Higher Yields on Savings Accounts? It Will Be Awhile

The US Federal Reserve building is seen
The US Federal Reserve building is seen on August 9, 2011 in Washington, DC. New recession worries and market havoc posed the toughest challenge yet this year for the US Federal Reserve as its policy board met Tuesday holding a near-depleted box of stimulus tools. Economists said the Federal Open Market Committee (FOMC), meeting for the first time since its "QE2" asset purchase program ended in June, had few options to overcome stagnating growth and the growing pessimism that sent stock markets on their deepest plunge since the crisis of 2008. AFP PHOTO/KAREN BLEIER (Photo credit should read KAREN BLEIER/AFP/Getty Images) KAREN BLEIER—AFP/Getty Images

Waiting for higher yields on savings? Don’t hold your breath.

The Federal Reserve said in September it would buy $40 billion of mortgage-backed securities a month until the labor market rebounds. The goal: to free up banks to lend more.

It’s the Fed’s third attempt since 2008 to use this tactic, called quantitative easing.

Targeting the 8%-plus jobless rate, QE3, as it’s known, is likely to hold down mortgage rates which in October hit a 60-year low of 3.36%.

The Fed also plans to keep short-term rates near zero through mid-2015, so get used to current savings yields (recently averaging 0.12%).

And if you’re looking to beef up bond fund income, Morningstar Investment Management economist Francisco Torralba suggests short-term corporates, which yield about 2% today. Though the risk of inflation is low, he says, a spike would hit higher-yielding long-term bonds harder.

Related: Should I invest in bonds or in a bond mutual fund?


Worried about the Fiscal Cliff: Should I Sell?

What changes do you think investors should make to their portfolios to avoid the financial meltdown that could result if we go over the “fiscal cliff”? — Mark Anderson, Lawrenceville, Ga.

If you’ve already set a reasonable investing strategy that reflects your risk tolerance and the length of time your money will be invested, then you probably shouldn’t be making any changes — at least not dramatic ones.

Granted, if we go over the fiscal cliff — that is, if tax increases and spending cuts kick in at the beginning of next year as currently scheduled — the economy could take a sizable hit. The Congressional Budget Office has warned that the unemployment rate could rise and the economy could slip into recession.

Should that happen, stock prices could go into tailspin. To avoid getting caught in the carnage, some advisers suggest that investors significantly cut back their stock holdings or move into more defensive shares that hold up better in downturns.

But I think this approach is wrong for a few reasons.

First, if you change course each time there’s the possibility of a setback in the market, you’re no longer staying true to an investing strategy.

You’ll just be reacting in a knee-jerk way to every potential threat that comes along. Indeed, if you had sprung into action every time investment managers and the financial press sounded the alarm, you would have rejiggered your portfolio many times over the past couple of years alone, responding to the U.S. debt ceiling imbroglio, Standard & Poor’s downgrading of U.S. Treasuries, the financial crises in Greece and Spain, not to mention the routine prognostications of doom that our fragile economic recovery could fizzle.

Related: Why There’s No Such Thing as Risk-Free Investing

More importantly, the idea that you should revise your investing strategy to protect yourself against some perceived calamity suggests that you know it will take place and how it will unfold.

That’s a big assumption. In the case of the fiscal cliff, for example, there are many possible scenarios that could play out, ranging from careening over the cliff to kicking the problem down the road to some sort of compromise on tax hikes and spending cuts.

Even if you could predict what will actually happen, you wouldn’t necessarily know what the fallout will be. No investment rises or falls in isolation. Stocks, bonds, Treasury bills, commodities, real estate, foreign securities — all are valued relative to one another as millions of investors globally make their individual buy-and-sell decisions. Predicting where prices will settle is a dicey business at best.

Finally, it’s not as if the fiscal cliff is some obscure issue no one’s aware of. It’s gotten tons of publicity. Which means that to some extent at least, asset values should already reflect investors’ concerns. Any moves you make are essentially trying to outguess the market consensus.

