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Why Knowing The Investment Style of a Stock Mutual Fund is Important

Different equity investment styles perform differently at different points in time, and all investment styles will under perform the general market indexes at some point. This is why it is very important that you have all styles represented in a well diversified portfolio. Simply picking two or three stock mutual funds without knowing the funds investment style doesn't always give you a diversified portfolio. The three funds you picked may all be growth managers. You are not diversified, but are in fact concentrated in one style. While this may work out if you picked correctly, it can be a disaster if you didn't.

Investment Styles

There are three broad equity investment styles:

  • Value fund managers look for fundamentally strong companies that, in the managers opinion, are temporarily out of favor with other managers causing their stock price to be depressed. Value managers purchase the stock of these solid companies and seek to benefit when the rest of the market recognizes that the companies are undervalued and stock heads back up.
  • Growth fund managers look for companies which are growing rapidly and which are expected to show continued strong growth in earnings and revenue. Everyone seems to want to owned these companies. Stocks that are often purchased by a manager with this style tend to have higher valuations as measured by the price to earnings ratio (P/E ratio).
  • Blend fund managers will mix the value and growth philosophies. The fund may contain growth stocks and value stocks, or it may contain stocks that exhibit both characteristics.

Within these three broad styles, the equity fund manager can further specialize by focusing only on companies of a certain size, called market capitalization or market cap for short. The two most common market cap styles are small and large. The definition of a small cap or large cap company varies, so don't worry about it. What is important is that you know what market cap area the fund focuses on. For the same diversification reasons that you don't want three funds that are all growth focused, you don't want all your equity funds to be focused in only one market cap area.

Here Is An Example

For the portion of my portfolio I want to invest in stocks, here is an example of a reasonable allocation between styles that would give me a well diversified, growth oriented portfolio: 50% in a large cap growth fund, 25% in a small cap growth fund, and 25% in a large cap value fund.

Where To Find Fund Style Information

Don't know the style of your different equity investment options? There are a number of good web based resources you can use to find out this information. One of the best is Morningstar (www.morningstar.com). Just enter the funds ticker or name in the Quotes & Reports dialog box and you will get complete information on the fund including style data.

Confused Or Just Don't Want To Deal With It?

Putting your equity allocation into an index fund can give you a style diversified portfolio without all the hassle. Index fund manager take a very simple approach. They attempt to mirror the exact holdings of one of the major stock market indexes. The most common is the Standard and Poor 500 index which contains both value and growth companies that have a range of market caps. A manager who is running a S&P 500 index fund is going to attempt to hold the same percentage weighting of a given stock as the actual index holds. Therefore, the style allocation (and investment return) on the fund is going to closely approximate that of the index. This is a passive approach to investing and has many advantages.

Remember, this information is provided as general guidance on the subject of asset allocation and is not provided as legal, tax or investment advice. Individual situations vary. Please be sure you consult with your tax, legal or financial advisor for more detailed information and advice.

This is for educational purposes only. The information provided here is intended to help you understand the general issue and does not constitute any tax, investment or legal advice. Consult your financial, tax or legal advisor regarding your own unique situation and your company's benefits representative for rules specific to your plan.

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