Ker-plunk.
If your portfolio of individual stocks is anything like mine, that's the sound it's been making throughout most of the summer. Among other things, I own Disney (NYSE:DIS), Sysco, and CSX, all of which are now mired in the red for the year. The mutual funds I hold, on the other hand, are faring relatively well. Indeed, all but one are handily beating my stocks and -- get this -- most continue to show a gain thus far in 2004.
Don't get me wrong: Mutual funds are hardly averse to market downturns. But compared with individual stocks, funds boast a number of built-in advantages when it comes to weathering turbulent times. For starters, any fund worth owning will provide broad-based exposure to the market's various sectors and industries. That's important because if tech picks such as Intel (NASDAQ:INTC) and Microsoft (NASDAQ:MSFT) drag a fund down, a slate of energy names -- ChevronTexaco (NYSE:CVX), ConocoPhillips (NYSE:COP), and ExxonMobil (NYSE:XOM), for example -- may help take up the slack.
Notice, however, the word "may." Diversification is a time-tested strategy, but there's certainly no guarantee it'll work its magic in every scenario. The performance of tech and energy stocks isn't closely correlated, but that's not to say that both areas of the market can't hit the skids at the same time. Sometimes, after all, a falling market just sinks all boats.
OK, real sorry about that mangled metaphor, but here's the payoff: Beyond sector and industry diversification, savvy-but-concerned investors need to take additional steps to fortify their portfolios. I'll be writing about these steps in upcoming columns, and today we'll get things kick-started with two that -- for my money (and yours) -- are perhaps the most critical.
1. Invest internationally
If you're reading this column, chances are good that you're heavily "leveraged" (as the pros like to say) to the U.S. economy. And I'm not just talking about your stock portfolio, either. You can't track their performance on Fool.com, but your house and your job are important parts of your "portfolio," too. And if both are located here in the States, you should carefully consider diversifying into investments that aren't so closely connected to the performance of our domestic economy.
Mutual funds, of course, make investing in foreign markets a cinch. These days, a U.S.-based investor can easily assemble a solid portfolio of international funds that provides battle-tested exposure to foreign firms of all market caps and styles.
To be sure, you have to pick the right funds, and if you're looking for specific recommendations, Champion Funds is just a click away. But however you do your homework, the important thing is to get it done, preferably in this order:
First, determine the international asset allocation you're comfortable with. Second, find the foreign funds that fit your investing timeline and tolerance for risk. Finally, commit to a disciplined program of dollar-cost averaging so you won't somehow "forget" to send a check during the month that HDTV you've been drooling over finally goes on sale. (Look, I'm not saying you shouldn't buy the sucker. Just don't forget to pay yourself first.)
2. Favor value funds
All else being equal, the return your investment generates will be a function not only of time, but also of your entry price. It's true, of course, that the stock market has gone up over the long haul, but it's certainly had its share of dry spells, too. As my colleague Nathan Slaughter recently pointed out, the Dow hit 874 on Dec. 31, 1964, and closed at 875 on Dec. 31, 1981. Pity the poor long-term Dow investor who invested in the benchmark's components at age 50 with plans to withdraw the proceeds and head to the Bahamas on his 67th birthday.
And woe, too, unto long-term types who bought Cubes (AMEX:QQQ) -- the ETF that rises and falls with the Nasdaq 100 -- near the market's peak in early 2000. Those poor souls have a long way to go before they'll see their principle again, let alone a positive return on their investment.
That cautionary tale in particular illustrates why paying close attention to price multiples -- you know, such things as price-to-cash-flow, price-to-book, and good ol' price-to-earnings -- should be at the top of your investing to-do list. It's also why I'm a big fan of fund managers who do that homework for you.
Indeed, I'm especially fond of those (such as Charlie Dreifus of the now-closed Royce Special Equity fund) who look to buy stock at a discount to a company's "enterprise value." That's the amount an informed investor would pay if she wanted to buy the entire firm, and when you (or your fund manager) "buy low" relative to that figure, you increase your chances of "selling high." You also build in a bit of a price cushion. If everything starts to go to hell in the proverbial handbasket, you won't have quite as far to fall -- at least relative to racy growth vehicles.
That said, all but the most conservative investors will want some exposure to growth fare, and down markets can provide wonderful opportunities to snap it up. With that in mind, I'll explain in my next column why some of the fund universe's brightest prospects currently reside at the bottom of the year's performance tables.
Shannon Zimmerman, editor and analyst for Motley Fool Champion Funds, aims to find tomorrow's winners today. Click here to take a free trial of his newsletter. Shannon doesn't own shares of any stocks mentioned. The Motley Fool has a disclosure policy.
