After two market crashes in 12 years, many Americans have lost faith in stocks. Investors have pulled $200 billion from stock mutual funds since the start of 2009, according to Lipper. And the selling has come even as the S&P 500 (.SPX) has more than doubled from its bear-market low of 677 in March 2009. (It’s at about 1,485 now.)
If you have just a few years to go before retiring, it makes perfect sense to scale back on stocks. But the “flight to safety” out of stock funds and into bond funds creates another risk: the chance you might outlive your money or gradually lose purchasing power to inflation.
“The average investor has a way of doing the direct opposite thing they should be doing at the worst possible time,” says James Miller, president of Woodward Financial Advisors in Chapel Hill, N.C. “This 'flight to safety' comes with a steep long-term price, since stocks offer a much better way of outpacing the growing cost of living.”
Stocks have a record of beating bonds over long periods. Over the past 30 years — the strongest bull market in history for bonds — stocks produced an 8.1% “real” return, adjusted for inflation, versus 6.1% for bonds, according to research from Fidelity Investments.
Even with the big rally in stocks since 2009, the market still looks reasonably priced, according to Brian Hogan, president of equities for Fidelity Investments. In 1999, the S&P 500 traded at a forward price/earnings ratio of 26, he notes. Today, the P/E is around 13. Yet earnings for the S&P have doubled since 1999. And the S&P 500’s dividend yield is 2.1%, higher than the yield of the 10-year Treasury note.
“Many people invest with the most recent history in mind,” Hogan says. “But the starting point today relative to 13 years ago is very different. You can get income from the equity market and more inflation protection than you can get out of bonds.”
How much stock exposure you should have depends on your age, tolerance for risk and a host of other factors, of course. For investors in their 20s, Miller, for one, recommends holding 90% in stocks. That should decline gradually into one’s 30s and 40s, eventually reaching 60% or less for investors in their 50s and 60s.
A mix with 60% stocks may seem risky if you’re in your 50s or 60s and need to start living off your portfolio income. But most people misjudge their time horizon, says Miller. With life expectancy rising, more folks who make it to age 65 in good health can now expect to live well into their 80s. “It’s not when you retire,” he says. “The money has to last through your retirement.”
To get more growth from your investments, it’s worth considering stock funds that focus on companies whose profits are growing at a strong clip. Companies growing at above average rates can generate strong long-term returns that should outpace inflation and help provide investment growth, says Hogan.
“I don’t have any idea if the market will be higher or lower six months or a year from now,” he says. “But I can say that 10 years from now, we’ll look back and say this was a pretty good time to own equities.”
To find top-notch growth funds, we asked Lipper to screen for funds with total returns in the top 20% over the last three years. We looked for funds across the market-cap spectrum and included foreign funds in the mix. And we eliminated funds with excessive fees, front-end loads and high minimum investments.
Bear in mind: These are just suggestions. You should do your own research or consult an adviser before investing.
Wasatch Core Growth Fund
- Ticker: WGROX
- Three-year annualized return: 16.1%
- Expense ratio: 1.31%
The small-cap universe is packed with high-flying, fast-growing companies. But JB Taylor, co-manager of Wasatch Core Growth Fund (WGROX), won’t touch them unless they have high returns on capital, stable cash flows and consistent growth. “We want companies that can grow in both good and bad economic environments,” he says.
Taylor figures the economy will plod along for some time, making it critical to focus on businesses that have a clear path to earnings growth. The fund’s top holding, for instance, is Copart (CPRT), a vehicle auction business that has grown revenues 10.5% annually over the past five years while boosting earnings at a 13.7% clip, according to Thomson Reuters. Life Time Fitness (LTM), another top holding, is expanding steadily throughout the country and has seen revenues jump 14.6% annually while earnings have climbed at a 16.2% pace over the last five years.
Sticking with these kinds of stable, steady growth companies has helped the fund beat 94% of peers over the last three years, according to Morningstar. Its five-year, 6.7% return beat 73% of rivals.
The downside: Despite its focus on “quality” growth, the fund lost 44% in 2008, trailing the small-cap market, and it’s likely to lag during rallies led by faster-growing names.
Fidelity Focused Stock Fund
- Ticker: FTQGX
- Three-year annualized return: 13.3%
- Expense ratio: 0.93%
Like a DJ at a top 40 radio station, Stephen DuFour sticks with what he considers his 40 to 50 greatest large-cap growth ideas. Companies in his fund, Fidelity Focused Stock (FTQGX), have growing revenues and earnings, healthy balance sheets and trade at reasonable P/E ratios relative to their growth rates. These companies have a clear path to higher earnings, he says, making them more attractive than companies going through a turnaround that may or may not succeed.
