Even well-meaning investors who have done their homework can assemble portfolios that harbour hidden risks, according to Christine Benz, associate director of fund analysis with Morningstar Inc, writing on morningstar.com. She poses five questions which could expose risks investors may not be aware of.
1. "Are you overweight to a single investment style?" Even a carefully selected portfolio can end up with a fair amount of style overlap, she says. Lately, she says some growth-oriented funds have been dipping into traditional value territory (for example, energy/industry) while more value managers are finding one-time growth stocks attractive. Also large-cap fund managers may venture into hot-performing mid-caps and small-company funds can be pushed into mid-caps as their assets have grown.
2. "Are you taking on too much risk with your bond investments?" It's a mistake to assume bonds and bond funds are risk-free, Benz says. Some of the best-performing bond funds over recent years have been those which delve into lower-quality credits or buy longer-duration bonds. Both of these increase a bond fund's potential for losses. Benz states "the foundation of every investor's bond portfolio should be an intermediate-term bond fund."
3. "Are you betting too heavily on one or two geographic regions?" Benz recommends particular care with big positions in emerging markets. "Stocks from these markets carry the potential for big returns - prompting many managers to load up on them over the past few years - but are also riskier than developed-market securities." At the other end of the spectrum, ignoring overseas markets altogether is a risk in and of itself.
4. "Are you paying more hidden costs than you need to?" Low fund expenses are the single best predictor of whether a fund will outperform in the future, Benz contends. "That's right, low costs matter more than good past performance or the presence of a star manager." She warns that funds can also incur charges when they buy and sell stocks and bonds and don't disclose these charges in their expense ratios. However, these charges still bite into the total return. Benz suggests one basic way to ensure you don't pay too many of these hidden fees is keeping most - if not all - of the portfolio in funds with low portfolio turnover rates.
5. "Are you trading too much?" Another way of adding to a portfolio's risks is trading too often yourself. While Benz says it's tempting to opt for the fund that lands on the top of the leader's list for the previous year, making frequent alterations can potentially rack up high transaction costs.
Reproduced with permission from financial alert.
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