Funds That Rev Up Your Portfolio

Just when mutual fund investors thought that things couldn’t get any worse–they did! In 2001, recession and terror attacks rocked the stock market, sending U.S. stock funds to double-digit losses. Large-company growth funds, the ones that led the way in the 1990s bull market, suffered the heaviest losses.

Last year should have been better. The economy recovered, albeit slowly, and Americans were mercifully spared from another catastrophic terrorist atrocity. Yet the stock market–and stock funds–turned in an even worse performance. During 2002, U.S. diversified stock funds lost nearly 23%, according to Morningstar Inc. There was literally no place to hide.

Small got smaller. Even small-cap value funds, which buy small-company stocks that sell at low prices compared to the company’s earnings and had excelled in 2000 and 2001, lost money.

Offshore, off-balance. Foreign stock funds also fell, although their losses were smaller than those of the domestic funds.

Nothing special. Specialty funds holding utility, healthcare, technology, and telecom funds dropped 24% to 43%. Tech funds now have posted three straight years of losses of more than 37%. In fact, if you had $100,000 invested in the average tech fund three years ago, your stake would be worth less than $25,000 today.

BRIGHT SPOTS
Only a few fund categories offered any relief:

Gold continued to gleam. The price of gold rose to nearly $350 per ounce in 2002, up about 20% compared to 2001. That was an indication of the second straight stellar year for precious metals funds, gaining 38%.

Real money. Real estate funds posted a small gain, reflecting continued strength in property values. During the three-year bear market, from 2000 to 2002, real estate funds have produced annualized gains of more than 12%, by far the best of any fund category tracked by Morningstar.

Bonds boomed. For the third straight year, bond funds blossomed while stock funds sagged. Except for junk bonds (which fell as defaults rose), all types of bond funds enjoyed solid gains. Long-term government bond funds returned 9%, bringing the three-year annualized return to more than 11%.

DOWN WITH EARNINGS
Why did stock funds perform so horribly in 2002? Actually, the stock market was holding its own in the first half of the year, with the Dow Jones industrial average near 10,500. Then stocks endured a five-month free fall that saw the Dow dip below 7,500 before rallying a bit in the fourth quarter.

Was this midyear plunge caused by all those reports of corporate book-cooking? “Make no mistake about it, the market abhors uncertainty and the seemingly weekly terrorist alerts and corporate scandals have destabilized investor confi

FUNDS THAT REV UP YOUR PORTFOLIO
dence,” maintains Anthony Ogorek, a financial planner in Williamsville, New York. “However, stock prices fell primarily due to poor earnings, not these more publicized factors.”

Improved earnings, then, could break a three-year losing streak, the first such activity since 1939—1941 at the end of the Great Depression. On the eve of America’s entry into World War II, U.S. stocks had a three-year annualized loss of 7.4%.

By comparison, the annualized loss in the 21st century so far is more than 11%. Stock funds may have reached a point where there’s more upside than downside–assuming no further bad news rattles Wall Street in 2003. “The base is slowly being built for the beginning of a gradual move towards the next bull market,” asserts Jerry Wade, a financial planner in Minneapolis.

On the other side of the equation, bond funds may have reached a peak–Wade suggests that Treasury bonds might be in a “bubble stage.” Bond prices rise when interest rates fall, and rates are now at their lowest levels in decades. If rates inch up, bond prices will fall, as was the case in 1994 and 1999.

With this backdrop, where do you go from here? Do you stick with stock funds, hoping for the long-awaited rebound? Or do you bet on bond funds, which have rewarded investors recently? One guide that can help you make such investment decisions is our list of the top 90 mutual funds, ranked by their one-year average return–all of which have outperformed the S&P 500 in 2002 (see chart). It’ll help you make smart investment moves regardless of your stage in life.

TAKING IT EASIER
After 26 years with the local phone company, working his way up the ranks to a management position, Richard Vaughn of Pasadena, California, took advantage of a buyout offer and retired last year so he could devote more time to his antique car collection. “Not only that, I decided against taking a pension,” says Vaughn, 47. “Instead, I took a lump sum, which I rolled into an IRA.”

Vaughn hopes to let his IRA build until age 591/2, when he can withdraw funds without paying a 10% penalty tax. “I lost money in 2002,” he says, “but my losses were less than the market’s. Over the next 12 years, I think I’ll do better than I would have if I had taken a pension.”

Arnetta Tolley, an investment advisor at the Pasadena office of Edward Jones Investments–a financial services firm based in St. Louis–helped Vaughn put together a diversified portfolio. “About one third is invested in cash and other fixed-income vehicles,” she says. “That includes Lord Abbett Bond-Debenture Fund, which mixes high-quality and investment-grade bonds.” Cited by Morningstar for its “excellent risk-reward profile,” this fund recently yielded nearly 9%.

The other two thirds of Vaughn’s portfolio consists of stock funds, including two Van Kampen growth funds [Enterprise (ACENX) and Emerging Growth (ACEGX)] and Lord Abbett Affiliated (LAFFX), a value fund with a 10-year return of more than 11% per year. “Growth funds have been performing at a negative recently,” says Tolley, “so this may be a good time to pick up quality investments at a low price. Stock prices already reflect bad news, but we think there’s a lot of good news on the horizon: low inflation, low interest rates, and relatively low unemployment.”

Having a balanced portfolio helped Vaughn keep his losses to about 9% last year, compared to the broad U.S. stock market’s 20% drop. He’s poised for a favorable recovery in 2003.

BUILDING UP
Robin Curry also has a long-term approach to investing, but short-term events will have an impact on her goals. “I have a new marriage and a new home,” says Curry, 35, an executive with a family-run construction company in Yorba Linda, California. “We’re investing as much as we can now in an annuity and a regular investment account, besides my company’s retirement plan. If we can earn 8% per year, the money will double every nine years and I’ll have more than three doubles by the time I plan to retire.”

Curry’s portfolio includes growth funds such as MFS Emerging Growth (MFEGX), Transamerica Premier Equity Investor (TEQUX), Oppenheimer Growth (OPIGX), and Janus (JANSX). She also holds value funds such as Alliance Growth & Income (CABDX) and Fidelity Advisor Equity Income (FEIAX), as well as Templeton Foreign (TEMFX).

STARTING OVER
“In my late 40s, I ran into an unfortunate situation,” recalls Dr. Allen Knox. “I went through a divorce, my practice declined–I had to regroup.”

Knox, now 53, found a position as chief dentist for the correctional facilities in Cook County, Illinois, which includes Chicago. “I got my financial affairs in order and I began to invest inside my employer’s 457 retirement plan and on the outside as well,” he says. “I may have to work for another 15 years, or even longer, but I want to be able to retire some day.”

Outside his employer’s plan, Knox invests in George Putnam Fund of Boston (PGEOX), a balanced fund that holds both stocks and bo
nds. Inside his 457 plan, Knox holds pure equity funds such as Putnam Voyager (PVOYX) and Fidelity Magellan (FMAGX).

This year, Knox is thinking about investing in a specialty healthcare fund, a field that is destined for profit growth as baby boomers age and technology advances. Funds under consideration are Putnam Health Sciences (PHSTX) and AIM Global Health Care (GGHCX) (formerly known as GT Global Health Care).

Knox plans to stabilize his finances as the economy recovers. Like thousands of other investors, diversification will serve as the key to future growth.

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