That mutual fund you bought, figuring it would shield you from pain in the stock market, may turn out to be a wolf in sheep’s clothing.
I’m talking about the mutual funds in 401(k) plans, individual retirement accounts and 529 college savings plans that carry the soothing words “moderate allocation” in their names or descriptions. These are the no-brainer funds that have become popular because novices don’t have to know much about investing. They simply buy a relatively mild-mannered fund containing both stocks and bonds and then they’re done making decisions.
People with these funds may assume they can go on with their lives, while relying on a fund manager to avoid taking big chances in the stock market.
But many funds that were cautious after the financial crisis have begun to morph into something very different. Fund managers that run a number of “moderate” funds are bulking up on stock and seem to have forgotten they are choosing investments for those who might be afraid of sharp losses. So if the stock market turns ugly, risk-averse people could be stunned by large losses in retirement and college savings.
Morningstar analyst Greg Carlson recently found moderate allocation funds that toned down the risk they were taking when investors were afraid in 2008-09 were only temporarily cautious. In February 2009, according to Carlson, the typical moderate-allocation fund had only 55.3 percent of investors’ money invested in stocks, with the rest in safer alternatives — bonds and cash.
But by the end of November last year, many funds with conservative reputations had shirked the conservative approach and channeled a relatively risky 70-75 percent into stocks. Some of the moderate allocation funds that have added risk are Dodge & Cox Balanced, Fidelity Puritan, Invesco Equity and Income, and Oakmark Equity and Income, Carlson said.
Keeping 70 percent of an investor’s money in stocks is a fairly large proportion and could mean big losses in a sharp stock market downturn. It is far higher than the 60 percent average that’s usually considered “moderate.”
For a taste of the difference, consider the financial crisis. If a person had $10,000 invested just before the stock market started falling 50 percent in late 2007, and put 70 percent into stocks and 30 percent into bonds then, he would have had only about $6,540 left by March 2009. If instead he had been more conservative, and had 60 percent in stocks and 40 percent in bonds, he would have had $7,140 left at the scariest moment in 2009. Because the person with a bigger chunk of money in stocks lost more money, it took him longer to get back to even.
Three years after suffering the worst losses, the person with 60 percent in stock (the Standard & Poor’s 500 index) and 40 percent in long-term government bonds had not only recovered, but had amassed a total of $12,340 in the moderate stock and bond combination. The person who had the riskier 70 percent allocation in stocks hadn’t regained as much. He had just $11,725.
Recently, fund managers have been adding stocks and cutting bonds because bonds have been paying so little interest.