2 Funds to Keep You Calm and Balanced

09/26/2011 7:00 am EST

Focus: ETFS

The current market volatility underscores the need to stay calm and carry on, says advisor, investment manager and author David McPherson. He likes a Vanguard blue-chip ETF for dividend yields, and a Vanguard short-term bond mutual fund for yield with reduced risk. He suggests that investors not currently in gold use caution if they are considering entering a position.

Kate Stalter: I’m speaking today with David McPherson of Four Ponds Financial Planning. In addition to being a planner, David is an investment manager and he contributed a chapter to a book with a very timely title, Investing in an Uncertain Economy for Dummies.

David, give us some of your thoughts on what investors should be looking at in the current uncertain market and economy.

David McPherson: Well, the first thing is to make sure they don’t make the mistakes that a lot of people made in late 2008 and early 2009, when we were in the midst of that terrible market. People panicked, went all to cash, and then missed out on the rebound that we had in the rest of 2009 and 2010.

I saw both sides of the coin. I saw the benefits to the people who kind of followed a long-term plan and kept their cool, and I also saw the downside of people who just panicked to the extreme, went entirely to cash, and then locked in losses and missed the rebound.

So, the first thing is—it sounds boring, and you hear it over and over—but you do have to kind of have a long-term approach. I’m not sure if we’re going to suffer through the same type of turmoil in the rest of this year, but it’s good to learn those lessons that we had to learn a couple years ago.

Kate Stalter: Given the current market volatility that just doesn’t seem to end, what are some of the investments that you are putting your clients into, or that you suggest individuals take a look at?

David McPherson: I try to follow the same basic approach in good times and bad and to stick with it. It’s a balanced approach, all about asset allocation. You want to be in a variety of areas, because you never know what particular segment of the market is going to do well at any given time.

That said, there are two areas, if I were to put a little bit of emphasis on right now in this environment. One, on the stock side, I’m a big believer in emphasizing dividend-paying stocks, companies with strong, healthy dividends above average, and to let the dividends provide some downside protection, and also to accumulate and reinvest those dividends.

For instance, one particular fund that I recommend a lot is the Vanguard High Dividend Yield ETF (VYM). That’s a fund that focuses on stocks that pay above-average dividends, but also are financially strong and can continue to pay the dividends.

As you may know, just because a stock or a company pays a high dividend, it doesn’t always mean that it’s in the best of shape. Sometimes it’s paying a high dividend, but can’t sustain it.

So this particular fund that I’m mentioning is above-average dividends, but it doesn’t reach for the sky. Rather, it’s focused on companies that can sustain the dividend.

I think it’s always a good idea to look for dividend-paying stocks or funds that emphasize dividend-paying stocks. But, particularly in these times, I think they’re a particularly good thing to include in your portfolio.

On kind of the other side of the portfolio, I’m also emphasizing a little bit short-term bonds, particularly short-term investment-grade bonds, corporate bonds of high-investment quality.

Obviously, interest rates are very, very low and someday they will go up, we don’t know when. But longer-term bonds are vulnerable when interest rates go up. I kind of put a little bit of emphasis on short-term investment-grade bonds.

Another fund that I tend to look at is again a Vanguard fund. It’s a mutual fund, the Vanguard Short-Term Investment Grade Bond Fund (VFSTX).

With any short-term bond fund right now, given the current rate environment, you’re not going to get a real strong yield. However, it will pay something more than cash or a treasury bond fund. So it gives you a little bit more yield without taking on too much risk.

There are people who will reach for yield either by going to a high-yield bond fund or maybe a long-term bond, but those, for me, pose a little bit too much risk. In both cases, both of those funds, you don’t want to go overboard, but I think they definitely warrant a look at in this environment.

Kate Stalter: Do you recommend that investors focus on funds, as opposed to individual stocks or bonds?

David McPherson: That’s my philosophy. I believe just for the average investor to be properly diversified, they just don’t have the portfolio size to purchase the number of stocks they need, to achieve the proper level of diversification.

For an ultra-high net worth client who’s got somebody who they can rely upon to do the necessary research, it might be appropriate, but I think for the average small investor, they’re better off either using mutual funds or exchange traded funds.

Kate Stalter: Any particular areas, David, that you think investors should really steer away from? The one I hear a lot is, of course, Europe. Anything that you would see, perhaps in a new client's portfolio, that you would suggest they exit?

David McPherson: Well, any of the particularly complex ETFs, like the leveraged ETFs, have gotten some attention. I think for the average investor, those are entirely inappropriate, and you really need to have a high level of expertise to use something like that appropriately.

There’s always the debate about the place gold should have in a portfolio. I’m not a big fan of gold, but I understand the argument for having it.

However, I think to be purchasing it right now at a very high price is potentially very risky. I know there are others who disagree with me on that, but I think that gold or precious metals can have a small place in a portfolio. But if you have none, I’d be very careful about what you add now in terms of gold exposure.

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