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By Ben Baden
While it's important to monitor the performance of broad-based indexes and the returns of your mutual funds, a number of other indicators can help you understand how the investment climate is changing. Investor sentiment surveys and records of fund flows, for example, can help you make prudent decisions. It's important to track a variety of indicators, however. "Not one of them will give you a perfect answer or an obvious signal," says Lipper Senior Analyst Jeff Tjornehoj. "You have to develop your own mosaic of market conditions that will help feel your way into a buying or selling position."
Here are six numbers every investor should follow:
Look beyond your mutual funds' trailing one-, three-, five-, and 10-year returns.
By tracking fund flows each week, investors can determine which asset classes are seeing the most inflows, and possibly overheating, as well as those that are the most unloved, and potentially poised for a turnaround. "[Fund flows] are a contrarian indicator more than anything else," Kinnel says. At times, it can be a bad sign if a certain asset class experiences huge inflows, and a positive sign for funds that are being ignored. Each year,
Historically, "unloved" funds tend to outperform their benchmarks over the next three- and five-year periods. At the same time, the "loved" funds, or the three best-performing asset classes, generally lag their benchmarks. From the beginning of 1994 to the end of 2010, the "unloved" funds earned an annualized 9 percent, compared with an annualized 6 percent gain for the "loved" funds, according to
The Chicago Board Options Exchange Volatility Index, or VIX, uses options prices to measure expected volatility in the S&P 500 over a 30-day period. It's often referred to as the "fear gauge" because it measures how fearful or complacent investors are at any given time. Professional money managers often use the VIX as a hedge against volatility because the VIX generally moves in the opposite direction of the S&P 500. Investors can follow the VIX on the
Rate of inflation.
Investors should always factor the current rate of inflation into their expected returns. In March, the Consumer Price Index (CPI), which measures the average change in prices of goods and services over time, rose 0.5 percent. Over the past year, the CPI has risen 2.7 percent. John Diehl, senior vice president in the retirement division of The Hartford, says fixed-income investors in particular have to make sure they are earning enough yield in their funds so their returns aren't eaten up by inflation.
The rate of inflation and interest rates have an important relationship. The Federal Reserve monitors inflation closely. "If the Fed observes increased economic activity, then it's only a matter of time until they begin to fear inflation, and they will begin to feel pressure to increase interest rates," Diehl says. The Fed controls the Fed funds rate -- or the interest rate at which banks lend to each other. It's been set at virtually zero for more than two years, and that's why many money market funds or savings accounts are yielding only pennies on the dollar.
When the Fed raises rates, it can mean trouble for some bond funds. "Although a progressing economy sounds like a good thing, for bond holders it usually isn't," Diehl says. No one can predict when the Fed will raise rates, but when it does, the value of existing bonds falls, which can lead to losses for certain types of bond funds. Investors should be aware of the duration (a measure of interest-rate sensitivity) of their portfolios so they are well-prepared when interest rates begin to rise again.
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