Q: Fidelity offered to look at my investment portfolio for free, so I took them up on it. After taking all of my information and asking some questions, the young man who met me said that I have “a hole in small-caps and emerging markets.” He offered suggestions to fix it that sounded good, but I don’t know. I want to keep things simple and I’m doing OK and I like the way I have things now. I never heard of the funds he said I should buy before. . . . How bad off am I, really, if there’s “a hole in my small caps,” whatever that is? Joe L. in West Palm Beach, Fla.
A: Your question is actually about diversification, and how much you have to spread your money around.
The smart money has long maintained that the best way to keep your portfolio moving steadily forward — smoothing out some of the bumps that the market inflicts on the long journey to growth — is through diversification. Most advisers want a portfolio to include different-sized stocks (some from small, medium and large companies) from across the globe.
The “hole in the small caps” means that your funds own shares in large and mid-sized companies, but that you don’t hold anything that buys stocks in smaller companies. (The “cap” is shorthand for “market capitalization,” so a small-cap stock is one where the total value of all outstanding shares is typically $750 million or less. The emerging-markets problem suggests that you have international funds that are focused on developed nations, rather than new economies.
The sad thing about both of those holes in the portfolio is that you have missed long rallies in small-cap stocks (although that slowed dramatically in 2007) and emerging-markets funds. The happy news is that it didn’t seem to bother you.
There is no denying that a portfolio that included small-company stocks and emerging-markets stocks would have outperformed one that lacked those holdings during the past few years, but there is also no arguing that both of those areas of investment can be a bit volatile.
Like my father, for example. I have said many times that he’s uncomfortable with small-cap funds, largely because he doesn’t recognize the names of the holdings, which makes him nervous. In his case — and possibly yours, judging from the letter — any costs associated with not filling every big asset class are offset by the peace of mind of being comfortable with the portfolio.
Q: My fund crashed in December. It lost more than $4 a share, and I haven’t seen anyone writing about it. Why don’t you write about things like this?
A: I get a lot of questions like this one every December, and invariably the reason I don’t write the story is that neither the fund nor its shareholders lost any money. The fund merely paid out a big distribution and adjusted its share price accordingly.
By law, funds must pass to shareholders at least 98 percent of dividends and capital gains — profits made when investments are sold — earned in a year. Throughout the year, the fund accumulates those gains — and may offset them with any investment losses — before distributing them to shareholders, typically late in the year.
Call the fund to make sure that’s the explanation, but don’t let a price fall scare you into action until you’re sure the fund has given you reason to be unhappy.
Chuck Jaffe: cjaffe@marketwatch.com
