The Best Mutual Funds for Safety and Stable Returns
Mutual Funds That Do a Good Job of Balancing Risk and Return
Which are the safest mutual funds to buy? I often get that question from friends, family and clients. Or they might ask, "How can I get good returns without taking too much risk?"
The word "safe" is a relative term. If you want to buy an investment that is guaranteed never to lose value, you won't find anything that can be accurately defined as an investment, such as stocks, bonds and mutual funds that have risk of losing principal. If you want guaranteed principal, you'll put your money in a bank account or certificate of deposit (CD). But in exchange for the guarantee, you'll be fortunate to find something that earns more than 1%, especially if its FDIC insured.
There's nothing "guaranteed" (other than a few misleading insurance products with hidden fees) that I've seen in all of my 15 years as an investment advisor that pays higher than the rate of inflation, which averages around 3%. If you're earning anything less than that, you're doing something I call "losing money safely."
The fundamental idea of investing is to grow wealth, which can only be done effectively by earning an average rate of return that beats inflation over time. If you're not doing this, your money will be worth less in the future than it is today. That's essentially losing money! Does that fit the definition of safe?
The Safest Mutual Funds You Can Buy
Before providing examples of the safest mutual funds, let's define what we mean by safety. First, remember that safe doesn't always mean guaranteed; safe generally means protecting your savings, which includes staying ahead of inflation. Therefore, ironically, to be safe from inflation, you need to take at least a small amount of risk. Otherwise, you'll lose money in a way that can be considered legalized theft -- where the banks hold your money and pay you a tiny interest rate while they invest at a higher rater it or loan it out to other bank customers at a higher rate.
But again, to get returns that average higher than the rate of inflation, you must take some degree of risk, which is to say that you must be willing to accept brief declines in market value in order to receive average returns higher than 3% over time.
The safest mutual funds that can either match or stay ahead of inflation by a small degree are bond funds. In fact, there is one particular bond type that is commonly used as a benchmark for what is called "the risk-free rate" and that's US Treasury Bonds.
A few good choices for bond funds that invest in US Treasury bonds are Vanguard Short-Term Government Bond Index (VSBSX) and Fidelity Intermediate Government Income (FSTGX). VSBIX has only been around since 2010 but 2013 saw a loss of more than 2% for most bond funds and this fund still managed a positive return of 0.29%. FSTGX lost 1.26% that year but will likely average between 3% and 4% for long-term returns, whereas VSBSX won't likely get more than 3%.
Note that I mentioned "loss" with these funds. Because the investor is not holding bonds (they are holding shares of the mutual fund), bond funds can lose money, although the average bond fund will only have brief declines in value in around one calendar year out of about seven to ten years. For this reason, an investment time horizon of at least three years is ideal for investing in bond funds.
Best Mutual Funds for Stability
When investors say they are seeking safety, they often mean that they want stability in price or low fluctuation in value. The types of mutual funds for stability will usually be balanced funds or target-date retirement funds, which are mutual funds that invest in a balance of stocks, bonds and cash, or other mutual funds, within one fund.
Sometimes called "funds of funds," balanced funds and target-date funds can diversify the holdings in such a way that losses are rare but long-term returns are higher than most bond funds.
One of the best balanced funds with a history of stable returns above the rate of inflation is Vanguard Wellesley Income (VWINX). One of the worst years for stocks was 2008, when the S&P 500 Index declined by 37%. VWINX had a loss of only 9.8%, which beats 90% of all conservative allocation mutual funds. The long-term returns (10 years or more) average nearly 7%. In different words, a patient investor who doesn't mind an occasional loss of around 10% in one year out of about 10 years, but still get average annualized returns significantly above the rate of inflation can consider VWINX.
As for target-date retirement funds, the lowest risk, most stable funds will usually be those with a target date year close to the current year. For example, as I write this, the year is 2015. For the best price stability, I might choose a fund like Vanguard Target Retirement 2015 (VTXVX), which is already conservative (at approximately 45% stocks, 45% bonds and 5% cash as of July 2015), and will gradually get more conservative as the time goes on.
Bottom Line on Investing for Safety and Stability
Before deciding to make your priority safety or stability, be sure to know your priorities. If you need your money in less than three years, it's not in your best interest to invest in mutual funds. And if your priority is safety, and you don't mind earning near-zero interest, mutual funds are probably not the best choice.
But if you want to keep up with (or outperform) inflation with your investments, you'll need to take some degree of risk and be willing to see the infrequent but inevitable declines in value.
If you are not sure how much risk is right for you, try measuring your risk tolerance.