Prevent the Pack-Rat Syndrome

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Prevent the Pack-Rat Syndrome
by Michael Iachini, CFA, CFP®, Director, Investment Manager Research, Schwab Center for Financial Research
January 5, 2007

Reprinted from the December 21, 2006 issue of Schwab Investing Insights®, a monthly publication for Schwab clients.

Does your mutual fund portfolio look like a pack rat's closet, bursting with yesterday's hot styles and top sellers? If so, you're not alone. Mutual fund investors tend to pour money into hot asset classes just as they're beginning to flame out, and bail out of poor-performing classes just before they hit bottom.

The problem is that a collection of historically high-performing funds does not necessarily make a well-diversified portfolio and can greatly increase risk. Avoid the pack-rat syndrome. Think of a well-diversified portfolio as a puzzle where each fund fits neatly with the others to complete a well-balanced picture.

Begin by establishing a long-term asset allocation plan—your combination of large-cap and small/mid-cap U.S. stocks, international stocks, bonds and cash. That plan determines the broad risk level of your portfolio. But don't stop there. Consider these five additional risk control steps.

Invest in both value and growth stocks. We suggest an equal allocation to each over the long run. For fund ideas, see the Mutual Fund OneSource Select List® on Schwab.com.
Diversify your international holdings. Consider funds that invest in developed-market large- and small-cap stocks, as well as in emerging markets (see the Select List). Although emerging-market and international small-cap stocks are risky on a stand-alone basis, they generally have lower correlations with developed-market stocks and, as such, offer attractive diversification benefits.
Don't concentrate in one investment strategy. Specific strategies perform better or worse in certain market environments. For example, growth funds that focus heavily on price or earnings momentum often outperform their peers in overheated markets, while funds that look for growth at a reasonable price (GARP) often outperform their peers in sideways or falling markets. So, in picking funds, remember to diversify across investment strategies.
Avoid overlap across funds. Consider the top holdings of each fund in your portfolio, making sure you're not inadvertently concentrated in a single sector or security. For a quick look at sector allocations across stocks and funds, use the Schwab Portfolio Checkup® tool on Schwab.com/portfoliocheckup.
Look for disciplined risk management. Sophisticated quantitative techniques are helping fund managers control risks better than ever.

Important Disclosures

Investors should consider carefully information contained in the prospectus, including investment objectives, risks, charges and expenses. You can request a prospectus by calling Schwab at 800-435-4000. Please read the prospectus carefully before investing. Investment value and return will fluctuate such that shares, when redeemed, may be worth more or less than original cost.

Charles Schwab & Co., Inc. receives remuneration from fund companies in the Mutual Fund OneSource® program for recordkeeping, shareholder services and other administrative services. Schwab may also receive remuneration from transaction-fee fund companies for certain administrative services.

This report is for informational purposes only and is not an offer, solicitation or recommendation that any particular investor should purchase or sell any particular security or investment strategy. Schwab does not assess the suitability or the potential value of any particular investment or investment strategy. All expressions of opinion are subject to change without notice.

The Schwab Center for Investment Research® is a division of Charles Schwab & Co., Inc.

All research has been compiled from publicly available, proprietary and/or licensed data.

Past results are not indicative of future performance. Diversification and asset allocation do not eliminate the risk of investment losses.

International investments are subject to additional risks, such as currency fluctuations, political instability and the potential for illiquid markets. Investing in emerging markets can accentuate these risks.

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