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Wealth Management - April 2018

by Stacy Wise | Apr 20, 2018

Don't Let Your Mutual Funds Drift Away


By Rick Imhoff, CFP ®

A common investment vehicle for many investors are mutual funds.  There are thousands of funds with a variety of investment characteristics from which to choose.  Many of those funds are actively managed and some of those actively managed funds may allow the portfolio managers a great deal of latitude in what they can invest.

Let’s take a mythical mutual fund called XYZ Fund as an example.  The investment objective for XYZ Fund is to invest most of its assets in U.S. stocks.  Historically, the portfolio managers of XYZ Fund have invested mostly in large cap stocks.  Sounds simple enough, but the portfolio managers for XYZ Fund appear to have the latitude to invest in large, mid, and small cap stocks.  This might be a good thing for the portfolio managers as they can change those types of stocks as they see fit attempting to outperform the market.

However, this might not be a good thing for the investor.  Let’s assume you have an investment portfolio of $100,000 and you establish your overall asset allocation for all your investments at 60% in equities and 40% in fixed-income.  For the $60,000 allocated to equities, you want $48,000 in large caps, $6,000 in small caps, and $6,000 in international stocks.  You select a couple of fixed-income funds, a small cap fund, and an international fund to fill out your asset allocation and decide to use XYZ Fund for the entire allocation to large cap stocks.  This means you would have nearly half of your entire portfolio invested in the XYZ Fund.

As we move forward in time, the portfolio managers of XYZ Fund decide to shift the holdings of the fund to smaller company stocks resulting in 20% of XYZ Fund invested in small cap stocks and only 80% in large cap stocks.  Your expectation and overall asset allocation was set based upon XYZ Fund investing entirely in large cap stocks.  Since nearly half of your overall investment portfolio is invested in XYZ Fund, their decision to invest more into small cap stocks significantly increases the amount invested in small cap stocks above your target allocation and significantly reduces the amount invested in large cap stocks below your target allocation.

On one hand, this may be okay in that the portfolio managers for XYZ Fund made a good move and might result in better performance in the future, enhancing your portfolio’s overall rate of return.  On the other hand, they may be wrong, and the fund underperforms in the future, potentially causing a drag on your overall performance.  The bottom line however, is you want to stick to your desired asset allocation as you established it based on your risk tolerance and long-term investment objectives.  

When choosing mutual funds as an investment vehicle for part or all your investment portfolio, you need to know the latitude of investment options for the fund’s portfolio managers and continue to monitor their investment style periodically.  You can do this on your own if you have the time or want to take the time to conduct appropriate research, or you can hire an investment advisor to do it for you.

Rick Imhoff, CFP®, is Senior Vice President & Senior Trust Officer for MidAmerica National Bank. He can be reached at 309-647-5000, ext. 1130 or by email.

Investments are not FDIC-insured, hold no bank guarantee, may lose value, are not a deposit, and are not insured by any federal government agency.

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