A Surprise in 30-Year Performance Study

A new study on mutual fund performance is challenging a widely held investment assumption: that you need to take big risks to score big gains.

The survey, by Lipper Analytical Services of Summit, N.J., tracks the performance of various mutual fund categories over a truly long time: the 30 years from Sept. 30, 1961, through Sept. 30 of this year.

The most interesting finding is that conservative stock portfolios fared as well as or better than their more aggressive counterparts.

Equity income funds, an especially low-risk group, stole the show by rising 2,127% over the period. Equity income portfolios invest in big, established companies paying generous dividends, often with a focus on companies in neglected industries. The funds now have large weightings in the utility, financial and natural resources sectors.

What gave equity income funds such a big boost over the 30 years was dividend payments. “This shows what above-average dividend income can do if reinvested over time,” says Steven E. Norwitz, a vice president at T. Rowe Price Associates in Baltimore. His firm found that reinvested dividends accounted for 57% of the total return of the Standard & Poor’s 500 index between 1970 and 1990.

As another plus, high-yielding stocks tend to hold up better in down markets. That makes equity income funds less likely to suffer disastrous losses from which they can’t quickly bounce back.

If you own some aggressive stock funds, this doesn’t mean you should necessarily switch into something more conservative. Over shorter periods, volatile funds can rack up much greater gains, as they did earlier this year.

Besides, the average yearly differences between conservative and aggressive funds isn’t as great as the aggregate 30-year numbers might imply. That 2,127% increase for the equity income group translates to 10.9% annual compounded growth. For capital appreciation and growth funds, the comparable compounded returns were 10.5% and 9.8% a year (see chart).

Still, the Lipper results suggest that conservative investors aren’t giving up as much appreciation potential as one might believe. This apparent breakdown in the risk-return relation means that investors can reap nice returns and still sleep easily at night.

Are these long-term investment returns a fluke? Probably not. Lipper Analytical divides general equity funds into five broad categories. Except for small-company portfolios, which didn’t debut until the early 1960s, all the other groups have enough funds with 30-year records to give fairly reliable results, says A. Michael Lipper, president of Lipper Analytical. And the three-decade span is certainly indicative of long-term potential, covering as it did several bull and bear markets and many political and economic traumas.

Most of the broad stock fund groups were able to outperform the S&P; 500 index, the yardstick against which mutual fund results are typically compared. “This shows that professional managers can and do add value over an index or passive investment approach,” Lipper says. However, the difference wasn’t significant: Over the 30-year period, the S&P; 500 chalked up an impressive 10.3% annual growth record.

One important lesson of the Lipper study is that long-term investors need stock market exposure to outpace inflation. The consumer price index rose at a 5.2% compounded annual rate during the three decades. Bond funds did better, but not by much. The average fixed-income fund rose 7.4% a year, including dividends. “This is a good argument against buying a bond fund and spending the dividends,” Lipper says.

It’s also a good argument against overweighting your fixed-income holdings. Although most retirees will continue to build their financial plans around bonds and bond funds, they should have some equity exposure to maintain their purchasing power. People in their 60s might want to earmark 35% to 50% of their liquid assets in stock funds, advises Carl J. Camp, an investment adviser and mutual fund specialist with Eclectic Associates in Fullerton. His favorite equity income funds include Financial Industrial Income (800-525-8085), Lindner Dividend (314-727-5305) and T. Rowe Price Equity Income (800-638-5660), none of which charges a sales fee.

Unfortunately, the Lipper results don’t reveal much about the long-term investment potential in certain fund categories, including small-company, international, global, utility and gold. Not enough of these funds were around in 1961 to make the numbers meaningful.

But over a 20-year period, which the study also tracked, global funds were standout favorites, gaining 1,253% on average (13.9% annually). Global funds had even better results over the 10 years from September, 1981, through September, 1991, rising 351% (16.2% annually).

Fortunately for investors, even the most sluggish domestic stock fund categories achieved solid returns over the past 10, 20 and 30 years. “All of these results are very favorable relative to inflation,” Norwitz says. “If you take a long-term view and have the discipline to stick with a strategy, any type of equity fund will work for you.”

Rethinking a Rule of Thumb

Must one assume big risks to achieve above-average gains? Not necessarily, a study by Lipper Analytical Services shows. Equity-income funds, among the most conservative stock portfolios, compiled superior results over 10, 20 and 30 years. Growth-and-income funds, another lower-risk category, also fared well.

Annual Gain Fund Type (Focus) 30 years 20 years 10 years Equity Income +10.9% +12.2% +15.3% (dividend-paying stocks) Small Company (small stocks) +10.8% +12.1% +13.3% Capital Appreciation +10.5% +12.1% +14.5% (highly volatile stocks) Growth and Income +10.1% +11.5% +15.6% (blue chip stocks) Growth (growth stocks) +9.8% +11.4% +15.1% Balanced (stocks, bonds) +9.0% +10.8% +15.7% Fixed-Income (bonds) +7.4% +8.4% +13.1% Inflation +5.2% +6.2% +4.0%

Results are compounded annual returns for periods ending Sept. 30. They assume all dividends have been reinvested.