The Investor's Guide to Fidelity Funds Winning Strategies for Mutual Fund Investing Peter G. Martin M.Sc. (Applied Physics), Durham, U.K. and Byron B. McCann M.B.A. (Finance), Stanford Second Printing Venture Catalyst Redmond, Washington To America, for fostering the best investment climate in the world; and Japan, for reminding us of the importance of saving. To Fidelity Investments, for the mutual fund innovations that have revolutionized individual investing. To our families, for putting up with so much for so long. Copyright 1998 by Venture Catalyst, Inc. All rights reserved. Reproduction or translation of any part of this work beyond that permitted by Section 107 or 108 of the 1976 United States Copy- right Act without the permission of the copyright owner is unlawful. Requests for permission or further information should be addressed to Venture Catalyst Inc., 17525 NE 40th Street, Suite E123, Redmond WA 98052. This publication is designed to provide accurate and authori- tative information in regard to the subject matter covered. It is sold with the understanding that the publisher is not engaged in rendering legal, accounting, or other professional service. If legal advice or other expert assistance is required, the services of a competent professional person should be sought. From a Declara- tion of Principles jointly adopted by a Committee of the American Bar Association and a Committee of Publishers. Publisher's Cataloging in Publication Data Martin, Peter G. and McCann, Byron B. The Investor's Guide to Fidelity Funds p. cm. Bibliography: p Includes index ISBN 1-881983-03-X 1. Mutual fundsÐUnited States. 2. Fidelity funds (Firm) I. Martin, Peter G. II. Title. Book composed using ScenicWriter Printed in the United States of America Originally published by John Wiley & Sons, Inc. 1989 as "The Investor's Guide to Fidelity Funds" This second printing published by Venture Catalyst, Inc. 1992 CONTENTS WHY READ THIS BOOK? vii 1 INTRODUCTION 1 2 WHY INVESTORS CHOOSE MUTUAL FUNDS 5 What Is a Mutual Fund? 5 Selecting a Fund Family 7 Advantages of Mutual Funds 9 Mutual Fund Innovations 11 Disadvantages of Mutual Fund Investing 13 Conclusions 15 3 REALITIES OF INVESTING 17 Financial Planning Basics 17 Real Growth Comes from the Stock Market 21 Risk and Return Go Hand in Hand 21 Random Events Trap the Unwary 22 Psychology Drives the Market 24 Beating the Market Is Difficult 25 Conclusions 28 4 THE FIDELITY FUND FAMILY 29 Industry Sector Funds 30 International Equity Funds 34 Capital Growth Funds 35 Growth and Income Funds 37 Taxable Bond Funds 40 Municipal Bond Funds 44 iii CONTENTS Money Market Funds 45 Conclusion 47 5 DEALING WITH FIDELITY 49 Connecting with the Organization 49 Opening an Account 50 Purchasing Shares 54 Monitoring Your Account 56 Switching Between Funds 56 Making Redemptions 59 Using the FAST System 59 Opening a Brokerage Account 63 Fidelity Telephone Numbers 66 Conclusion 67 6 RETURN, RISK, AND PERFORMANCE 69 Measuring Total Return 69 Causes of Risk 71 Conventional Risk Measures 73 Exposure and the Ulcer Index 77 Risk and Reward 81 The Real Meaning of Performance 84 Maximizing Wealth 86 Implications for Investment Strategies 87 7 PASSIVE INVESTMENT STRATEGIES 89 Buy-and-Hold 89 Dollar Cost Averaging 91 Market Timing with Moving Averages 91 Testing the Passive Strategies 94 Conclusion 96 8 BOOSTING PERFORMANCE THROUGH ANALYSIS 97 Fundamental Analysis 98 Technical Analysis 101 Combining Fundamental and Technical Analysis 106 Applying Results of Analysis 106 Investment Newsletter Strategies 108 Conclusions 114 iv CONTENTS 9 DESIGNING A FUND SWITCHING SYSTEM 115 Design Goals 115 Underlying Assumptions 117 Selecting Funds to Be Monitored 117 Identifying Price Trends 119 Measuring Historical Performance 125 Conclusions 129 10 MARKET TIMING 131 Dividend Yields and P/E Ratios 131 Monetary Indicators 132 Combining Market Yields and Interest Rates 133 Testing the SVI Indicator 134 Combining SVI Timing with Fund Switching 141 Interpreting the Test Results 142 Alternative Timing Indicators 145 Conclusions 146 11 HOW TO EVALUATE INVESTMENT STRATEGIES 149 Slippage Can Impact Real Returns 149 Are Test Results Statistically Valid? 152 Exposure to Hidden Risks 159 Dependence on Hidden Assumptions 161 Changing Market Behavior 165 Are Results Too Good to Be True? 167 Build Your Own StrategyÐPainlessly 170 Conclusions 171 12 AGGRESSIVE FUND SWITCHING STRATEGIES 173 Select Fund Strategies 173 All-Funds Portfolio 175 Conclusions 177 13 TAX SHELTERING WITH MUTUAL FUNDS 179 Definition of Terms 180 1986 Tax Reform Act 181 Tax Sheltering with Fidelity Funds 181 Effects of Deductibility and Deferral 182 Retirement Plans for Everyone 185 Variable Insurance Products 190 v CONTENTS Pay-Out Options 194 College Investment Plans 196 Conclusions 196 14 FUND SWITCHING IN PRACTICE 199 Matching Financial Objectives 199 Monitoring Performance 201 Implementation Tools 203 Sources of Fund Prices 204 Spreadsheet Model 209 Worksheets for Manual Calculation 216 15 CONCLUSIONS 225 