Five Funds for Smoother Sailing
It's getting bumpy out there. It's not just that the market has fallen 7.3% from the time it set its record high on July 19 through August 3. The ups, as well as the downs, are sharper -- with the Dow Jones industrials often rising or falling 200 points or more in a single day.
Rising volatility isn't a predictor of the market's direction. And the reason it feels so rocky lately is largely because the market has been remarkably placid during the past five years. Since the current bull market began in October 2002, the market has chalked up its longest stretch ever without so much as a 10% dip. Stocks have endured numerous periods with more thrills and spills than today. Stocks were twice as volatile, for instance, during the 1998 credit crunch after Russia defaulted on its loans.
But the question for you, the investor, is whether this new level of volatility is keeping you up at night. If you can't handle the way the stock market is behaving, you probably had too high a percentage of your money in stocks and stock funds to begin with. If so, dial back your risk now -- and keep it lower. After all, the market has barely been nicked so far. Standard & Poor's 500-stock index has still nearly doubled since the start of the bull market. If you plan to take some chips off the table, this is an ideal time to do it.
How to cut your risk if you don't want to raise cash? Trade in some of your higher-risk funds for low-risk substitutes. Here are five funds that each get the job down superbly. All are substantially less volatile than the S&P 500, and none lost more than 8% in the 2000-02 bear market -- compared with a 47% loss for the S&P. (Don't expect that kind of great bear market performance relative to the S&P this time; no sector is remotely as overpriced as tech and telecom were in 2000.)
All five of these funds boast low expense ratios: None charges more than 1% annually, and all but one charge 0.73% or less. Only one fund has a management team that has been in place for less than five years. Finally, while only two funds have beaten the S&P during the current bull market, none has lagged it by a considerable margin, except for one especially low-risk fund. I've listed the funds from highest risk to lowest risk.
The Low-Risk Five
T. Rowe Price Equity Income (PRFDX). Brian Rogers is chairman and chief investment officer of T. Rowe Price, but he spends most of his time managing Equity Income, just as he has for the past 22 years. He looks for stocks of large companies with healthy dividend yields that are trading at the low end of their historical valuations but have the strength to bounce back. The fund has returned an annualized 14% over the past five years through August 6 -- an average of more than one percentage point per year better than the S&P. This is a classic, low-risk blue-chip stock fund.
T. Rowe Price Capital Appreciation (PRWCX). At most fund firms, a manager change is at least a signal to watch carefully and often a warning to sell. Not at T. Rowe Price, where the corporate culture is collaborative and the firm's top officials rarely make a mistake in picking a fund manager. David Giroux was named co-manager of Capital Appreciation just a year ago and became solo manager in June, but he had been a T. Rowe analyst for seven years. He impresses me as a solid manager who likes to play it safe. The fund typically has about two-thirds of assets in stocks. It looks for higher dividend yields and cheaper valuations than does T. Rowe Price Equity Income. The rest of Capital Appreciation is in cash, bonds and convertible securities. This fund has also beaten the S&P over the past five years, returning an annualized 14%.
Fidelity Puritan (FPURX). This fund is less risky still. Stephen Petersen has been lead manager here since 2000, and he has run Fidelity Equity-Income since 1996. Puritan invests mainly in stocks of large companies and high-quality bonds. It has returned an annualized 11.5% over the past five years -- just 1.5 percentage points per year, on average, behind the S&P. But this fund has more than one-third of assets in bonds. Like Rogers and Giroux, Petersen likes to buy stocks when they're out of favor -- and cheap.
Vanguard Wellington (VWELX). A smidgen less risky than Puritan, Wellington is sponsored by Fidelity's archrival. But from an investment standpoint, these funds are kissing cousins. Wellington looks for stocks of large companies with decent fundamentals selling at cheap prices relative to earnings, sales and other metrics. Also like Puritan, this old-fashioned balanced fund typically has one-third of assets in high-quality bonds. Stock manager Ed Bousa has been in place for five years -- and Wellington has run the show here since long before there was a Vanguard. Indeed, the fund was launched during another volatile market, in July 1929. Over the past five years it has returned an annualized 12% -- just one percentage point per year behind the S&P. Expenses are just 0.30% annually. Bousa says Wellington suits "people who want to buy and hold a fund forever."
Bridgeway Balanced (BRBPX). This fund is different from the other four funds in practically every respect. To start with, it's managed using a quantitative approach -- that is, manager Richard Cancelmo and colleagues continually refine sophisticated computer programs to pick stocks. Then they largely sit back and watch. This fund is designed to be no more than 40% as volatile as the S&P. In other words, if the S&P falls 10%, Bridgeway Balanced's manager doesn't want it to lose more than 4%. The fund uses put and call options in addition to buying stocks.
Over the past five years, the fund has returned an annualized 8%. That's not world-beating performance, but it's a heck of a lot better than earning 40% of the return of the S&P, which would total just 5% annualized. I think Bridgeway is a first-class fund firm, and here it shows it can deliver with a low-risk fund. Expenses are the highest of the five funds, at 0.94% a year.
Steven T. Goldberg (bio) is an investment adviser and freelance writer.