Jason Stipp: I'm Jason Stipp for Morningstar. In investing, as in a lot of endeavors, an important but sometimes overlooked metric of success is simply to avoid mistakes. With the proliferation of investment vehicles out there, there is a lot of opportunity for investors to choose poorly and use poorly.
In that vein, Christine Benz, Morningstar's director of personal finance is here to talk about some investment types that she just wouldn't touch. Christine, thanks for joining me.
Christine Benz: Jason, nice to be here.
Stipp: So you wrote an article recently about "Just Because You Can Doesn't Mean That You Should" and the article was talking a little bit about all the different options that investors have and with a lot of them, they can get into some trouble. So you have three different categories of investments that you would stay away from as an investor. Let's take it from the top and tell us about the first one.
Benz: Well, the first category and I lump these two groups together, would be sector funds as well as region-specific funds. And the reason, I would say most investors should avoid them, Jason, is that first of all, they are likely to be redundant. If they've got a well diversified portfolio, they probably already have exposure to that sector or region. So they are redundant.
And then the other thing that I come back to is that investors' timing with some of these funds is terrible. So we have the statistic called Investor Returns on the site, so you can see what the typical investor actually earned in a fund, and what you often see is that the investor returns are lower than the funds published total returns, because investors have themselves a disservice with poor timing. And what we see is that with some of these narrowly focused categories, investors' timing is the worst of all. So that's another strike against these funds in my book.Read Full Transcript
Stipp: So certainly investors want to be diversified and want to have exposure across the globe. So, if you do want to make sure that you are properly getting some exposure to maybe some areas that have more growth potential, what's a good way to do that then?
Benz: Well, I think you want to make sure that you're well diversified across the style box. My thought, though, is that if you are paying an active manager, give that manager room to run a little bit. So, some of my favorite funds do give the manager a lot of latitude to invest, not just across different sectors, but also across the globe. So, I think that that's one idea to think about a global fund, where the manager isn't hindered by any strict mandates on what he or she can invest in.
Stipp: Sure, second category you want to talk about, and this one has probably been on a lot of investors' minds throughout the downturn. It has to do with people wanting to protect their downside and some of the mistakes they make there. What's one way that you would not recommend that investors protect on the downside?
Benz: Well, there are a lot of what are called inverse funds or funds that are set up to essentially short the market or short a market segment, such as technology stocks or something like that. And again, investors' timing worries me. I think that investors will often gravitate to these funds at market inflection points when things are looking really gloomy right before an upturn.
And the other thing is the very setup of these funds, and my colleague, Paul Justice, has written very eloquently on this topic, but essentially these funds are set up to deliver the inverse of the market's return on a day.
So if you're looking to short the market on a day, maybe this is the right product for you. But if you're looking to buy and hold one of these funds, you can end up with some very perverted returns. So the funds may not reflect the market's downturn over a long period of time.
Stipp: So these investment vehicles may give you some very different results than you expected, but still the fact that I want to have some downside protection is probably an important thing for my portfolio. What would you recommend?
Benz: Well, a simple way to give your portfolio good protection on the downside when stocks are going down, just buy a bond fund, and granted you won't have that sort of tremendous explosive upside potential that you can through shorting, but I do think it's a safer, low maintenance way to add some downside protection to your portfolio.
Stipp: So, Christine, your third point has to do with investors wanting to capitalize on things that they are reading in the headlines and sometimes they can make a lot of mistakes there as well. Tell us a little bit about the third type of investment that you would stay away from?
Benz: Well, these are thematic funds, Jason, and the themes that we see tend to vary with whatever is going on in the world. Lately, we have been seeing a lot of green or climate-change funds, certainly nothing wrong with wanting to pursue that as an investment idea. But oftentimes to me these funds are set up more to give the fund company a quick buck, not so much to benefit investors, and also by the time the company gets around to setting up a fund, it's oftentimes well reflected, the theme is well reflected in security prices.
So I think these funds can be risky, and you don't always know what to expect in them. So you might see, say, a climate change fund and actually look at the investments and see that it's something maybe that's only peripherally related to that issue. They are often not very focused.
Stipp: I would imagine kind of difficult to implement as far as an asset allocation, trying to control that in your portfolio. These funds could maybe be across the board in a lot of different areas.
Benz: Exactly. So one thing I would say, Jason, is if you are looking for an investment that's attuned to some of these big themes, and certainly the role of green energy and climate change will be one going forward, delegate that portion of your portfolio to a growth fund, where the manager is very likely thinking about some of these big picture themes and thinking about what are the investable ideas.
Stipp: Christine, some great ideas for avoiding pitfalls for investors. Thanks for joining me today.
Benz: Thanks, Jason.
Stipp: For Morningstar, I'm Jason Stipp. Thanks for watching.