Lipper's Don Cassidy on KTLK AM-760

Thursday, July 11, 2002

A. We have been hearing and reading a little of that too...I'm very sorrythat those people have been hurt that badly. And from a confirmedcontrarian's viewpoint, it's a good sign that the end of the decline may begetting near. The opposite attitude, in late 1999 and early 2000, was, "Idon't care how high the IPO goes in the aftermarket, just buy it for me. IHAVE to be in it!" Extreme attitudes mark market extremes -- notinstantly, but fairly soon.

Q. OK, but let's talk about ways that people CAN invest with little or norisk. Certainly that is what many people seem to want these days.

A. It depends on how you define risk, I guess. In a money-market fund youhave essentially no risk of loss of principal -- almost as strong aprobability as in an INSURED bank CD or savings account. But there is NOchance to grow principal, so while you get that $5,000 or whatever BACK innominal terms, it may be worth LESS in purchasing power. And there isOPPPORTUNITY-COST risk as well.

Q. And rates on CDs and money funds are pretty low now, too, right?

A. Absolutely! Money fund yields are in the 1%+ range. If you get anominal 1.5% and it is taxable, you have 1% left. Subtract 2 or 3%inflation and you DO have a loss! In fact, if you go up to about 4.5%taxable in a longer CD, subtract a third and you have 3%, and that isinflation, so you are no better than even in buying power -- a zero realreturn. Yes, you avoid risk that way, of losing anything in stocks orequity funds, but you also lost the opportunity to gain, and you lost time.You have only so much time to invest, to get to where you need or want tobe. So I would call break-even an actual loss due to time value.

Q. What are the kinds of mutual funds that have done the best in avoidinglosses, Don?

A. I'm going to use Lipper Indices here, which are in effect averages, so Iam NOT saying every single fund was loss-free in the types I mention. Ourvarious Lipper indices go back from 10 to 20 years or more. I took a20-year look. There are eleven different types of money-market funds -- tobe expected -- that show no single annual average losses in that period.There are only 3 other kinds of funds: ultra-short investment grade (3-12month) debt funds, and short muni funds, and short US Govt funds. For thetime we've kept indices, these eleven have averaged 4.5% a year (but muchlower NOW) and we just talked about how 4.5% = zero after 3% inflation.

Q. So there is no way to avoid risk and make money?

A. Well, there may be one... TIPS or "Treasury Inflation ProtectedSecurities" bond funds, or the underlying bonds themselves. If you assumethat UST obligations are beyond any question, these work. Basically theypay an interest rate of between 2.5 and 3.2% real interest, PLUS the annualinflation rate. So they would provide a SMALL net return after taxes andinflation, UP TO about 6% inflation. At that point or higher the tax onthe total return eats up the 3% base rate. You pay federal tax but nostate tax.

Q. What if a person were willing to take a LITTLE risk -- say not more thana 5% loss in a year?

A. That opens up the field a little, but going back 15-20 years we justget a longer list of different types of bond funds, about another 28 types.No equity funds except Balanced funds, which of course are part bond. Theaverage annual return of these has been 6.1%, but for some of them thatstretched back to the early 1980s when overall rates and inflation weremuch higher. Two of possible interest are ARM and GNMA funds, but thereyou need to find out if the portfolio manager uses derivatives, becausethose can backfire fast on a wrong guess. And in all of this, the pastdoes not guarantee the future! And again, we're talking about AVERAGEperformance for the type of funds being no worse than -5%, not that everysingle fund never lost more.

Q. Slim pickings... what can an investor do?

A. There are 3 things that interact to produce a given future given sum ofmoney. One is the Amount of money you invest at the start, or more likely,each year. The second is the amount of Time involved. Longer gives youmore. The final one is the Rate of return you get on average over theterm. If you insist on low risk, you will get very low rates, so you needto invest much more per year, and maybe for longer. That means lesscurrent spending and maybe a delayed retirement.

Q. Not very appealing, Don...

A. Sorry, I didn't invent the formula, I'm just describing it. An investorCAN control all 3 of those factors. You probably can't work TWICE as long,and saving twice as much per year might be difficult. But you might gettwice the rate, by taking on risk by being in equities. And it isprecisely THAT, that people are NOW saying they don't want to do, now themarket is low.

Q. So... it seems impossible to be comfortable doing what is right?

A. It sure feels that way. Look at a long-term chart of the stock market.When were the best times to buy? At the bottoms, the 1987 crash, the 1990bear market, the end of 2 nasty years in 1974, and so on. At marketbottoms it ALWAYS is scary. We perceive high risk exactly when the risk,in hindsight, will prove to have been low. At tops, like 2000, we arefearless, and in a few years the charts tell us that actual risk of losswas at its maximum then.

Q. Is there any way to find equity funds with lower risk profiles?

A. We think so, altho of course the past cannot guarantee the future. OurLipperLeaders measure (see www.LipperLeaders.com -- which is free) calledPreservation identifies funds that in recent years have tended not to beespecially volatile on the downside. Such performance has given investorsgreater comfort in the decline, and that in turn helps them "hang in"during the rougher periods.

Q. So how else does a person compensate?

A. If you are nervous, go on an automatic investment plan and DON'T WATCHthe market ! In any case, diversify to several KINDS of funds so not allof them go in the same direction at one time. By all means, resist thetemptation to jump in with both feet when things are happy, and to jump out100% when things are tough. Those emotions will always guide you to dothings backwards. We at Lipper know this from studying funds .. fundcompanies will tell you that the average investor does NOT achieve thepublished average rate of return for a given period. That is because onaverage people jump in late (high) and jump out late (low).

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Don Cassidy is a Senior Research Analyst at Lipper specializing in fund flows, exchange-traded funds, (ETFs), closed-end funds, equity fund performance, and author of Trading on Volume (McGraw-HIll).