So as I see it, moving out of stocks into cash or bonds or making any other change specifically to protect yourself against the consequences of the looming fiscal cliff isn’t so much a rational choice as an emotional decision masquerading as a rational one. Any action you take could work out, or it may not.

Either way, you would then have to figure out what to do afterall the dust settles. Stick with the changes you made? Go back to your old stock-bond allocation? Shift to yet another portfolio mix based on some other potential threat or development? You’d be engaging in little more than an ongoing guessing game.

A better approach: Set an asset allocation strategy and stick to it regardless of whatever issue investors happen to be obsessing over at the moment.

Any money you’ll need to tap for emergencies or other purposes over the next couple of years should be in FDIC-insured accounts where it will be immediately available and immune to market downturns. You can divvy up the rest between stocks and bonds based on your risk tolerance and when you’ll have to tap into it.

Money you’re investing for a retirement that’s decades away you can afford to put mostly in stocks and shoot for higher gains, as you’ll have plenty of time to rebound from market setbacks. If you’re on the verge of retiring or already retired, you’ll want more of a buffer against market downturns, which argues for scaling back stocks and emphasizing bonds more.

The point, though, is that you should base your strategy not on shielding yourself from just any single risk like the fiscal cliff. Rather, you want to arrange your portfolio to provide adequate protection from the many different types of threats your portfolio may encounter, while still giving it a chance to grow.

One more thing: Aside from market concerns related to the fiscal cliff, there’s also the issue of whether investors should reap gains in their taxable accounts this year since the maximum tax rate on long-term capital gains is scheduled to increase next year from 15% to 20% — and in the case of very high-income investors, it’s supposed to rise as high as 23.8% due to a new Medicare surtax.

If you have long-term gains in investments you’re already thinking of selling — either as part of your regular rebalancing strategy or for other reasons — then carrying through on those plans before the end of the year makes sense. But I’d be wary of unloading investments with gains just because tax rates might go up, especially if you’re planning to hold those investments long-term.

Either way, don’t let any selling you do for tax purposes distort the balance and diversity of your portfolio. And if you plan on buying back any securities after selling them for a tax loss, be sure you don’t run afoul of the IRS’s wash-sale rules.

Bottom line: Until someone develops a crystal ball that will allow investors to truly foretell the future, you’re better off building a diversified portfolio of stocks, bonds and cash that can protect you from a variety of risks — and then resist the impulse to rebuild it every time a new worry comes along.


Why There’s No Such Thing as Risk-Free Investing

What is the best no-risk way to invest my $500,000? — R.S., Las Vegas, Nevada

Sorry, but neither I nor anyone else can give you a no-risk way to invest $500,000, or any other sum.

All investing involves taking some form of risk, even if it’s not apparent. And while you may be able to sidestep one threat by choosing a particular type of investment, you will still leave yourself open to a different kind of danger.

Here’s an example. When investors say they want a low- or no-risk investment, they typically mean they want to protect the value of their principal and any interest or other investment earnings. Even if the economy and the markets go kerflooey, they want to know their account balance won’t drop.

That assurance is easy to get. Just put your $500,000 in FDIC-insured savings accounts. As long as you spread your money among several banks or otherwise take care that federal deposit insurance will fully cover principal and interest, you can rest easy. FDIC insurance is backed by the full faith and credit of the U.S. government after all. So unless you envision some sort of apocalypse that would force Uncle Sam to renege on his obligations, you don’t have to worry about losing a cent.

However, since bank accounts, Treasury bills and comparable cash-equivalents are so secure, they typically pay relatively modest returns. Their annual yields have been particularly low the past year or so, well below 1% on average. By keeping your dough in such accounts, you’re virtually guaranteeing you’ll earn a very low rate of return. And that leaves you vulnerable to other risks.

