Mutual funds: the pits or the pendulum?
Boston — ''The whole concept of the free market is that you get a pendulum effect.'' Right now, says Michael Lipper, a mutual fund expert, the pendulum is swinging the wrong way for most fund investors. For two quarters in a row - the fourth quarter of 1983 and the first of '84 - mutual fund managers, as measured by Lipper Analytical Services, failed to outperform the Standard & Poor's 500 index. This was the first time this happened in more than 10 years.
Mr. Lipper points out, however, that pendulums have a habit of swinging back in the other direction.
In the meantime, investors recently introduced to mutual funds may still be wondering what they have gotten into. For many of these people, their first exposure to this form of investment came in 1980 or '81, when high interest rates and high inflation made money market funds' mid-teen yields highly attractive.
Then, in August of 1982, the stock market began its historic rally. But the impressive results from mutual funds that invest in stocks did not become fully apparent until the following summer. So many people became first-time mutual fund investors or moved from money funds to equity funds last June or July - about the time the stock market began slipping and the funds were being pulled down with it.
After being lured into mutual funds just in time to watch them take a big dive, then, these investors are probably asking themselves, ''Now what do I do?''
For many, the answer seems to be: ''Keep buying mutual funds.'' Monthly sales of the funds reached their second-highest level ever in April, reports the Investment Company Institute, the mutual fund trade organization. Similar results were reported for the first quarter, with sales of $11.9 billion making the period the second-best quarter in the industry's history. This included sales of $5.5 billion for common stock funds, another near-record.
It could be a case of perverse logic, but the funds' poor performance may be the reason their sales are so high. ''I may be the eternal optimist,'' said Rick McDonald, a financial planner in Salem, Mass., commenting on the funds' two quarters of underperforming the S&P 500. ''But I look at numbers like that and figure the funds are about due.''
History is on Mr. McDonald's side. A look at the long-term record of the stock market shows that while it may go down sometimes, it also goes back up - eventually surpassing previous highs. When the market goes up, the mutual funds aren't far behind. And when the market goes down, investors in multifund ''families'' can preserve the gains made earlier by switching to money funds. Or , if they are in a fund that permits itself to switch large portions of their assets to cash equivalents, the fund can preserve these gains for the investor. The Janus Fund of Denver and the Strong Funds of Milwaukee are two examples.
In recent months, investors could also have switched to gold funds or international funds that invest in foreign stocks. Both have outperformed most United States equity funds.
But with fund prices about as low as they have been in a year, now may be a good time to buy mutual fund shares when they are cheap, as long as you plan to hold them for a few years. ''Equities and long-term bonds represent unusually good values right now,'' as do the funds that invest in them, Mr. Lipper says.
Also, through a technique known as ''dollar cost averaging,'' an investor in a mutual fund with a long track record of overall good performance can do well in bad times as well as good. With this system, the same amount of money is put into the fund at whatever regular intervals are selected. It may be every month, every quarter or twice a year. When the fund's price is down, more cheap shares will be bought. Then there will be more shares to increase in value when the fund's price goes back up. Again, this is really only effective for the long-term investor.
But the most important strategy now, mutual fund experts and financial planners agree, is diversity. Don't stick with one mutual fund, no matter how well it seems to be performing. That may come as a surprise to people attracted to mutual funds partly because they tout diversified investments, but it's the best way to avoid getting clobbered when the price of any one fund drops through the floor.
''A person should not have all their assets in one type of fund when they have various needs and investment goals,'' said Charles Atwell, a financial planner with Waddell & Reed, a division of Torchmark Financial Services of Boston.
''It's fine to have 10 to 20 percent (of the money invested in mutual funds) in one fund. You can go a little higher, but not much,'' he continued. He recommends spreading the mutual fund portfolio among several funds in a single ''family'' of funds offered by one company. ''This gives you the freedom to change from one fund to another when you want,'' he said. Lord Abbett, Franklin, Oppenheimer, and Dreyfus are four fund families that have given investors good results with this strategy, Mr. Atwell says.
McDonald prefers spreading the investment dollars among three or four totally separate fund companies. Three that he likes for this purpose are the Strong Fund, the Nicholas Fund of Milwaukee, and the Pennsylvania Mutual Fund of New York.
Many people concentrate too much on recent performance when they are selecting a fund, says Mary Malgoire, a financial planner in Washington.
''People are always trying to find the best fund for the last six months or a year,'' she said. ''That's not good. It's like chasing your tail,'' because the short-term leaders change so often. ''Look at five or 10 years.''
But Ms. Malgoire adds that ''performance is not always the first criterion.'' Among the other things she looks for are flexibility of management (being willing to change strategies when one isn't working out), the volatility of the fund (''Some funds are great in up markets and lead balloons in down markets''), and a portfolio that is as well diversified as its prospectus will allow.
Then, there is the question of how much money a person should have before ''graduating'' from investing in just mutual funds to buying some stocks on one's own.
The right amount, a recent survey of 10 financial planners by the Wall Street Journal found, is $20,000 to $25,000. An individual needs at least that much investable money, the planners said, to buy 10 stocks averaging $25 a share in round lots (100-share blocks).
''I think it depends on the person's investment nature and how they want to handle their money,'' Ms. Malgoire said. ''Some people may have half a million dollars and don't know anything about stocks and just want to keep their money. They should not put anything in stocks. But then, someone else might have an interest in it. They could take one-quarter of that $20,000, pick a couple of stocks, and get the experience.''
''I would raise the figure,'' said Peter Ferucci, a financial planner in Suffern, N.Y. ''People should not be playing the market with $20,000. I wouldn't have them doing it with less than $50,000 or $100,000. Depending on their goals and financial needs, you might put $50,000 in a managed portfolio and the rest in stocks.''
''I thought it was low,'' Mr. Atwell agreed. ''I wouldn't go below $100,000 to $125,000. You have to have the time and temperament to go into stocks.''
Mr. McDonald, however, agreed with the lower figure. ''I think you can start to look at some stocks above $25,000,'' he said. ''I look at individual stocks as a way of emphasizing one particular area or industrial sector you're not able to get enough of in a mutual fund.
''Or you can take advantage of a special situation. The person may feel very strongly about some industry or company. Once important bases are covered, there's nothing wrong with putting a little extra here or there.''