Investments/29″/dt1st/mark2nd

CHET CURRIER

One of the unheralded skills of a good mutual-fund investor is knowing when not to invest in mutual funds.

Whatever your goals, you can ask yourself whether you can pursue them better by investing directly in the securities markets instead of a fund.

Take bonds and bond funds. The bigger an investment in bond mutual funds grows, the more reason you have to consider putting your money directly in bonds.

Many financial advisers figure you need a stake of about $100,000 to put together a bond portfolio on your own with decent diversification. Now, a study says that even with $50,000, it’s worth doing the homework to see whether you’d be better off going the direct route.

“Our analysis suggests that you can build a diversified portfolio of bonds with a $50,000 investment at estimated costs that are equal or better than that charged by low-cost bond funds,” said the authors of the study, James Peterson and Vinay Singh of Charles Schwab Corp.’s Center For Investment Research.

San Francisco-based Schwab, the world’s largest discount broker, offers clients 991 bond mutual funds for sale.

In practice, the tradeoffs between funds and direct investing vary widely from one type of bond to another. At one extreme, you can invest as little as $1,000 directly in U.S. Treasury securities at virtually no expense by bypassing brokers and buying from your nearest Federal Reserve bank or branch.

At the other extreme, creating your own diversified portfolio of risky junk bonds might require much more than $50,000, and demand constant vigilance besides.

“I would not recommend that people buy junk bonds on their own,” said Sheldon Jacobs, publisher of the newsletter No-Load Fund Investor in Irvington-on-Hudson, N.Y.

In all cases, your best choice may depend on factors other than costs. For instance, if you want an investment with a set maturity date, a bond provides that and an open-end mutual fund doesn’t. Conversely, if you want the simplest, easiest vehicle for moving money in and out at short notice, funds may be the logical place to look.

Assuming a 10-year investment period for its study, Schwab compared the costs of investing $50,000 in bond funds charging fees of between 0.15 percent and 0.20 percent a year against the costs of packages of five individual $10,000 bonds Treasury, corporate, and tax-free municipal with “laddered” maturities of two, four, six, eight and 10 years.

Using its own estimates of commission expenses, dealer markups and spreads, it figured the cost for Treasury bonds at 0.13 percent of assets per year, or $65, against 0.15 percent per year, or $75, for the lowest-cost Treasury mutual fund offered by Schwab.

In investment-grade corporate bonds, it put the annual cost at 0.11 percent of assets per year, or $55, compared to 0.20 percent, or $100, for a low-cost corporate fund.

In investment-grade municipal bonds, Schwab’s estimate of annual direct-investing costs, at 0.21 percent of assets or $105, was slightly higher than the 0.19 percent fee, or $95, charged by the lowest-cost municipal bond fund.

Maybe you don’t care much about $10 either way. If the comparison helps you keep both choices in mind, though, it may improve your chances of picking the investment that best suits your needs. Otherwise, an investor might choose a bond fund for a purpose like college tuition payments with a known deadline, when an individual bond could serve better.

When the tuition bill comes due, a bond maturing at that time will provide an amount that can be known in advance. By contrast, the value of a bond fund investment will be determined by market conditions then. “The biggest problem with bond mutual funds is no fixed maturity,” said Jacobs.

Conversely, if you plan to buy bonds rather than bond funds, you must be reasonably certain that you will not need to liquidate your individual bond portfolio prior to your horizon date, said Peterson and Singh.

Mutual-fund shares can be redeemed any U.S. business day at their net asset value. If you sell a bond before maturity, the price you get will depend on how easily you or your broker can find a buyer.

“While costs play an important role in making a prudent investment decision,” said the Schwab researchers, 11 considerations such as simplicity and additional diversification can be just as important for investors. Bond mutual funds provide these benefits for investors who do not want the responsibility of managing their portfolios.

Vanguard a good bet

Strange as it may sound today, mutual fund investing was supposed to be simple.

You didn’t buy funds so you could spend hours tracking them and analyzing them. You bought funds to save yourself the trouble of tracking and analyzing.

Those days are gone. Even so, there may be a few people around who still invest in funds the old-fashioned way beginners who don’t yet have the money or the knowledge to build an elaborate fund portfolio.

Not for them the emerging markets fund, the sector fund, the market neutral fund or the Internet Skyrocket Momentum Fund.

They want, at the outset anyway, only one or two funds that are truly diversified, mixing stocks for growth with bonds for income. The modern term for this is total return: Making money on dividends or interest as well as price appreciation, just in case the price appreciation doesn’t come through the way you hoped it would.

If you’re a beginner, or just would like to recapture some of the simple virtues of mutual funds, David Wright, a contributing editor at the advisory letter Dow Theory Forecasts in Hammond, Ind., has a few suggestions on how to proceed.

“Get started now,” he said. “For those with long time horizons, the biggest risk to investing is being out of the market during advances.”

Care to specify any candidate by name? Sure. Vanguard Wellington Fund, part of the Vanguard Group in Valley Forge, Penn., makes a great starter fund, Wright said.

It’s big (about $27 billion in assets), old (70 years last month), low-cost (no load, or sales charge; modest 0.31 percent annual expense ratio) and conservative. Among funds that are actively managed that is, ones that try to pick winning stocks and bonds rather than copy an index any expense ratio under 1 percent of assets per year is considered relatively low.

As of Aug. 17, Vanguard Wellington had an average annual return for the past five years of 17 percent, good enough to rank ahead of 77 percent of all stock funds and 89 percent of its competitors with similar investment objectives.

Its short-term performance is only a little less glittering. The year-to-date return of 5.9 percent beat 65 percent of all stock funds and 79 percent of all balanced funds.

The fund, like others in the Vanguard stable, requires a minimum initial investment of $3,000, which may be an obstacle to some first-timers. The ante drops to $1,000, though, in individual retirement and custodial accounts.

Chet Currier is a columnist for Bloomberg News.