When it comes to a choice between making a lot of money in the stock market and being able to sleep at night, many investors would rather get their beauty rest. And who can blame them? A 55% decline in the Standard & Poor's 500 Index ($INX) from October 2007 through March 2009 was a painful lesson for those who had underestimated the risks of owning stocks.
But a strategy of boycotting stocks entirely comes with a big risk of its own: Inflation relentlessly eats away at the value of your money. If costs rise 3% annually, a dollar today will buy only 74 cents' worth of goods in 10 years. Even the most risk-averse investor needs to find a way to at least stay ahead of inflation.
Below, we examine a dozen investing ideas that should provide inflation-beating long-term returns without giving you insomnia. We selected investments that combine better-than-average returns for their category with decent performance in down markets. We also picked funds and stocks that have a record of making money for their owners but without the wide price swings exhibited by other, more-volatile investments.
As a result, they'll probably provide ho-hum returns in bull markets. But if you'd rather be safe than sorry, our choices probably won't cause you to lose much sleep.
The investments are arranged in order of risk, from lowest to highest. On the low end, bond fund returns should beat inflation, though not by much. The more risk you can stomach, the higher your returns should be. Keep in mind that the returns of ultrasafe investments, such as short-term bond funds, may not be enough to meet your savings goals, especially after taxes. If that's the case, you'll need to swallow hard and add some riskier investments to the mix.
Bond funds: For the timid
Although bonds, in general, are safer than stocks, don't assume that all bond funds are equally low-risk. The safest ones invest in Treasurys and high-quality bonds issued by U.S. government agencies and corporations. They also favor short-term maturities because rising interest rates can ravage the value of longer-term bonds. Among the funds we like best:Vanguard Short-Term Federal (VSGBX) hasn't had a down year since 1994, when it lost 0.9%. It emerged from last year's storm with a positive return of 7%. The fund, managed since 2005 by Ronald Reardon, achieves its stability by sticking mostly to bonds issued by government agencies. From a credit-quality perspective, agency bonds are virtually as safe as Treasury securities.
Short-Term Federal has a low 0.2% expense ratio, a particularly important consideration when investing in a fund that doesn't promise big returns. The fund, which sports a current yield of 1.5%, has returned an annualized 5.3% over the past 10 years and gained 2.9% this year (all returns are through Oct. 8).
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Although corporate bonds carry a higher risk of default than government issues, the Price fund tempers the risk by sticking with high-quality debt. All but a small fraction of its corporate-bond holdings have an investment-grade rating of triple-B or better from Standard & Poor's. The fund, run by Edward Wiese since 1995, squeezed out a 1.2% gain in 2008, and it has returned 8.4% in 2009. Over the past 10 years, it returned an annualized 4.9%. The fund yields 2.6%.
One way to get more from a low-risk bond fund's modest returns is to avoid paying taxes on them. Fidelity Intermediate Municipal Income (FLTMX) buys only issues that are free of federal taxes (and, in some cases, state taxes).
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The muni market has been far from sedate. Some funds suffered huge losses, and virtually all of the companies that insured municipal bonds have suffered severe financial setbacks. But you can barely see evidence of this turmoil in the returns of the Fidelity fund.
Managed by Mark Sommer, the fund eked out a 1% return last year, and so far this year it has gained a solid 8.5%. It yields 2.6% tax-free, equivalent to a taxable 4% for an investor in the 35% federal bracket. Because the fund invests in medium-maturity bonds, it is more vulnerable than the other two funds to rising interest rates.
Mixed funds: More growth
Adding stocks to an all-bond portfolio can improve returns with only a relatively small increase in risk. That's because the risks of stocks and bonds are somewhat offsetting. Below, we describe three solid, low-risk balanced funds (for others, see "Stocks + bonds make for a smoother ride").While many balanced funds hold a fairly constant mix of stocks and bonds, Hussman Strategic Total Return (HSTRX) takes a different approach. It owns mostly Treasurys and government-agency bonds, supplemented at times with foreign-government bonds and shares of precious-metals and utility stocks. In addition, manager John Hussman sometimes invests in options, futures and currency exchange-traded funds to hedge his fund's exposure to interest rates and the dollar.
The strategy is a bit complicated, but Hussman, a former economics professor, has an excellent track record. The fund has had no down years and only four losing quarters since its 2002 launch. It returned an annualized 7.7% over the past five years through Oct. 8, compared with 1% for the S&P 500.
FPA Crescent (FPACX) is another atypical balanced fund. Manager Steven Romick pursues a go-anywhere strategy in search of the best combination of bargain-priced common stocks, preferred stocks, bonds and sometimes cash (37% of assets lately). He'll also bet against stocks by shorting them -- selling borrowed shares and replacing them later at what he hopes will be lower prices.
Romick, who has run the fund since 1993, has an outstanding record, producing an annualized 9.9% return with relatively low risk over the past decade. The fund, a member of the Kiplinger 25, did lose 20% in 2008. Although the decline was a rare occurrence, investors who can't tolerate a loss that large should choose a more conservative fund.
About 60% of the assets of Vanguard Wellesley Income (VWINX) are in high-quality bonds, and the rest are in dividend-paying stocks. The combination provides stability and a nice payout (the fund recently yielded 3.7%). Wellesley Income lost 10% in 2008, proof that stocks can bite you even in a fund designed for safety. But that was an anomaly.
The fund has suffered just three down years in the past 15. And even though two new managers were recently named -- John Keogh and Michael Reckmeyer III from Wellesley's longtime adviser, Wellington Management -- we don't expect any negative impact on the fund's performance. Over the past 10 years, it has returned an annualized 6.6%; the S&P's return was essentially flat.
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