I am traveling this weekend, but regular posting will resume on Monday.

Target-date funds, which are widely used in 401k plans because many investors assume they have less risk, failed miserably during last year’s market meltdown.

SmartMoney reports that Morningstar now has come out with a new ranking system designed to make it easier to compare these types of funds:

Ever since target-date funds were introduced a few years ago, critics have complained that the funds — a mix of stocks and bonds that are supposed to get more conservative the closer the investor gets to retirement age — are nearly impossible to compare to one another.

Not anymore, says Morningstar, the biggest and most popular mutual fund research and ratings firm. On Wednesday the company announced its first comprehensive rankings of the funds. Vanguard, known primarily for its low-cost index funds had the best group of target-date funds. Oppenheimer was ranked last. Fidelity, the largest manager of target-date assets, offers two series of target-date funds: its no-load Freedom Funds were rated “average” and its advisor-sold Freedom Advisor funds were rated “below average.”

Again, while it is helpful to compare apples with apples, it does not mean that these types of investment can be purchased indiscriminately.

I wrote about these funds, which used to be called Lifestyle funds, during the last bear market in 2002 in an article called “Do Lifestyle Funds Provide Greater Security?” Their miserable bear market performance then was repeated in 2008 to the same degree.

Don’t let ranking schemes give you a false sense of security. These types of funds will work in bull markets but will harm your portfolio when the bear shows up for his curtain call. As always, if you invest in anything, be sure to use my recommended exit strategy to protect your portfolio should disaster strike again.

My latest No Load Fund/ETF Tracker has been posted at:

http://www.successful-investment.com/newsletter-archive.php

The bulls remained the upper hand during the first week of September, and all major indexes gained.

Our Trend Tracking Index (TTI) for domestic funds/ETFs has now crossed its trend line (red) to the upside by +7.88% keeping the current buy signal intact. The effective date was June 3, 2009.



The international index has now broken above its long-term trend line by +16.00%. A Buy signal was triggered effective May 11, 2009. We are holding our positions subject to a trailing stop loss.



[Click on charts to enlarge]

For more details, and the latest market commentary, as well as the updated No load Fund/ETF StatSheet, please see the above link.

Two days ago in “A Hopeless Reader,” I talked about the importance of knowing your risk tolerance. Reader Mel had this to say about it:

I’m worried too, but going from fully to zero to 75% invested in a matter of days? If I don’t know which way the market is going, I try to pick a percentage–50, 30, etc–that I can live with for at least a couple of weeks while waiting to see if there’s a direction forming. That way I’m not pretending to know something I don’t know, and I’m protected either way.

It appears to be a common problem trying to find an entry point to deploy a certain percentage of assets after the markets have rallied, and you have sold out prematurely.

Here’s an easy way to determine your risk tolerance. Say, you have a total portfolio of $100k in cash and want to re-invest in the market. How aggressive should you be? Should you go in 100% this late in the game or use a smaller percentage?

Let’s find out where you are coming from in these 3 scenarios:

1. Imagine that you have invested your entire $100k all at once and, right thereafter, the markets head south and your sell stops are triggered leaving you with a 7% loss, which equals $7,000. How do you feel about that? Are you aggressive enough to accept that situation without being emotionally upset? If not, move on to number 2.

2. Assume that you only invested $66k (2/3 of your portfolio value) and the same circumstance as above occurs. The markets reverse their trend right after your purchase, and you lose 7% again. Since you only had $66k invested, your actual dollar loss would be some $4,600, which represents 4.6% of your total portfolio. Do you find this risk more acceptable? If not, move on to door number 3.

3. Same situation as above, except your initial investment is only $33k (or 1/3 of total value) before the markets head south again. Using the same 7% sell stop, your loss would be $2,300 or 2.3% of your total assets. Is that more in line with your risk tolerance?

If not, you should not be in the markets to begin with. This is a simple but quick and effective way to evaluate your risk profile. Sure, you can get far more complicated, but what it comes down to is how much can you accept to lose while in pursuit of growing your portfolio?

Next time, you are faced with an investment decision, apply these simple rules (and involve your better half if necessary), and you will find that your decision becomes much easier.

One anonymous reader had these comments a few days ago:

Can you please explain how someone who appears to advocate Market tracking investing using stop losses can also advocates hedging “the simple hedge strategy”?

Can you please explain to me why you advocate both approaches, and the advantages of both?

When following major trends in the market, there will be prolonged periods of time where our Trend Tracking Indexes (TTIs) are in bearish territory and therefore keeping us out of the markets.

Case in point is the past 1-1/2 years. Our domestic TTI generated a sell signal effective as of 6/23/08. The markets subsequently crashed, recovered towards the end of 2008, dropped again 22% until making a low on March 9, 2009 and then rallied some 50% as measured by the S&P; 500.

Our domestic TTI did not cross above its long-term trend line until 6/3/09 when a new Buy signal was generated. That’s almost one year later after we headed to the sidelines.

Just because our TTI is in bear market territory does not mean there are no other investments opportunities. However, with the markets having shown the volatility they did, going outright long (against the major trend) or outright short had huge risk factors attached to it.

This is why I developed the SimpleHedge Strategy. It allows us, as described in the book, to enter the markets safely at a much earlier time to attempt to add profits before our regular buy signal occurs. This is exactly what happened, as the hedge strategy generated a buy late in December 08, when uncertainty reigned.

As it turned out, the hedge opportunity was profitable and allowed us the option to drop the short component of the hedge when the domestic Buy was generated. Some clients like the hedge so much, that they preferred staying with it.

However, let me be clear. In an outright bullish run, such as we’ve seen off the lows in March, a hedge will always lag in performance. Here again, as I discussed yesterday, a client’s risk tolerance would determine which path he should take.

The hedge concept is designed to fill the “lengthy gaps” inherent in trend tracking. I have found it to be a nice combination worthwhile considering by anybody but the most aggressive investor.

In case you missed it, reader Chuck had some interesting comments a few days ago:

It’s true that there are so many conflicting opinions as to whether the markets will rise or fall. There are good cases to be made on either side. It seems to me that, up until now, the big money is betting on this bull.
…
I think that’s why I like trend following. You can ignore the opinions and react only to what the market is actually doing. That is, if you can stick to your strategy and not let your emotions rule you. I can’t, LOL. I sold out Thursday.

Am I hopeless?

What Chuck is referring to is something I deal with in my advisor practice on a daily basis. It’s called a client’s risk tolerance. With new clients, I tend to start out with a more conservative stance within the framework of trend tracking and then switch to a more aggressive mode, if requested.

When you are investing in anything, you have to be sure that you’re comfortable with the approach itself along with the potential risk involved. If you’re not, you will not stick with for the long-term, which is where the rewards are.

While I don’t advocate setting stops as tightly as Chuck does, he seems more comfortable with the outcome and apparently does not mind the more frequent whip-saws resulting from his approach.

However, when dealing with tight stops and frequent whipsaws, you have to make sure that you don’t do the same on the upside, which is taking profits too quickly. You need to let your winners run until the trend ends and reverses. Your trailing stop loss will then tell you when it’s time to exit your position.

Not letting your profits run and cutting your losses too quickly is a bad combination. You may find out that, while your downside is well controlled, you’re not making enough on the upside to make up for the small losses you incurred. In other words, you’re simply treading water.