Long-Distance Funds - Page 2 of 6

Long-Distance Funds

85% goal because of Williams’ caution. Now, she plans to move his stock allocation up to that level because she has more confidence in the stock market.

“I probably will add a mid-cap fund, such as Artisan Mid Cap Value (ARTQX) or Meridian Growth (MERDX),” says Williams. “I’m also looking at Ariel (ARGFX), a small-cap fund.” If the economy continues to expand this year, the smaller companies that made it through tough times might post impressive profits.

Keep your balance. Although small- and mid-cap funds have excelled recently, you shouldn’t overexpose your portfolio to those asset classes. “Don’t chase returns,” says Gareth Lyons, an analyst at Morningstar. “Just because an area was hot last year doesn’t mean it will be a leader in 2005. In fact, some of last year’s top funds might take a back seat to large-growth funds this year.”

Lyons’ recommendation is to seek a balance: Most investors should hold bond funds as well as stock funds. Among stock funds, you should have a mix of large- and small-cap, growth and value, and foreign and domestic. “Dollar cost averaging is a sound strategy,” he says, referring to the practice of investing a certain amount each month or each quarter to catch market lows and highs.

Although you shouldn’t chase performance, you shouldn’t ignore the past, either. “It’s very important to look at how funds performed during the bear market in order to get an idea of their long-term potential,” says Williams.

In fact, looking back five years gives you a good picture of what a fund has done in bear (2000 to 2002) as well as bull (2003 to 2004) markets. If the next few years will produce modest returns, as some forecasters expect, you’ll want funds that have run well — muddy course or fast track. “Look for funds and fund companies that have been good stewards of capital,” says Lyons. “You’ll want experienced managers who have performed well over an extended time period. In addition, investors should focus on expense ratios. Choosing funds with low expenses is a proven way to increase long-term returns, especially if we’re moving into a period where funds are going to return 8% or 9% a year. Funds with expense ratios of 1% or less will have a huge edge over funds that eat up 2% of your return each year.”

Cut your costs. If you’re hunting for inexpensive funds, do your homework. “I use Morningstar’s publications to help me diversify among mutual funds,” says Rick B. Miller, 43, an administrator for a government contractor in Silver Spring, Maryland. “I try to stick with four- and five-star funds because they’re the ones that have done best over the years.”

By conducting some careful research, Miller has put together a mix of cost-efficient funds. “For the most part, I prefer index funds, which tend to protect you if the market goes down,” Miller says. “My index funds are Vanguard funds, which have very low expense ratios.”

For example, Vanguard’s largest fund, Vanguard 500 Index (VFINX), which tracks the S&P