Dividend-stock funds have been some of the best performers lately, says Christine Benz of Morningstar, and she recommends these for both the short term and the long haul. She also shares her views on index funds versus actively managed investments.
Kate Stalter: Today I am speaking with Christine Benz. She is the director of Personal Finance at Morningstar.
Christine, you write regularly giving advice to individual investors. I’ve looked at some of your recent articles, and I wanted to start out today by asking you: What’s the appropriate way for longer-term investors to approach mutual funds at this juncture, given all the uncertainty in the market?
Christine Benz: Well, Kate, I can’t over-emphasize the importance of having a plan, of having that asset-allocation framework that you’re working within. Far too often, investors start by picking individual funds or individual stocks or whatever it might be, without taking a step back and saying, “OK, here I am in my life stage, what is an appropriate mix of stocks, bonds, and cash?”
So start by making sure you have that asset-allocation blueprint, and then you can proceed to the specific process of picking individual securities.
Kate Stalter: I know it’s a huge question, but just any quick tips on how to determine the correct mix of asset allocation?
Christine Benz: Right. It is a huge question. Jack Bogle would say that a good starting point is subtracting your age from 100 and that’s the amount that you should have in stocks.
I think that’s a decent rule of thumb, but I also think that there are a lot of great tools on the Web to help you put an even finer point on your asset allocation. So for example, someone who is lucky enough to have a pension—and it’s a solid pension that is well funded—someone like that could arguably have more in stocks then someone who does not, because they have that steady stream of income that they’ll be able to rely on in retirement.
So it is pretty individual-specific. Look at a few different online calculators and see if you can find some commonalities.
One other quickie piece of guidance I’ve been giving for people trying to get their arms around asset allocation is to look at target-date funds geared towards someone in your general age band.
Even if you don’t intend to invest in one of these all-in-one funds directly, I still think that you can harness some good asset-allocation guidance by looking at how they’re set up, looking at what their foreign stock weightings are like as a percentage of overall equity weighting, looking at how much they have in stocks, bonds, and cash. I think that that can also be a good shorthand way of getting your arms around an appropriate asset allocation.
And last but not least is: A financial advisor can certainly help a lot on this front, so if you are someone who is working with a planner, this is something that they should absolutely be able to help you with.
Kate Stalter: One of the things, Christine, that you’ve written about recently are some of the top funds that your Morningstar screening tools have returned. So give us a few of your top picks and why you like them.
Christine Benz: We do a periodic article where we look at our premium fund screener. So we’ve been looking a lot at bond funds, and we’ve been looking at how many bond funds have actually underperformed the market recently.
We’ve also looked at how stock funds, large-cap blend stock funds, have underperformed the S&P 500 in the recent flight to quality. So we did a screen where we looked at some of the best-performing funds in the recent past. What we found was a lot of convergence around dividend-paying stock funds, so I think there’s a lot to like about this category, not just right now, but for the future.
One perennial favorite in that area is Vanguard Dividend Growth Fund (VDIGX). That is an actively managed fund, but we also like the firm’s index fund that focuses on the same general universe; that’s Vanguard Dividend Appreciation (VDAIX). That particular fund is available in both an exchange traded fund (VIG) and in a conventional fund format. So those are a couple that we like.
We also like T. Rowe Price Dividend Growth (PRDGX). It’s not an official Analyst Pick for us, but we do think that the fund has a lot of what we look for. It has reasonable expenses, a long-tenured manager, and a very good long track record of keeping a lid on volatility.
So those are a few funds that we’ve highlighted recently as having attractive characteristics, not just for the current market environment, but as good core-type long-term holdings.
Kate Stalter: Great distinction there, because a lot of people do wonder, “Do I need to be making changes, given what’s going on in the current marketplace?” What’s your quick take on that?
Christine Benz: Well, I would say not. In fact, I think that investors can often hurt themselves by paying to much attention to the daily news flow.
I was out at a fund shop last week, and they were sharing some data with us, just about how uncorrelated economic performance is with market performance. So right now, for example, people might be looking at Europe and saying, “I absolutely want to stay away from anything connected to Europe.”
This was Vanguard. What their research showed was that actually economic performance is not a great predictor of market performance. Valuation is actually a much bigger consideration. So in general, I think that investors can end up making costly mistakes by paying too much attention to whatever is dominating the economic headlines recently.
Kate Stalter: One last question for you today, Christine. You’ve also written recently about actively managed funds versus passive management. What’s your best advice when investors are trying to choose between the two?
Christine Benz: My best advice is to not get to dogmatic, because I think you can actually do fine using one or the other approach, or maybe better yet, a combination of the two approaches.
I think that investors often get bogged down in this debate, where they’re bickering over one method definitely being better than the other. You can certainly create a low-cost, low-maintenance, hands-off portfolio using all index funds, and that will tend to be the lowest-maintenance way to go about setting up a financial plan.
But I think if you have a long-term mindset and take care in selecting your individual actively managed funds, and you don’t chase performance, you can do well with that strategy, as well.
So I think it pays to step back and think about what type of investor you are. If you are someone who doesn’t want to spend a lot of time babysitting your investments, then index funds are the way to go.
If you want to have at least the opportunity of beating the market, then maybe you want to have some actively managed funds in your portfolio, but recognize that actively managed funds in aggregate have not beaten market benchmarks over time.