A Retirement Investment to Avoid

Before you go, we thought you'd like these...
Before you go close icon

News flash: The stock market is risky.

We've always known that, at least in the abstract. But the crash of 2008 brought it home in a big way, with many folks seeing losses of 50% or more in their retirement portfolios. That forced a lot of investors to scale down their retirement dreams -- as well as their bruised portfolios' risk exposure.

Always ready to jump on a trend, Wall Street's financial "engineers" rushed to introduce new products that would help investors manage risk -- for a price. But like a lot of Wall Street inventions, some of these new funds make it hard to tell who benefits.

Absolute return? Not so much.
It's a great idea: a fund designed to make money whether the market is moving up or down. That's the promise put forth by absolute return funds, which typically combine a variety of different asset classes in a combination of long and short positions to try to generate an "absolute" level of return that stays fairly steady regardless of market conditions.

It sounds so simple in theory, and it was probably inevitable that we'd see mutual funds run this way -- hedge funds have used variations on the basic long-short strategy for years. But in practice, these funds haven't done well, especially in rough markets. In today's new issue of our Rule Your Retirement newsletter, Foolish fund whiz Amanda Kish notes that 16 of the 20 absolute return mutual funds that were around in early 2008 lost money that year.

When you look a little more closely, it's hard to see how they could do well over the long haul, at least relative to the stock market. Over time, stocks have beat just about everything, so a fund that holds stocks plus other stuff seems likely to have trouble keeping up.

Ah, but you say that's overly simplistic, and smart management and financial engineering can make up the difference? History says otherwise: Funds labeled as "absolute return" funds returned just over 3% in 2010, according to Morningstar, and a bit under 11% in 2009.

Not bad? I say not good: Consider that the S&P 500 returned 15% and 26.5% respectively over the same two periods. You could have had that with an index fund -- without the hefty fees that many absolute return funds charge.

Admittedly the funds did better, at least relative to the S&P 500, during 2008. While the index took a 37% haircut as a result of the economic crisis, the funds as a group were "only" down about 13%.

That's better than a 37% loss. But it's hardly an "absolute return." There has to be a better way, doesn't there?

I think there are a few better ways.

Stocks for "absolute return"
There are no guarantees in the stock market, but a recession-resistant company that pays a dividend comes close. While the stock price of a company like Kleenex-maker Kimberly-Clark (NYS: KMB) is unlikely to shoot to the moon, it's just the kind of business that is likely to keep thriving when the economy tanks. The fact that it has raised its dividend every single year for almost four decades says volumes.

Or consider Campbell Soup (NYS: CPB) , with its huge return on equity and a dividend that has been paid every year since 1980. Household budgets might get cut during hard times, but canned soup is an affordable staple for millions -- and a profitable one.

Soup addicts are one thing, but tobacco might be the last word in recession-resistant consumer businesses. Altria's (NYS: MO) overseas spinoff Philip Morris International (NYS: PM) is the gem here, with top-notch brands and amazing free cash flow. And unlike Altria, Philip Morris International has no exposure to the declining -- and likely to be even more heavily regulated -- U.S. market.

If investing in tobacco doesn't feel right to you, how about investing in medicine? Johnson & Johnson (NYS: JNJ) makes everything from Band-Aids to cutting-edge medical devices, great businesses to be in during good times and bad. How great? J&J has raised its generous dividend every year for almost 50 years.

Stocks not your thing?
Still rather have a mutual fund? Or maybe you have one of these absolute-return funds in your 401(k) and want a better option? Check out the new issue of the Fool's Rule Your Retirementnewsletter, in which the aforementioned fund whiz Amanda Kish takes a look at the pitfalls of absolute value funds (as well as a couple of other not-so-bright ideas from Wall Street).

Amanda's got some great ideas for managing the risk of a shaky market that won't cost you a fortune in lost returns -- or in management fees, either. And they'll work just as well in your 401(k), your IRA, or in your regular brokerage account.

Rule Your Retirement is a paid service, but you can get full access to Amanda's article and all of the service's great content free of charge, with a no-obligation 30-day trial. Just click here to get started.

At the time this article was published Fool contributor John Rosevear has no position in the companies mentioned. The Motley Fool owns shares of Johnson & Johnson, Altria Group, and Philip Morris International.Motley Fool newsletter serviceshave recommended buying shares of Philip Morris International, Johnson & Johnson, and Kimberly-Clark, as well as creating a diagonal call position in Johnson & Johnson. Try any of our Foolish newsletter servicesfree for 30 days. We Fools may not all hold the same opinions, but we all believe thatconsidering a diverse range of insightsmakes us better investors. The Motley Fool has adisclosure policy.

Copyright © 1995 - 2011 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.

Read Full Story

Want more news like this?

Sign up for Finance Report by AOL and get everything from business news to personal finance tips delivered directly to your inbox daily!

Subscribe to our other newsletters

Emails may offer personalized content or ads. Learn more. You may unsubscribe any time.

From Our Partners