Small Stake, Big Break

February 12, 2007

Steve Butler at the Contra Costa Times describes the value of adding a small stake in a high-risk emerging market fund to his conservative portfolio.

Beginning with a quick lesson in calculating a "weighted average return," I will assume that I have a $100 portfolio and that $5 will be invested in an aggressive fund or combination of funds.

If the $5 doubles in value in a two-year period, I will have $5 of earnings.

If the remaining $95 invested conservatively averages 10 percent per year for two years, that portion will earn $9.50 per year for a total of $19. On the entire portfolio, I have earned $24 in two years.

This works out to be $12 per year, or a 12 percent average annual return. (I have ignored compounding because the time is so short.)

Some would argue that investing only 5 percent of a portfolio aggressively is not enough to "move the needle," but this simple example shows that it can be worth it when the high-risk investment is successful.

On the flip side, what happens if the high risk investment on 5 percent of our money drops by 50 percent in two years?

On $5, we just lost $2.50, or $1.25 per year. On the remaining $95 we still made $19, or $9.50 per year. Our total annual earnings on the entire $100 works out to be $8.25 -- or 8.25 percent. We haven't lost everything. We just had two years where our return was about 2 percent less than it otherwise would have been. Overseas funds of all types are being swamped with new money.”

He ended up investing in T. Rowe Price Emerging Markets Stock (PRMSX), to which our newly overhauled Fund-O-Matic gives a MAXrating of 80. The fund with the highest MAXrating in the category is currently the DFA Emerging Markets Value (DFEVX), but with a $1 million minimum that choice might be a little rich for most people's blood. Our top MAXadvisor Favorite Fund in the category is SSgA Emerging Markets I (SSEMX)