For example, if you’re still investing for a retirement that’s some years down the road, keeping your savings in low-yield investments could so stunt the long-term growth of your nest egg that you would have difficulty maintaining your standard of living in retirement.

Conversely, if you’re nearing or have already entered retirement and are counting on withdrawals from your $500,000 to pay living expenses, a meager return on your savings would force you to keep those withdrawals to a very modest level — say, an initial 2% to 3% of your portfolio’s value, or about $10,000 to $15,000, which you would then increase by the inflation rate each year to maintain purchasing power. Pull out more, and you would run a very high risk of running out of money early in retirement.

You can protect yourself against the risk of earning inadequate returns by investing your 500 grand in a diversified blend of stock and bond funds. There’s no guarantee, but over the long run you’re likely to earn several percentage points more a year than you would in bank accounts and similar “safe” investments.

For the 20 years to the beginning of this year, for example, stocks and bonds beat cash equivalents by 4.6 and 3.1 percentage points a year, respectively. So theodds are good that divvying up your money between stock and bond funds will leave you with a larger nest egg when you’re ready to retire — and allow you to draw more without running through your savings too early.

By owning stocks and bonds, however, you’re leaving yourself open to the danger that your savings will take a hit in the short-term. During the severe market downturn in 2008, for example, even a conservative portfolio of 50% stocks and 50% bonds would have lost 16%. Granted, such a portfolio would have recouped nearly all of that loss the next year. But for someone concerned about the security of his savings, a 16% drop could be pretty unnerving.

I could go on and on with other types of risk, but you get the idea. No investment can act as an impregnable shield that protects you from all possible harm.

Given that reality, how should you invest your $500,000?

Start by realizing that while you can’t totally eliminate all threats, you can at least gain some protection bytaking on several different risks simultaneously.

You’ll no doubt want to have money set aside in a secure place so it will be available in full no matter what happens in the market. But unless you plan on spending all your savings in the next few years, you don’t have to put it all in such a secure place.

So figure out how much you’ll need to tap over the next couple of years — $50,000, $100,000, whatever — and invest that amount in an FDIC-insured account. That way, you’ll have accessto the moneyyou’ll really need in the short term without subjecting the whole shebang to the prospect of anemic long-term returns.

Related: Should I Quit My Job and Travel?

Since you won’t need the rest of your dough immediately,you can afford to take more risk and shoot for higher returns. If you’re investing all or most of the remaining amount for retirement, you can divvy it up between stock and bond funds, depending on how far you are from retirement. If retirement is still a couple of decades or more away, you might want to invest, say, 70% or so in stock funds and 30% in bond funds. Such a mix will get whacked during market setbacks, but your savings will have plenty of time to bounce back.

If retirement is much closer or you’re already retired, stability is a higher priority, although you’ll still want some growth. So you may want to scale back your stock exposure to say, 50% or even less and keep the rest of your portfolio in bonds. This will give your nest egg more of a cushion should the stock market head south.

Bottom line: You can’t eliminate all risk when investing, and the more you focus on avoiding just one peril, the more vulnerable you’ll be to others. By diversifying smartly, you should be able to protect yourself adequately against a variety of risks, and lower the chances that any single threat will do your portfolio in.


Contrarian Fund Bets on Europe – and Wins Big

Tweedy Browne Global Value placed a big investing bet on troubled Europe. Photo: Thinkstock

There’s no secret to Tweedy Browne’s success. For decades this respected investment-management firm has sought out underappreciated stocks and held them until other investors eventually came around.

This explains why the four managers of the firm’s foreign-stock fund (who declined to be interviewed) are willing to keep far more assets in troubled Europe than their competition does.

Yet despite this, Global Value has generated annual returns of 12% for the past three years, vs. less than 4% for the MSCI EAFE index of foreign shares.

A big bet on Europe

How has Global Value beaten 98% of its peers over the past five years while investing so much in recession-racked Europe?