“I don’t own ‘what if’ stocks,” he says. “The stocks I own are producing good numbers today.”
Concentrating on a handful of top ideas helped the fund beat 94% of peers over the past three years, according to Morningstar. And the fund outperformed 92% of large-cap growth funds over the last five years with a 6.3% annualized gain.
Finding growth at a reasonable price isn’t easy in today’s market, says DuFour. Wall Street expects the S&P 500 to grow earnings just 1.9% in the fourth quarter, according to Thomson Reuters, and the S&P is trading at 13 times earnings. That’s a bit steep for companies growing at anemic rates, he says.
Still, DuFour says he’s finding double-digit earnings growth at only a slight premium to the market. A top holding, for example, is MasterCard (MA), which is benefiting from the switch from cash to plastic around the world. He also sees opportunity in the cell-phone tower industry, where companies are riding the growth in wireless. And he likes some petrochemical manufacturers and paper companies that are using cheap domestic natural gas to lower their costs and boost profits.
The downside: Holding a concentrated portfolio can backfire if even a handful of names in the fund trail the market. But DuFour sees scant reason to own companies with “substandard” growth. “The market doesn’t make me feel optimistic,” he says, “but there’s a subset off stocks that look relatively attractive.”
PRIMECAP Odyssey Aggressive Growth Fund
- Ticker: POAGX
- Three-year annualized return: 13.6%
- Expense ratio: 0.69%
Patience is needed if you’re going to invest in PRIMECAP Odyssey Aggressive Growth Fund (POAGX). Based in Pasadena, Calif., the four managers of this mid-cap growth fund hold stocks for years and may ride them all the way down — buying more shares at rock-bottom prices — if they think the stock will eventually head higher.
While this contrarian style has risks, it’s been effective over the long term. The fund beat 88% of rivals over the past three years and 98% over the past five years with a 10.5% annualized gain, according to Morningstar.
Lately, the managers have concentrated on biotech and medical technology stocks, which account for nearly 40% of the fund’s stock holdings. These stocks are highly volatile, but the managers see good long-term growth in the sector, driven by innovative new drugs and technologies from top holdings such as Pharmacyclics (PCYC), Seattle Genetics (SGEN) and ImmunoGen (IMGN).
The downside: The fund is more volatile than the average mid-cap growth fund, according to Morningstar. Its long-term record looks “very impressive,” however, ranking in the category’s top 10% since the fund launched in late 2004, according to Morningstar analyst David Kathman. Its 0.69% expense ratio is below average in its category, though it has a $75 transaction fee on the Fidelity platform.
Artisan International Fund
- Ticker: ARTIX
- Three-year annualized return: 7.2%
- Expense ratio: 1.22%
With more than half its assets in European stocks, Artisan International Fund (ARTIX) may seem like it’s tethered to Europe — one of the weakest global economies. But European consumer companies such as Daimler (DDAIF), Nestle (NSRGY) and Pernod Ricard (PDRDY) make only a fraction of their money in the euro-zone. A growing share of their profits now comes from developing countries, where the rise of the middle-class is spurring long-term growth, says Charles-Henri Hamker, co-manager of the fund.
Demographics and brand strength are big themes of the fund, which invests in large, stable growth companies based in Europe, Asia and Latin America. A strong global brand is a big competitive advantage, says Hamker, because it allows companies to sell commodity products for a good profit margin. And there’s a big opportunity for these brands to grow in the developing world as more consumers trade up to western brands. Nestle is one of the world’s largest makers of halal-certified foods for Muslims, he notes, yet it has barely penetrated the Indonesian market, where more than 85% of the population is Muslim.
Following such long-term growth trends has helped the fund put up strong numbers, beating 95% of foreign stock funds over the last three years, according to Morningstar.
The downside: The fund’s heavy European exposure could hinder returns if Europe’s economy worsens and euro-zone markets sell off. The fund also takes currency risk and could be hurt by swings in foreign currency markets. Long-term, though, the fund’s track record has been impressive, outpacing the return of the MSCI EAFE Index by 1% a year, on average, over the past decade, according to Morningstar analyst Greg Carlson.
Daren Fonda is Senior Writer and Investing Columnist with Fidelity Interactive Content Services. He does not own any of the securities mentioned in this article.