: 16
- Sharpe: 0.86
Sequoia (SEQUX): The managers will keep money in cash if they can't find cheap stocks.**
- Expense ratio: 1.00%
- 5-year rank: 1
- Sharpe: 1.40
T. Rowe Price Mid-Cap Growth (RPMGX): Seeks out fast-growing but steady growth companies.**
- Expense ratio: 0.80%
- 5-year rank: 14
- Sharpe: 1.01
Yacktman (YACKX): This value-minded fund has beaten 99% of its peers over past 15 years.
- Expense ratio: 0.80%
- 5-year rank: 1
- Sharpe: 1.27
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