Jason Stipp: I'm Jason Stipp for Morningstar.
As part of Morningstar's Investor Starter Kit, we're delving into investment selection on Wednesday, and here to talk about some of their favorite funds for first portfolios are Russ Kinnel, our director of mutual fund research, and Christine Benz, our director of personal financial.
Thanks for joining me.
Christine Benz: Jason, good to be here.
Russ Kinnel: Good to be here.
Stipp: There are a couple of different ways that you can build a portfolio, and we're going to talk about some of the different segments and some of your favorite funds in those segments.
We're going to start off broad, for folks who want more of an all-in-one solution or a more inclusive solution, and one of the ways to get that, of course, is target-date funds.
Christine, among your favorites for broad exposure are, in fact, from target-date series.
Benz: Absolutely. These funds really do a lot of the heavy lifting for you. They set your asset allocation and then they gradually make it more conservative over time. And they also rebalance back to that target allocation.
That combination of factors has tended to make target-date funds a really effective solution for investors. When we look at investor returns for target-date funds--that's looking at the cash flows coming in and out of the funds--what we see is that investors seem to do a really good job of buying and hanging on in these funds, in part because so much of the work is being done for them behind the scenes. So, the actual investor dollars in target-date funds have out-earned the funds' total return. Investors have had a good experience in these products.
Stipp: There are a lot of different fund companies that offer target-date series. What would be your recommendation for investors who are interested in target-dates?
Benz: They are not good across the board, but we do think that some of the best funds are very, very good. Vanguard's target-date series is one of our favorites. Of course, it has very low costs working for it--a primarily index-based approach with just 0.14% in asset-weighted expenses within the series.
T. Rowe Price's [target-date series] is the other series that we like a lot for no-load, do-it-yourself investors. Those funds are primarily composed of actively managed funds and so are a little bit more expensive. They are also a little bit higher on equities than is the Vanguard lineup, but we like both series quite a bit. I think that it would be hard to go wrong with either series if you just want to set it and forget it.
Stipp: Russ, another kind of fund that you can use if you are looking for more of an all-in-one option, although not quite as automatic in some respects as a target-date fund, is a balanced or an allocation fund, and your pick is in that area.
Kinnel: That's right. Vanguard Wellington does some of the same things that target-date funds do, but it's an old school, before there were target-date funds setup. It's about two-thirds equity, one-third bonds, and even that mix does some of the things Christine touched on, which is, it helps investors to stick with the fund because that mix is just enough to provide the diversification and the stability that it keeps you from the big highs and lows.
It's well-run by Wellington, [with a] value approach on the equity side, high-quality bonds on the bond side. You put it together, and it's a very well-run portfolio and with very low costs, almost as cheap as an index fund. It's a nice fund you can buy and put away.
Also if you start off with a small amount of money, this is a fund you can just keeping contributing more and more to, because it covers such big parts of the core. It's not everything like a target-date fund, so foreign equities, foreign bonds, some other parts of the market are not covered. But it's still a great core fund.
Stipp: Will their allocation stay relatively static or will they go more into stocks or more into bonds at certain times?
Kinnel: Relatively static. They have a little bit of flexibility, but historically it's only been about 5% up or down from that 65% in equity--pretty consistent. They don't make really big allocation calls.
Stipp: Russ, I'm going to stick with you as we move to our next category. If you're not using an all-in-one option or a balanced fund, you can pick some funds in certain big segments and build a portfolio yourself.
We'll start in the U.S., because [U.S. equities] is a big allocation for most investors here. You have an actively managed stock fund [recommendation], if you're looking just primarily for U.S. exposure.
Kinnel: I'm a big fan of Dodge & Cox Stock. I'm staying old-school today, I guess. It's just a really good, well-run fund. Again, low costs, about 50-55 basis points, very cheap. [It has a] very stable management team, a very good value approach, and I just like firms where the managers and the analysts make a career of it, and that's what you have at Dodge & Cox. This is a really nice core holding of U.S. equities.
Stipp: Christine, for U.S. equity exposure, you look pretty broadly for your pick and actually indexing there.
Benz: Absolutely. Although I like Dodge & Cox Stock, too. For people who want a very hands-off portfolio that they can just add to without giving a lot of thought over the years, it would be hard to go wrong with a total market index fund. You could also use an S&P 500 index fund, but the total market index gives you a little bit more in mid-caps, a tiny bit more in small caps, and so it's a little better as an all-in-one vehicle.