First, it has largely stayed away from the region’s worst debtors, the PIIGS: Portugal, Italy, Ireland, Greece, and Spain. Its biggest stakes are in Switzerland, the U.K., and the Netherlands.

The fund also favors multinationals with emerging-market ties.

Last year nearly a quarter of sales of top holding Nestlé came from fast-growing Asia Pacific and Africa. And the fund tilts toward defensive consumer stocks, led by recession-proof brewer Heineken. Consumer staples make up 31% of the fund, vs. 10% for its peers.

Of course, says Todd Rosenbluth, an analyst at S&P Capital IQ, “it’s a risk if consumer staples begin to lag.”

As the dollar goes …

Tweedy Browne plays defense in other ways. The managers are holding nearly 15% of assets in cash. When they buy foreign currencies to invest abroad, they offset that through forward currency contracts that effectively expose the fund to an equivalent amount in dollars.

Related: How to Invest in a Natural-Gas Boom

With the buck thriving lately, this strategy has bolstered returns.

Over the past three decades, though, the dollar has fallen more than it has risen, which has been a drag on the portfolio at times. The firm launched a version of the fund that doesn’t hedge. But by going unhedged, you’d be exposing yourself to currency risk, says Morningstar analyst Kevin McDevitt. You’d also be betting even more on Europe, since that fund would benefit if the euro rebounds.

Lower highs, higher lows

This fund, which has ranked in the top 1% of its peers during the past 15 years, may seem like a no-brainer.

But Lipper analyst Tom Roseen notes that Global Value’s annual fees of 1.4% are “only mediocre” within its category. (The average, in fact, is 1.4%.) And though Global Value has thrived over the long run, there have been shorter periods when it has lagged.

Analysts liken Tweedy Browne’s approach to that of Warren Buffett’s. Both search for deeply undervalued stocks that may be overlooked for years. Sounds great, but when the markets sizzle, Global Value — like Buffett — can underperform. Between March and December 2003, for instance, when foreign stocks soared nearly 49%, Global Value trailed by 14 percentage points.

MONEY Ask the Expert

The Case for Investing in Bonds, Too

Q. I’m 52 and have had 100% of my savings in stocks since I began investing at age 25. Given my high risk tolerance and the fact that I expect that my pension and Social Security to cover a substantial portion of my expenses in retirement, why should I reduce my investment returns by investing in bonds? — Eric C.

A. If you’ve been putting your dough exclusively in stocks for the past 27 years, then you know firsthand how lucrative they can be over the long term. Since 1985, the year you began investing, stocks have gained an annualized 11%.

You no doubt also know how risky stocks can be over shorter periods. You’ve lived through the Crash of 1987 when the Dow Jones Industrial Average plummeted 508 points — nearly 23% — in a single day. And you’ve survived both the bear market of 2000-2002, which saw stock prices fall 49%, and the meltdown of 2007-2009, when stock values dropped almost 57% (a setback from which they still haven’t fully recovered).

I’m sure I also don’t have to tell you that bonds returned far less than stocks over the past 27 years and that their yields are especially low right now, with 10-year Treasury bonds yielding less than 2% and investment grade corporates paying only a half percentage point or so more.

Given your experience with stocks and the state of the bond market these days, I can understand why you equate keeping any of your savings in bonds as nothing more than an invitation to subpar returns.

But I think you need to revise your thinking. Here’s why:

You became an investor near the beginning of one of the greatest bull markets in history. The surge in stock prices that began in 1982 and with few interruptions continued through the end of 1999, showered investors with almost unprecedented rewards. It also included some truly phenomenal stretches, like the 10-year span from 1989 through 1998 when stocks gained a compounded 19% a year, almost double equities’ long-term annualized return since 1926. So I think it’s fair to say that this outsize performance has a lot to do with the way you feel about stocks.

