Investing In Principal Protection Funds

by Alan Lavine and Gail Liberman

Principal protection mutual funds sound like a good deal. You invest for a required 5 or 7 years in a common stock mutual fund. At maturity, you get your principal back.

Aha! You can invest in stocks and get your money back.

Are you going to drop everything, call a broker, pay them a fat commission and invest?

Don’t do it. There is no free lunch. Roy Weitz, publisher of FundAlarm.com says that these funds only invest a small percentage of your money in stocks. The rest is invested in bonds and cash. The reason: The funds have to invest in bonds and cash to make sure can pay you back at least your principal.

In addition, the funds charge sales commissions of about 4.5 percent. So your entire principal is not invested.

Weitz says the average stock fund gained 12 percent and 33 percent in 2003 and 2004 respectively. By contrast principal protection funds gained, on average, just 2 and 5 percent respectively.

Weitz says that principal protection funds are a big rip-off. They were designed so brokers could sell a stock investment to squeamish investors.

So what is the safest way to invest in stocks? You always face risks when you invest in stocks. Bad news about a company can send a stock’s price south. And if the stock market declines, your mutual fund that invests in stocks is likely to drop.

The best way to reduce your risk:

• Also invest in bonds, money funds, U.S. Treasury bills, real estate, precious metals and money market funds. These investments will cushion your stock market losses.

• Invest for the long term. A 50 percent stock and 50 percent bond mix has never lost any money over holdings periods greater than 10 years, according to Ibbotson’s Associates, Chicago.

• Invest in an asset allocation mutual fund that diversifies for you.

Alan Lavine and Gail Liberman are husband-wife personal finance columnists, journalists and authors. They are the authors of "Rags To Retirement," published by Alpha Books. Their columns appear in newspapers throughout New England and the Southeast, as well as online. Their commentary on mutual funds and personal finance is carried by 200 radio stations nationwide every Sunday over Business News Network's Charles DeRose Financial Advisor Show. Al and Gail’s new book is "Rags To Retirement:  Stories from people who retired well on much less than you think," published by Alpha Books.

More articles by Al and Gail can be found here.