Mutual Funds for the Utterly Confused

Value funds are supposed to act in an opposite world from their growth-oriented counterparts. Value mutual fund managers tend to hold on to more cash as they troll the markets for the beaten and forgotten, the has-been names of companies that for whatever reason, remain solid players but are not so attractive as to entice investors in great numbers. They may pay dividends. They may have once been considered a growth venture but those days have since passed.

Value fund managers take an incredible risk when investing in these fallen angels. As someone once said, they make their living by standing on the tracks. The companies they look for may have fallen out of favor with the actively invested crowd but there is always the hope that the sentiment is temporary. Value managers attempt to be there when that turning point occurs and profit from the resurgence of a business.

But what happens when you focus on a segment of the market that is considered “value” only to find out that you have over-valued the stock yourself? Many value funds sailed along with handsome returns while growth stocks fell and then rose and subsequently fell again. There were numerous bumps along the road in between those moments, but value funds seemed to ignore those zig-zag movements and turned a tidy return for those that were patient.

The problem with this type of investing became evident as a particular value sector, namely the financials, fell even more precipitously in 2008 than the overall market. This sector, along with the broader market dependent on credit fell to the point that what was growth was now value and what was value was now nearly worthless.

Numerous value companies will have extended problems as they try to access a still-chilly credit market. Without long-range goals of growth or readily provable potential, just getting by may not be enough to get bankers to lend - at affordable rates. Some of these value companies may close their doors, declare bankruptcy or simply downsize themselves right out of the marketplace.

Should you ignore value funds if you have had them in your portfolio for awhile, especially as they were among the best performers in your retirement plan? No. If you have them, hold them. Value managers have become much more nimble as the amount of companies that were once growth now crowd this sector. Some of these companies still have access to credit and are suffering from depressed valuations by default of what the greater marketplace has wrought.

But owning value funds as they fell, many of which were without a doubt, heavily weighted in your portfolio, should be a lesson in the kind of risk the market can dole out. Balance is still the key. You don’t have to balance the funds with sales of shares. Simply make sure you have some of a lot and not just a few winners.

In fact, value may be the first to recover when the economy finally rights itself.

One final note, avoid a similarly named kind of fund that is now available in numerous 401(k) plans. The stable value fund is something wholly different than a value fund that invests in common stock.

Up next, stable value fund risk.