Related: Investing: When to ‘Take Money off the Table’

What’s more, up to now you’ve viewed the risks and rewards of stock investing primarily through the lens of a relatively young person. Which means you’ve been much more likely to shrug off stocks’ periodic setbacks. They’re not as scary when you have decades to rebound from them.

But looking ahead, conditions may be quite different. While stocks are still likely to beat bonds over very long stretches, many analysts believe stocks won’t deliver anywhere near the same size gains they did in the go-go ’80s and ’90s, nor will they outperform bonds by as large a margin.

That’s certainly been true for the past 10 years with stocks gaining 7.3% vs. 6.3% for bonds. Some investment advisers, like PIMCO’s William Gross, are even forecasting extremely meager stock returns for the years ahead.

And while you may still think of yourself as quite the risk taker, I think you should allow for at least the possibility that a 50% decline in the value of your savings — and the retirement income it might produce — may be much more upsetting as you get closer to the end of your career than it was when you were starting out. I’m a bit older than you, but I’ve found I’m much more sensitive to stocks’ volatility myself.

As you weigh the issue of risk, you may also want to factor into your thinking recent research that suggests that the severity of downdrafts we’ve seen in stocks in the past may occur more frequently than we previously believed.

At any rate, I recommend that you at least consider scaling back your equity exposure. I’m not talking about a total retreat. Rather, I’m suggesting a stocks-bonds mix that allows for long-term growth, but won’t get hammered as much should the market tank during your home stretch to retirement — say, 70% stocks and 30% bonds. As you age, you would then gradually reduce your stock stake, dialing it back to 50% or so of your holdings by the time you retire and then eventually paring it down to between 20% and 30%.

If you expect that your pension and Social Security will cover most of your basic retirement living expenses, you’ll have more leeway in how much you’ll have to draw from your stock portfolio. That flexibility could allow you to be more aggressive and increase your stock percentage a bit. But I’d be wary of going higher than, say, 75% to 80% stocks today and 55% to 60% at retirement.

Related: Retirement Income: Five Steps to a Sound Plan

Many investors are particularly wary of making bonds part of their portfolio these days for fear they could suffer losses if interest rates rise. But the potential setbacks in bonds — especially those with short- to intermediate-term maturities — pale in comparison to the hits stocks have taken in the past and could take in the future. So despite any anxiety about interest rates rising, bonds are still a worthwhile way to reduce the overall risk level of a portfolio.

Bottom line: I’m all for maintaining reasonable exposure to stocks in the years leading up to and following retirement. But the key word is reasonable. Obviously, you have to decide what’s appropriate for you. But you’ll be a lot better off if your decision includes a realistic reassessment of your risk tolerance rather than simply going with what worked over the past 27 years.


Investing: When to ‘Take Money off the Table’

When it comes to investing your money, focus on creating and maintaining the mix of stocks and bonds that's right for you. Jupiterimages—

I think I get the idea of “taking money off the table” when it comes to investments. What I don’t understand is when you should do it and how much. Any advice? — Mark Tyner, New York, N.Y.

You hear this expression a lot around the investing world, usually when people are worried about a possible market setback.

For example, I recently saw a money manager on TV tell viewers it was time to “take some money off the table” because he thought that the stock market, which had gained roughly 10% the previous three months alone, was getting too pricey.

But like many concepts that pass for wisdom in the investing world — dollar-cost averaging being a prime example — this one doesn’t hold up very well when you really think about it.

Let’s say that you “take some money off the table” by selling $10,000 worth of stock from your investment portfolio. Unless you actually spend the proceeds of that sale on living expenses or whatever, you now have $10,000 in cash that has to go somewhere.

Whether you decide to put it in bonds, real estate, commodities, gold or an FDIC-insured savings account, it’s still part of your portfolio — and the return you earn or don’t earn on that money still counts as part of your portfolio’s overall performance.

So you haven’t really taken anything “off the table.” All you’ve done is move $10,000 to a different place on the table.

