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The Wise Investor

Resources Getting Started The Wise Investor Online Investing Glossary Book Centre globefund.com Alert Table of Contents Put your financial adviser on a leash February 11, 2000 100% Foreign content for your RSP December 22, 1999 Tax Loss Selling or Dealing With Your Mistakes November 26, 1999 Life Stages of your RRSPs November 12, 1999 Just give me boring (but great) rates of return November 3, 1999 De-mystifying Demutualization - part Two October 25, 1999 De-mystifying Demutualization - part One October 19, 1999 Seg funds for the simple minded September 14, 1999 The interest rate game Part 2 August 12, 1999 The interest rate game Part 1 July 30, 1999 Choosing funds: Five for the long run July 14, 1999 New Funds: To buy or not to buy July 2, 1999 Making sense of momentum investing June 18, 1999 Rating the fund managers June 4, 1999 Resource recovery hinges on supply and demand April 30, 1999 Tech funds draw strength from favourable trends March 24, 1999 Withdrawing from your RRSP March 9, 1999 The economic implications of the euro - An interview with Ranga Chand February 12, 1999 Underperforming small-cap funds have strong upside potential January 29, 1999 How to pick a winning equity fund portfolio January 15, 1999 View the Weekly Insight archive

How to pick a winning equity fund portfolio PATRICK MCKEOUGH Author of Riding the Bull and publisher of The Successful Investor and The Canadian Wealth Advisor Friday, January 15, 1999 Rule #1: Get personal security. Your best protection as a mutual fund investor is to choose funds whose managers feel some personal connection with the funds they manage, and with the investors who have money in those funds. If the manager's prestige, career and personal fortune rises or falls with the fund's long-term results, so much the better. Rule #2: Insist on investment quality. Invest only in funds that stick to high-quality investments. To put it another way, stay out of funds that dabble in junk. Conservative fund portfolio* Fund Category % Large Cap N.A.: 65% Small Cap N.A.: 15% International: 15% Japan: Avoid Emerging markets: 5% Gold: Avoid * A model equity portfolio for a conservative investor, as recommended by Patrick McKeough. All numbers given are general, and vary depending on each individual's risk factors, temperament and time horizon. Rule #3: Diversify. Spread your mutual fund investments out over several funds that pursue a variety of investing styles. Vary your exposure to each of these areas to reflect your financial circumstances, temperament and goals. Conservative funds should form your foundation Most investors are likely to want to focus on funds that invest mainly in large, well-established U.S. and Canadian companies. Funds like these should make up between one-third and two-thirds of most fund investors' portfolios. Small caps add growth potential More aggressive investors will want to include funds that invest in smaller companies -- so-called 'small caps' with a market capitalization (total value of all shares outstanding) of less than, say, $500-million. When chosen wisely, small cap stocks can grow at a rate of five-to-10 percentage points faster than the rest of the market. However, small cap funds are more volatile than funds that focus on larger companies, and they expose you to greater risk of permanent loss. Small cap fund investors need to be especially careful about the fund managers to whom they entrust their money, since these funds can include many low-quality investments. Funds that focus on small caps should make up no more than perhaps 10% of the holdings of a highly conservative investor. But a young, aggressive investor with secure income might want to invest as much as 60% of his or her fund holdings in small cap funds. Investing in Europe has appeal, up to a point European stock markets have moved up early in 1998 in anticipation of gains from the creation of the euro and closer economic integration of countries in Europe. We are less certain of the benefits from conversion to the euro, especially in the early years, in light of left wing political trends now becoming apparent in Europe. We think the best way to invest in Europe is through international funds such as Templeton Growth Fund, which includes Europe among areas it considers for investment. These international funds could make up perhaps 10% of the holdings of a highly conservative investor, to as much as 30% of the holdings of a more aggressive investor. (Note that we are combining funds you hold in and out of your RRSP; under current rules, foreign funds can only make up 20% of your RRSP's book value.) Japanese funds may be close to levelling out Japanese investing was something of a craze for North Americans in the 1980s. Around the start of this decade, the Japanese stock market reached a peak and started to drop. It has fallen by more than 60% since then, and there is some controversy as to whether it is ready to quit dropping and level out, or if it is headed substantially lower. The main problem for Japan's economy is that big Japanese banks have lent money to creditors who are unable to pay it back, because the value of Japanese real estate has collapsed. This makes Japanese banks hesitant to lend money to anyone, so there is a shortage of ready credit even though Japanese interest rates are far lower than ours. However, the Japanese government hopes to persuade the banks to write off their bad loans. In return, it may inject money into the banking industry to spur lending. We think the Japanese stock market will level out close to current prices, but it may go sideways for months or years before setting off on a lasting rise. We think most North Americans can do without any direct Japanese holdings. Investors who want Japanese holdings should keep their exposure under 10%. Emerging markets funds expose you to heavy risk In the early part of this decade, investors came to believe that the newly industrializing nations of Asia, Eastern Europe and Latin America would expand into an economic vacuum and grow much more quickly than established economies of North America and Europe. Emerging markets funds became something of an investment craze in the middle years of this decade. Mutual fund companies were continually launching new emerging markets mutual funds. Brokers and mutual funds salespeople found these funds an easy sell to their clients. In fact, investors were eager for gimmicks that would let them invest more than 20% of their RRSP in these funds. Some funds used derivatives to expand emerging markets exposure, adding even more risk. Until recently, we generally advised staying out of emerging markets because we feel they expose you to way more hidden risk than funds that invest in North America. The stock markets of newly industrializing countries went through a horrendous setback in 1997 and 1998. Many emerging markets funds dropped 60%-to-80% from their peak. In many cases they are back to where they were five-to-seven years ago. Now that the inevitable collapse has come and emerging markets have dropped as much as they have, they're much more attractive than they were. But they still involve far more risk than North American markets. Investors who can accept some risk may want to invest 5% of their fund portfolio assets in emerging markets funds. Gold funds have a built-in negative The price of gold hit a peak of $850 (U.S.) in January, 1980. It has been moving sideways to downwards ever since (for more background on the price of gold and the metal's place in our monetary system, see my book, Riding the Bull). Many gold enthusiasts think gold will inevitably return to its old peaks and go on to still higher prices. Maybe they're right. But the problem is that most gold stocks are priced as if gold is sure to rise. In other words, they need a rise in gold prices to justify their current stock prices, let alone go higher. Under these circumstances, we can't get enthused about gold mutual funds, especially those that invest in major gold stocks. In our view, they offer average to below-average profit potential coupled with above-average risk. For investors who insist on gold exposure in their portfolios, we recommend a couple of gold funds that invest in junior golds. But gold funds should make up no more than 5% of your portfolio. The above is an excerpt from "The Cautious Investor's Guide to Huge and Safe Mutual Fund Profits," a report by Patrick McKeough. The $29 guide is published by The Successful Investor Inc., and contains seven sample fund portfolios for seven different investors and the mutual fund "bargain of the year," as selected by Mr. McKeough. A limited number of free copies of the guide are available with a trial subscription to the author's new mutual fund newsletter, The Canadian Wealth Advisor. For a free sample and more information, e-mail mckeough@home.com; or call 1-888-292-0296 or 416-222-3759.

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