Ultimate fund portfolio
The best choices for stable, long-term growth in five essential categories.
NEW YORK (Money Magazine) -- Chuck Royce oozes expertise. From his bespoke suits and bow ties, to his passion for handcrafted wooden boats, to his patrician bearing, the president and chief investment officer of Royce & Associates comes across as the kind of old Wall Street hand who set your grandparents up in their comfortable retirement.
Heck, he might well have. Royce, 67, has 43 years of experience, and he's steered his Pennsylvania Mutual fund to average annual gains of 16 percent since 1973.
A pioneer in small-company investing, he's such a legend that we've made him a model for our own stock portfolio (see "The Fortune 40").
And when you ask him about his duty to shareholders, he doesn't joke around. "I have a responsibility to run this money in the best possible way for the very long term," says Royce. "That is definitely on my mind."
In short, Royce is the kind of guy you want picking stocks for your retirement portfolio - if you're not going to do it yourself, that is.
And for those of us who aren't natural DIY-ers, turning the task over to professionals makes a lot of sense. (Quick quiz: Do you check stock quotes obsessively on your BlackBerry? Read 10-K filings in bed at night? Impress your friends by reciting P/E ratios from memory? No, no, and no? This strategy may be for you.)
With a diversified group of funds you can get the upside of equities without quite so much volatility, and leave the stress over quarterly earnings to unflappable types like Chuck.
To simplify things even further, for the past two years we've selected standouts in several basic categories - what we call the Ultimate Mutual Fund Portfolio.
The group is designed to produce robust long-term gains, but our choices (including Royce's fund) have delivered in the near term too.
The funds we assembled in 2005 averaged a one-year return of 16 percent, vs. 10 percent for the S&P 500 index.
Last year we updated our picks, and the portfolio returned 21.2 percent from June 7, 2006, through June 5 of this year, vs. 23.4 percent for the S&P (our four equity funds averaged a 24.2 percent return, and our capital preservation fund returned 9.2 percent).
Given that success, we kept the basic building blocks in place this year.
The anchor of our lineup remains a total-market index fund, which invests in companies of all sizes. To complement that core holding, we have an actively managed large-cap fund along with more specialized small-cap and international picks for diversification and return potential. There's also an alternative-asset fund for additional balance.
Of course, mutual funds aren't the only option if you don't like to trade individual stocks. Exchange-traded funds (ETFs) continue to grow in both numbers and assets (there are now over 500 ETFs with some $480 billion in assets in the U.S., according to State Street Global Advisors).
And each of our mutual fund choices is accompanied by an ETF alternative. Those exchange-traded funds - which feature low expenses and are tax-efficient - may be right for you, particularly if you're looking to invest a large lump sum in the market. But if you plan to invest periodically, the mutual funds listed here can help you steer clear of the trading commissions that can add up when buying ETFs.
Total stock market
Whether you choose mutual funds or ETFs, broad-based indexes still make for sensible core holdings.
Our choice in this category last year, Vanguard Total Stock Market Index, remains an excellent option. But for investors looking to invest $10,000 or more, Fidelity Spartan Total Market Index (FSTMX (Charts) is even more appealing because it provides the same exposure and takes an even smaller cut of your money. (The expense ratio is just 0.10%.) The fund tracks the Dow Jones Wilshire 5000 total market index and holds more than 3,000 stocks.
That blend has helped it post annualized gains of 11.2 percent a year over the past five years, more than a percentage point better than the large-cap-dominated S&P 500.
Large company stock
After years of being outperformed by small-cap stocks, large caps may finally be ready to reassert themselves as market leaders.
Over the past six months, the S&P 500 has gained 10.3 percent, edging out the 8.4 percent advance of the Russell 2000 small-cap index.
If that trend continues, the $4.5 billion Dreyfus Appreciation (DGAGX (Charts) fund should take off. We anticipated big gains for big caps when we added Dreyfus to our mix last year, but the fund has lagged behind the S&P 500 by three percentage points.
However, we still like veteran manager Fayez Sarofim's portfolio, which is heavy on blue chips such as Altria (Charts, Fortune 500) and Citigroup (Charts, Fortune 500). Extremely low turnover and a modest 0.95 percent expense ratio add to our conviction.
Small company stock
Not that you should abandon the pip-squeaks. Even if market momentum shifts to larger stocks, small caps can diversify a portfolio and improve long-term returns.
And Royce's Pennsylvania Mutual (PENNX (Charts) fund remains a standout. The $4.9 billion portfolio holds more than 400 small- and mid-cap stocks and has posted three-year annualized returns of nearly 19 percent.
Investors chasing grande returns in overseas markets have flooded money into foreign funds in recent years.
Following the trend, our pick, Dodge & Cox International Stock (DODFX (Charts), has ballooned to more than $41 billion in assets since it launched in 2001. But its growth hasn't hindered performance. The Dodge & Cox managers have posted total returns of 28 percent annually over the past three years by loading up on value stocks such as French pharmaceutical leader Sanofi-Aventis and Finnish mobile-phone maker Nokia.
No matter how spread out your stock bets are, you shouldn't live by equities alone. Our choice for diversification is the Pimco All Asset fund (PASDX (Charts), which focuses on capital preservation and aims for a 5 percent real return (above inflation).
Manager Rob Arnott invests in everything from commodities to bonds to real estate investment trusts, and his fund offers a generous yield of 5.2 percent. Arnott recently had 17 percent of his portfolio stashed in ultrasafe Treasury inflation-protected securities, or TIPS.