I don’t make this distinction to be coy or to engage in semantics. I do so because the phrase “taking money off the table” creates the false impression that it’s okay to view different parts of your portfolio in isolation.

But it’s not. You’ve got to look at the big picture because changes you make in one part of your portfolio necessarily affect the whole. And to truly understand the effect of any transaction, you’ve got to consider what that move means for your investment holdings overall — and how any move leaves your portfolio positioned for the future.

Related: Boost Retirement Income, Minimize the Risk

If you sell stock and put the proceeds into bonds, you’ve tilted your portfolio more toward the conservative end of the risk spectrum. Plow the proceeds into cash, and you’ve moved even more in that direction. More importantly, though, you’ve changed the balance of risk and reward in your portfolio. Essentially, you’re saying you’re willing to give up more potential gain in return for less volatility.

That’s fine, as long as your decision is consistent with your long-term goals and tolerance for risk. But from what I see, people who use the phrase “taking money off the table” aren’t talking about a long-term strategy. They’re reacting to something going on at the moment, such as a fear among investors that the economy will falter or the market will drop.

Combine that urge to react to short-term issues with the failure to appreciate how moves in one investment affect the portfolio in its entirety, and investors who think in terms of “taking money off the table” can very well end up undermining their long-term investing strategy.

To avoid that possibility, I recommend you simply settle on an overall mix of stocks and bonds that makes sense for your situation.

If you’re saving for a goal that’s decades away, you might keep 70% to 80% of your portfolio in stocks, even more if you’re okay with seeing the value of your holdings bounce around a lot in the short-term.

If you’re planning to tap your investments sooner, you’ll want to hold less in stocks.

Once you’ve chosen the right blend for you, stick with it except to rebalance periodically — say, once a year — to restore your portfolio to its target allocation. If stocks outperform bonds one year, you would sell some stocks and put the proceeds into bonds to get back to the right mix. This way, you’re not letting emotional reactions to market ups and downs dictate your investment strategy.

I can imagine that some readers are now saying, “Wait a minute. Isn’t rebalancing just another way of ‘taking money off the table?'” The answer is “no.”

Related: How Much Does Your Money Manager Cost You?

For one thing, rebalancing is systematic, not based on subjective notions of investments being overpriced or poised for a setback. There’s also no false sense that you’re removing money from the investment equation when you rebalance. It’s clear you’re taking money from one investment and putting it into another with the goal of maintaining a trade-off between risk and return in your overall portfolio.

Finally, people generally talk about taking money off the table when they have a gain or when an investment has recently soared. With rebalancing, it’s the relative proportions of the assets that dictate action. Thus, even if both stocks and bonds have a down year, you would still rebalance by selling some of the asset that performed better and plowing the proceeds into the one that did worse.

Bottom line: Forget about this notion of “taking money off the table.” It’s misleading and potentially harmful. Instead, focus on creating and maintaining the mix of stocks and bonds that’s right for you.


Investment Advisers See Some Bright Spots

Nearly 60% of independent advisers think a double-dip recession is unlikely over the next six months, and more than 60% expect the S&P to increase in the same period, according to a survey released recently by Charles Schwab.

But don’t go betting the farm on these optimistic findings just yet. A look at the results from January’s survey of advisers shows that they aren’t necessarily the best augurs. In that earlier survey, 49% of advisers expected inflation to increase in the next six months (it hasn’t); 47% expected consumer spending to increase (it hasn’t); and 40% expected unemployment to increase (it hasn’t). Advisers did get some things right, though. In the January survey, 59% expected consumer savings to increase in the next six months (it did); and 46% thought the housing market would continue to soften (it has).

Schwab acknowledges that the survey has limited forecasting value. “We’re thinking [the study] is more like a national view of what’s going on,” says Bernie Clark, executive vice president for Charles Schwab Advisor Services. “It’s not a predictor as much as where we think that the trends are taking us.”

