Lighten your load

Kiplinger's Personal Finance Magazine,  July, 1998  by Steven T. Goldberg

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It was a particularly taxing spring for mutual fund investors. What with a Schedule D that asked for more information than usual and 1099 forms that sometimes didn't provide enough, taxpayers can be forgiven for raving "nevermore" and vowing to let their accountants take over next year.

We can't hire a tax preparer for you or control the vagaries of congressional legislation to "reform" the tax code. But to the extent that your tax-time headaches are caused by a pileup of investment-related paperwork, we can recommend a midyear cleaning that's guaranteed to lighten the load and clear your head (as well as the surface of your desk).

KICK THE FUND HABIT

A fund here (bought on the recommendation of a colleague at work), a fund there (purchased after you read a magazine article), and pretty soon you're talking about real clutter. For each fund you own there are semiannual and annual reports, newsletters from fund companies, apologias from fund managers--plus those aforementioned 1099s.

If you're just starting out, two mutual funds may be adequate: a money-market fund and a "fund of funds," such as T. Rowe Price Spectrum Growth (800-638-5660), which invests in T. Rowe Price domestic- and foreign-stock funds and charges no expenses except those of the underlying funds.

If you can afford to invest at least $15,000, you might want to skip Spectrum Growth and consider instead a diversified trio: Third Avenue Value (800-443-1021), which buys undervalued stocks of small companies; Harbor Capital Appreciation (800-422-1050), which invests in shares of fast-growing large companies; and a broad-based foreign fund, such as Artisan International (800-344-1770), which invests some of its assets in emerging markets.

With a sizable portfolio, you can smooth out your investments' overall volatility by adding a fund, such as Berger New Generation (800-333-1001), that buys stock in fast-growing small companies; another, such as Clipper (800-776-5033), that invests in undervalued shares of large companies; and a tax-exempt bond fund, such as Vanguard Municipal High-Yield (800-635-1511).

Six stock funds plus a money-market fund will certainly suffice. If, however, you want still more diversification (and there's still room on your desk), you can put small slices of your money into a high-yield bond fund, such as Northeast Investors Trust (800-225-6704), and a real estate fund, such as CGM Realty (800-345-4048).

That's a grand total of nine funds, and nine is enough. While you may choose to make substitutes in the lineup, there's no need to increase the roster.

Note to stock investors: A dozen or so blue chips spread among different industries will give you the full benefit of diversification, says John Markese, president of the American Association of Individual Investors. With small companies, however, there's safety, if not simplicity, in numbers; you may need as many as 35 to 40 stocks to provide enough diversification, says Gerald Perritt, editor and publisher of the Mutual Fund Newsletter.

SELL THE CHAFF

It's easy to cut off your portfolio at a manageable number if you're starting from scratch. But if you've been indulging over the years and are already way over the limit, you'll just have to slim down by selling.

Start by grouping your funds by type, following these category guidelines: money-market funds; each of the four different kinds of domestic-stock funds (small-company growth and value, large-company growth and value); municipal bond funds; and foreign-stock funds. Within each category, pick the one fund that stacks up best according to the following criteria, and chuck the rest. You can find the data you need in Kiplinger's August issue or by calling the funds' toll-free numbers:

LONG-TERM PAST PERFORMANCE. Keep the hind that has performed most consistently well over the past three- and five-year periods.

RISK. Volatility measures how much a fund's returns bounce around from month to month. The less volatile, the better. Kiplinger's simplifies this calculation by rating each fund on a scale of I (least volatile) through 10 (most volatile) based on "standard deviation"--how much a fund's month-to-month returns vary from its average rate of return.

As an alternative, look at a stock fund's performance for 1990, a year in which most stock funds lost money. Funds that held up best are likely to be better bets. (For bond funds, use 1994 as a benchmark.)

MANAGEMENT TENURE. The longer the fund manager has been around, the better. When a fund hires new management, it effectively becomes a brand-new fund with no track record--and therefore a candidate for sale compared with funds whose managers have been around longer and have achieved consistently good returns.

TOTAL ASSETS. The smaller, the better. Other things being equal, smaller funds tend to outperform larger ones because managers can move in and out of the market more nimbly.

EXPENSES. The lower, the better. On average, funds that charge lower fees tend to have higher returns, if only because the fund company takes a smaller cut. That's especially true of bond funds and money-market funds.