We've seen price wars break out among some of the broad index providers. That's been very good for investors. For smaller investors, a Gold-rated total stock market index fund is from Fidelity. That's a very cheap fund and has just a $2,500 minimum. Vanguard also has a great total stock market index product that is available [in the Admiral share class] with a slightly higher minimum, but a slightly lower expense ratio. Either would be just a tremendous starting fund.
Stipp: Of course, investors putting together a portfolio don't just want exposure to the U.S. They should also get exposure to foreign equities and look abroad.
Russ, your pick is from Causeway. It's Causeway International Value. It comes from a group that some folks might not have been as familiar with.
Kinnel: They are a good value shop established about 12 years ago, with very good value stock-picking. They've been consistent, low-turnover value pickers, and they are focused on … developed markets, so not emerging markets, just developed. But they've built a really good track record. I do think you need to be fairly patient with a fund like this, so you need it to hold it for, say, 10 years or more, but it's really been a consistent value fund.
I seem to have a value bias today. I do like growth funds, too, but anyway I think it's really a strong, consistent fund. It's smaller than the other two I mentioned, which is good because it gives the managers a little more flexibility for stock-picking. It's got about $5 billion in total assets under management, so they've got a little more flexibility to make those stock picks really add value.
Jason Stipp: Christine, as another option to an actively managed fund, you have an index pick for this particular category in foreign equities?
Christine Benz: Right. Russ is keeping it old school; I'm keeping it simple today. The pick would be Vanguard FTSE All-World ex-U.S., a broad foreign stock fund. There is a little bit of a difference with the Causeway fund, in that it does have some emerging-markets exposure. But I think that's probably a great place to start in terms of core foreign exposure--that you do get substantially more in developed markets, but also a slice of emerging markets. If you have a long holding period, I think you probably want the emerging-markets stock.
Jason Stipp: Lastly, Christine, I'm going to stick with you, for fixed income. You're actually going to go with an active pick for your fixed-income exposure. Is there any reason why you are looking more active in fixed income versus indexing, and also what is your pick in this category?
Christine Benz: So the pick is T. Rowe Price Spectrum Income. I'm wrestling with this idea of active versus indexing in the fixed-income space. I think that arguably active management makes more sense right now, in that we have a very challenging bond market that we're looking at. I like the idea of an active manager who has a broad toolkit, can shorten duration, invest overseas, use a variety of different strategies.
This T. Rowe Price fund is a fund-of-funds that has exposure to a lot of different segments of the fixed-income market. It also typically has about 15% in dividend-paying stocks through T. Rowe Price Equity Income Fund. I think of it as a good core fund.
I think back to a time when a friend called me up, and she said that she had run some asset allocation tools and determined that she was light on fixed income in her portfolio. This was a really easy, one-stop fixed-income fund to recommend to her. You can get a lot done with this single holding.
Stipp: Russ, your pick for fixed income is actually a certain type of fixed income that can be very useful for some folks, especially in higher tax brackets.
Kinnel: That's right. I like Fidelity Intermediate Muni. It's a muni fund, so the yield is tax-free. Yes, it has particular appeal if you are in a high tax bracket, though right now, munis are often yielding more than Treasuries, so even in a lower tax bracket, it might still be of value.
What I like about this one is that it's conservative in a lot of ways; it doesn't take big interest-rate risk. It doesn't take any big market calls, really, or big credit risk. Fidelity managers are just focusing on picking good issues. Mark Sommer is the manager here, and he delivers a nice, consistent approach. When you have a big rally of lower-quality stuff, it's not going to do the best, but it really holds up nicely in down markets. It's just a very consistent fund, and again, low cost, which is one theme throughout all of my picks.
Stipp: Do you think people going into munis right now need to be prepared for any potential disruptions? You hear headlines out of Detroit and pension problems in other cities. Do you need to be extra cautious in municipals right now?
Kinnel: A little bit. I think diversification takes care of a lot of that. For instance, Detroit was not a very big deal for muni funds, because they are: 1) diversified; 2), well-run, so they knew long ago not to mess with that. Puerto Rico has been a more serious issue for muni funds, but that's why I pick a conservative fund like Fidelity [Intermediate Municipal Income]. I think really all the bond market has issues. On the taxable side, we are worried about tapering and government shutdowns and all sorts of problems, too. So there are some bumps, but I think generally munis have a very low default rate, and Fidelity has got probably the best muni team out there. So I feel really confident in this fund.
Stipp: Russ and Christine, fantastic ideas for a good starter portfolio. Thanks for joining me today.
Benz: Thank you, Jason.
Kinnel: You're welcome.
Stipp: For Morningstar, I'm Jason Stipp. Thanks for watching