And what looks like the dominant trend these days? The biggest challenge facing advisers and their clients right now, Clark says, is what he calls the “uncertainty factor.” About half of advisers’ clients feel less optimistic about the economy than they did in 2009. Forty percent of advisers say their clients are less optimistic about their investment performance than they were six months ago, and 50% of advisers say their clients feel less confident they’ll be able to retire when they want to. Advisers report that 47% of clients are reducing expenses, and more than half are spending less on discretionary items.

Advisers have their own doubts, too. Seventy-one percent say it will be difficult to achieve their clients’ financial goals. That’s down from the 84% who held that opinion in early 2009, but up from the 58% who expressed these doubts earlier this year.

In any case, people are increasingly turning to independent advisers for help with financial planning. More than 9 in 10 advisers said they received new assets in the past six months.

For the record, the sector of the market that advisers think will perform the strongest over the next six months is information technology, cited by 47% of them. Of course, if you have your doubts about advisers’ predictive powers (see above), maybe you’d also like to know the sector in which they have the least confidence. And that’s consumer discretionary—the pick of only 9% of professionals. Check back in six months to judge their accuracy.

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Your Midyear Tax Checkup, Day 2: Sell Investments Strategically

Having hit the midpoint of 2010, we’re doing a week-long spree of tax planning posts this week (check out the earlier one on figuring out if you’ll be square with Uncle Sam). As any tax pro knows, a little foresight can go a long way toward making your next April 15 a little more pleasant.

Today’s topic: Investing strategy.

If you sold an investment in ’07, ‘08, or early ‘09 for less than you bought it for — as many people did — you may still have capital losses that you’re carrying forward. If so, you also have a great opportunity to switch up your investments, rebalance your portfolio or simply liquidate into cash without incurring any taxes, says Rob Seltzer. You can apply losses to cancel out gains, which gives you an out: “If you want take some money off the table, you have a painless way of doing it,” he says. So take a look at your portfolio to see if there’s a need to change up or cash out.

But don’t forget too that up to $3000 of losses can be applied to ordinary income per year, and that can be worth a lot in terms of tax savings. So there’s no need to rush to use losses if you don’t have to. Besides, “Any losses carried over will be very valuable in future years, as the tax rates go up,” says Tustin, Calif. CPA Monica Rebella. That’s because the long-term capital gains rate is slated to increase to 20% for everyone in the 28% bracket or higher next year vs. 15% now for the 25% bracket and up.

In fact, because of the expected tax increase, Rebella notes she’s advising some retirement-age clients to liquidate more money than they ordinarily would this year, since it will be more costly for them in 2011. Now that’s foresight.

Tune in tomorrow for info on availing yourself of the most deductions you can.

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Vanguard Joins the ETF Price War

Now the ETF game is really getting interesting.

Vanguard announced it has removed trading fees on all 46 of its exchange-traded funds. In addition, the fund group lowered its commissions for buying or selling stocks or non-Vanguard ETFs to just $7 to $2, depending on the size of your account.

With these moves, Vanguard has trumped rivals Schwab and Fidelity, at least for now.

Schwab started the commission-free war last year by removing trading fees on eight of its own ETFs; it currently charges $8.95 a stock trade. Fidelity, which charges $7.95 a trade, recently waived fees on 25 iShares ETFs.

Vanguard is clearly determined to dominate. The firm, which took over its brokerage operations from Pershing last year, now manages some $100 billion in ETF assets and ranks as the third-largest ETF provider, behind iShares and State Street. That rapid growth has come about largely because Vanguard’s ETFs generally carry the lowest expense ratios of any fund family, an average of 0.18%.

That growth is likely to continue, since commission-free trading has eliminated one of the few reasons to avoid ETFs: For those who seek to make regular deposits, or simply rebalance, the cost of paying for trades can quickly outweigh the advantage of the lower expense ratios that ETFs may offer. And investors are also attracted by the generally (but not always) low fees and tax efficiency of ETFs, as well as as the ability to trade while the markets are in session.