What the Future Holds 225 Pulling It All Together 227 APPENDIXES A FIDELITY FUND TABLES 229 B PRICE AND RELATIVE STRENGTH CHARTS 239 How to Read the Charts 239 Industry Sector Funds 241 International Equity Funds 258 Capital Growth Funds 261 Growth and Income Funds 266 Taxable Bond Funds 269 Municipal Bond Funds 273 S&P 500 Stock Index 275 RECOMMENDED READING 277 Books for Further Study 277 Periodicals for Fidelity Investors 278 INDEX 279 vi WHY READ THIS BOOK? From the explosive growth of the mutual fund industry in the 1980s, the giant Fidelity family has emerged as a clear market leader. With more than 100 funds under management, Fidelity offers a unique opportunity to focus your investments in almost any class of securities, domestic or international. Switching your assets among funds is quick and easy, and trading costs are essentially zero. Focusing your investments on sectors of the global economy that have the greatest potential for profit is one way to beat the market averages. Combine this approach with the safety provided by each fund's inherent diversification, and you have an investment vehicle with all the advantages of trading individual securities, but none of the disadvantages. Just as with any other investment, it is essential to develop a strategy for selecting which funds to buy and sellÐand when. These decisions cannot be left to the emotions, or to chance. In this independent guide we explain some of the methods used today for managing Fidelity fund investments. But most of all, we develop a straightforward money-making strategy you can use yourself. We also show how the strategy is tested so you can be confident it will continue making money for you in the future. We clear up some of the common misconceptions about investing with Fidelity, and we show how to avoid the pitfalls that can prevent even the best strategy from working for you. Using the techniques described in this book, you should be able to beat the market by an average of 10 to 15 percentage points per year, without assuming more than market levels of risk. If you plan to develop an investment strategy of your own, you will find this book full of useful tools for design and testing. We have included historical price charts and statistics on Fidelity's retail funds. vii WHY READ THIS BOOK? Fidelity is a broadly diversified financial services company, and space does not permit in-depth coverage of all its products and services. Our goal is to deal comprehensively with matters of interest to mutual fund investors. Statistical data in this book are current as of December 31, 1988. Information on Fidelity products and services has been updated through March 15, 1989. As researchers into mutual fund investment strategies, we have first-hand experience of what Fidelity investors do right, and what they do wrong. By sharing these insights with you, we hope to put you on the path to financial security. PETER G. MARTIN BYRON B. MCCANN Seattle, Washington April 1989 Acknowledgments The authors are deeply indebted to the following for making this book possible: our Wiley editor Karl Weber for his expert guidance and counsel; Richard Sandmeyer and Nina Martin for their criticism and en- couragement; Colleen Kearns for her support and listening to investors' needs and ideas; the staff of Fidelity Investments for their review and comments; and Maryan Malone, Michael Bass, Ellen Silge, and Susan Swanson for their patience and thoroughness in design, copy editing and proofreading. Note to Second Printing The Diversified Portfolio of funds described in this book includes Fidelity's High Income Fund (since renamed Capital and Income Fund). Because of a change in this fund's fee structure, it should be replaced by the Investment Grade Bond Fund (formerly Flexible Bond Fund). Fund names and price charts throughout the book have been updated through July 1992. We have also corrected minor typographical errors, but no other changes have been made for this printing. viii Chapter 1 INTRODUCTION In writing this book we assumed that many investors share our concerns: How do we make a substantial amount of money without exposing ourselves to unreasonable risk? How can we devise a decision- making approach that eliminates emotional reaction to random events in the marketplace? How do we construct a system that is easy to operate and absolutely clear in terms of what to do? Finally, how do we determine whether the system will continue to work in the future? Although those goals are quite ambitious (modern investment theory says they are practically impossible) we shall show you that they are achievable. Extensive thinking and research advanced us toward our ambitions and the innovations of Fidelity Investments made them reality. The background on Fidelity and the chapters on investment practices are quite useful, but the power of this book lies in the details of a trading system that takes advantage of Fidelity's unique products and services, and some small but significant market inefficiencies.