Educational Programming Video
The Value Line Mutual Fund Survey
Program 22: Picking a Fund - Part 1
In our last session, we discussed the three moderate-risk profiles that Value Line recommends. Now, we'll discuss selecting a mutual fund.
Throughout this series, we have stressed the importance of creating a financial plan. Know that your goals, your time frame for meeting those goals and your current financial position are the building blocks from which you start to build a portfolio. They are also important aspects to consider when selecting individual funds. With this in mind, we will examine the medium time horizons/moderate risk portfolio that we created last time.
For this group, Value Line recommends only 12% of assets in cash, 44% in bonds, and 44% in stocks. Thirty six percent of this portfolio is in foreign investments. Within the domestic equity area, large-cap growth funds should make up 8% of this portfolio, large-cap value 7%, and the small-cap growth and value weightings comprise 2% and 3% respectively. Gold and natural resources funds make up about 1% of the portfolio. The foreign equity weighting is 13% and emerging market exposure is 10%.
On the bond side, domestic bonds should comprise 17% of the portfolio; high yield bonds should make up 14%, and foreign bonds 13%. Notice the significant amount of foreign exposure in this portfolio, as well as the focus on large-cap companies. For this type of investor, the cash asset group should be comprised mostly of money market funds. More conservative types can invest in certificates of deposit or plain Jane bank accounts, but money market funds offer a good combination of relatively high interest rates and liquidity.
An investor's risk tolerance level will ultimately determine what fund he or she purchases. For this example portfolio, we will assume that the investor in question is rather middle of the road not leaning drastically in any single direction. Indeed, both stock and bond funds run the gambit from high risk to low risk and each investor needs to figure out what is best for themselves.
Our hypothetical investor doesn't want too much risk, but knows that some risk is necessary. So, the first job is the break the mutual fund universe down to a more manageable size. Since investors obviously want good funds, the first cut is to look at only those funds that receive Value Lines two highest Overall Ranks, either a one or a two. This brings the universe down to a more manageable number, but still leaves us with a significant number of funds to choose from. Keeping in mind that out hypothetical investor has a moderate risk profile, only those funds that score three or above (the three best risk ranks) on Value Line's Risk ranking are selected. Now we have a group of funds that have performed well and are moderate to low risk.
From here, we can start to look at the different asset groups; the first area we will start with is the broad equity group. This is a diverse group that can include anything from an income fund to a high tech offering. So where does out intrepid investor start? With her investment profile.
As was discussed in an earlier session, there are certain stock sectors and fund groups that are more volatile than others. Now our investor should break out each fund into different objective groups (the broad categories, such as Income, Growth and Income, or foreign equity, into which Value Line separates funds). Once this is done, she should screen for funds that have standard deviations (a measure of risk that was discussed at the beginning of this series) that are equal to or lower than its group norm. This will weed out the really volatile funds that don't match up with her moderate-risk profile.
So now we have a more manageable list of funds broken out by different fund groups. The next question is which groups are right for our hypothetical investor? For this example, we'll assume that our investor wants to stick with Growth and Growth and Income funds on the domestic front, we'll look at foreign equity investments later on.
There is, however, still a wide range of funds that fall into the domestic equity category. Remember that the four general areas that need to be filled are large-cap growth and value and small-cap growth and value. Thus, the remaining funds should be broken out into these groups based what the fund's portfolio looks like.
This can be done in a number of ways, the easiest of which is to examine the management style box on The Value Line Mutual Fund Survey page. This places funds across the growth/value and size spectrum. Once the funds are broken down in this way, it is time to start examining each fund's management style.
This important aspect of selecting a fund will be our next topic.