Still, for longtime Vanguard investors, it’s surprising to see the fund family shift toward commission-free ETF trading. After all, Vanguard founder Jack Bogle has often complained that ETFs foster “short term speculation” — exactly the opposite of the patient, buy-and-hold investing approach he has long advocated.

But the move toward commission-free trading will ultimately benefit Vanguard’s mutual fund investors, says investment adviser Rick Ferri, head of Portfolio Solutions.

That’s because of the unique nature of Vanguard’s ETFs, which are share classes of existing mutual funds. This patented structure gives managers tremendous flexibility in buying and selling the portfolio’s stocks and bonds, which can improve tax efficiency and lower costs.

Ferri notes that the commission-free trades will help attract more assets and trading liquidity to Vanguard’s ETFs, some of which — its new bond ETFs, for example — still lack critical mass. So, odd as it may seem, if Vanguard sees an influx of day traders, who furiously churn their portfolios, that may eventually benefit its core group of buy-and hold investors.

UPDATE: A Vanguard spokesperson says that the fund group “will closely monitor trading of our ETFs, and if a client is engaged in excessive trading, we will reserve the right to reject further trades.”

Does all this mean you should rush out and buy Vanguard’s ETFs? Or swap your existing Vanguard mutual funds for their more glamorous ETF counterparts?

Not at all. You first have to look at your long-term goals and asset allocation strategy. In many cases, your mutual funds may give you access to asset classes that you can’t find in ETFs. Or the ETFs may be thinly traded or fail to track their indexes closely; that’s especially true for micro-cap and some types of emerging market stocks. And many bond funds have had trouble hewing to their indexes, particularly during the 2008 credit crunch.

Still, for your core portfolio, ETFs do offer great choices for tracking broad asset classes. And Vanguard, along with iShares and State Street, offers sound, low-cost options. [UPDATE: According to Vanguard, a switch from a Vanguard mutual fund to its ETF share class is not considered a taxable event.] The Money 70 funds, for example, include Vanguard Total Stock Market ETF and Vanguard Europe Pacific ETF VANGUARD TAX MANAG FTSE DEVELOPED MKTS ETF VEA -1.2999% , among others.

And if the price wars continue, the choices are likely to get even better.

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The Market Boomed… and 401(k) Investors Sat on Their Hands

A new survey out today from Hewitt Associates finds that 401(k) investors haven’t been very busy lately. Just 16% of participants made any kind of fund transfer in 2009, vs. about 20% the year earlier. In other words, relatively few people noticed the 27%-return rally in the works and said to themselves, “Hey, I should jump back into stock funds.” That’s good… and it’s bad. And it’s an opportunity to make 401(k)s work better.

Why it’s good: Chasing hot-performing funds or sectors is a pretty-sure fire way to lower your return. But the majority of investors didn’t do that.

Why it’s bad: As Hewitt notes, the numbers also mean that the majority of investors didn’t move to rebalance their portfolios. That means that as the value of the stocks in their portfolio grew, they were more exposed to equities (as a percentage of their overall portfolio) at the end of the year than they were at the beginning. Trimming back on stocks to get back to your original asset allocation can help reduce risk, and it gives your portfolio a slight (and smart) contrarian tilt, because it forces you to sell what’s hot and buy what’s not.

How to make 401(k)s better: If employers and policymakers want people to get more out of their 401(k)s, investors who underreact aren’t as big a problem as investors who overreact. It’s hard to convince someone who thinks that frequent trading is helping his return that he’s wrong about that — although he probably is. But for most investors, it seems, inertia plays a huge role in their investment decisions (or, more precisely, their non-decisions). That suggests that you can do a lot of good just by nudging people into low-cost, well-diversified investments at the very beginning.

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