What is Behind the Holdings Door?

Understanding Fund Contents

Over time I have come to realize that the things that seem simple and obvious to me are far less obvious to most of the investors who read my blog or seek Zoom training from me. A lack of knowledge can limit a person’s decision-making capabilities and cause them to delay and flounder in endless indecision. One of the basics of investing is a good understanding of some common terms used by fund managers to describe the nature of their fund.

This is true of both ETFs and mutual funds. Some of the most common terms are value, growth, blended, balanced, core, and sector. Each of these can have differing degrees of their stated name. For example, you cannot look at two funds that say they are “value” funds and conclude they are similar. The same is true for the others. However, there are some basic similarities, differences, and some cautions regarding each type of fund. In this post, I hope to give you a general knowledge of the types of funds. I also hope to caution you regarding some funds. There are some types that I do not think are good for the long-term investor’s portfolio.

In order to do this, I will talk briefly about each type of fund. The sequence is important. I will list them in order from “worst” to “best.” Understand, however, that my ranking is based on my investing strategy. It is also with the understanding that I do not view volatility in the same way that I view risk. Risk is the potential for long-term investing disaster. Volatility is only the short-term behavior of “Mr. Market.” Finally, because I think bonds are a poor safety net, any fund that is more than 10% bonds is of very little interest to me.

One final caution: Just because a fund says it is “value”, or “growth”, or “blended”, doesn’t mean it is. There are names on some funds that are fantasy at best, and misleading at worst. Lets dive in now and talk about my least favorite fund: the Balanced Fund.

Balanced Funds

Balance is a good thing, don’t you think? The word balanced conjures up an image of stability and health. A balanced diet is a good thing. An acrobat that is balanced is also wonderful.

A balanced fund is a fund that contains a mix of investments. For example, it is not uncommon for a balanced ETF (or mutual fund) to hold stocks, bonds, and money market investments. If for example, a balanced fund contains a mix of fixed-income instruments and equities, the asset mix is usually defined to contain a certain percentage of each type of investment. An ETF could have an asset mix consisting of 40% equities, 50% bonds, and 10% money market instruments.

The argument can be made that this type of fund is less risky because (in a sense) it is more diversified. You can get both growth and income. The growth comes from the stocks and the income from the bonds and other cash investments.

Sadly, the income is rarely a growing income. Why? Because bonds don’t change their payout over time. Furthermore, as 2022 proves, bonds are not really all that safe when interest rates are rising. This is another reason why I dislike Target Date Funds or Retirement Date Funds. They are just terrible balanced funds that reduce your growth prospects as you age.

My grade for balanced funds is “F”, or at best “D-.” I cannot in good conscience recommend them. Take for example, Fidelity Balanced Fund No Load (FBALX) which has an Allocation–50% to 70% stocks with the balance in bonds. The ten-year return on this fund is 17.37%. Let that sink in. Furthermore, although the fund holds 4,996 different investments, 20% of the assets are in the top five investments. That is not balanced. There are other funds from other companies. I have yet to find one I would buy.

Blended Funds

A blended fund is slightly more appetizing and appealing. A blended fund should have no bonds or other fixed-income investments. It is a fund that holds both value and growth stocks. The goals of this type of fund are a) growth in the value of the total investment, b) diversification, and c) income, often from growing dividends. However, blended funds aren’t a guaranty of quality.

Blend funds are also often further categorized according to their specialization in small, medium, and/or large-cap stocks. I don’t believe there is really higher risk with blend funds just because their primary investment is in the stock market. Rather, the investor needs to expect volatility and ignore it.

One example of a blended fund is the ever-popular ETF known as SPY. SPY is the SPDR S&P 500 Trust ETF. This fund has a profile that states, “It invests in stocks of companies operating across diversified sectors. The fund invests in growth and value stocks of large-cap companies. It seeks to track the performance of the S&P 500 Index, by using full replication technique.” In other words, it includes growth stocks like Apple and Amazon, and value stocks like Exxon Mobil. Some of the companies pay growing dividends and some pay no dividends.

My grade for blended funds is “C”, or at best “B-.” For example, the VBAIX Vanguard Balanced Index Fund has a ten-year return of 69.74%. The same is true for VBINX Vanguard Balanced Index Fund. The dividend growth rate and dividend yield on these funds is less than satisfactory.

Sector Funds

A sector fund can be a useful tool in an investor’s toolbox. A sector fund focuses on a specific business sector. Some common examples are Communication Services (like AT&T and Verizon), Consumer Discretionary (automobiles, furniture manufacturers, and restaurants), Consumer Staples (food, personal products, beverages), Energy, Financials (banks, insurance companies, BDCs), Healthcare, Industrials, Information Technology, Materials, Real Estate, and Utilities.

The biggest market sector today is Information Technology, followed by Healthcare and the Financials. If you believe that IT and Healthcare are good long-term investments, then adding a sector fund like FTEC for technology or FHLC for healthcare might make sense for you.

My grade for some sector funds is “B”, or at best “B+.” However, Real Estate, Communications Services and Utility sector mutual funds would get a “C-“ in my thinking.

Growth Funds

A growth fund is one that focuses on company stocks with a high growth trajectory. ETF VUG Vanguard Growth ETF is one example. VUG has a ten-year price growth of 226%. The dividend yield is minimal, so to get cash in retirement, you would have to sell shares to get cash. It isn’t surprising to see the same ten companies in the top ten that you would see in many other funds. In fact, 46% of the total investment in this fund is in companies like Apple, Microsoft, Amazon, Alphabet, Tesla, NVIDIA, Visa, and Mastercard. One surprising company in the top ten is The Home Depot.

The problem with growth is that it can shift. When there are wars and recessions, growth investors are generally more nervous than value investors. They often will see stomach-churning drops in the prices of their funds and stocks during times of market stress. At one time a company can be a growth darling (Blackberry) and then turn into a disaster.

Another problem with growth is that it is focused on the hope for a continuing increase in the price of the shares. Dividends play second fiddle or are non-existent. Having said that, my grade for some growth funds is “B+”. VUG is a good place to start. Another possibility is Schwab’s SCHG. However, don’t be surprised to see almost the same set of companies in the top ten for both VUG and SCHG.

Value Funds

This one is my favorite in terms of total investment dollars in our portfolio. ETFs like VYM and SCHD fall into this category. Most of our top ten investments are value stocks. Value stocks frequently have a lower level of risk and volatility. They are usually larger, more established companies or they are mid-cap or small-cap companies with a great set of products and some good earnings growth.

My experience says it is not unreasonable to expect the share prices to increase and the dividends to continue to flow regardless of the state of the economy. In fact, during the last eleven years, the growth of dividends has been more than satisfactory. Our current yield from our total portfolio is about 5.1%. None of that comes from bonds and very little of it comes from CDs.

Full Disclosure

Most of the stocks Cindie and I own are value stocks that pay growing dividends. However, we own shares of Microsoft, Amazon, and other more aggressive healthcare stocks with the potential for growth.