MONEY

Mutual Funds Gone Down the Drain

Forty-one percent of U.S. mutual funds operating 10 years ago, closed before 2014.

Your mutual fund does worse when its close to extinction. Here's what to do about it.

Of all traditional U.S. mutual funds operating a decade ago, four in 10 shut down before 2014, reports Morningstar.

Why care? Even though you can cash out (or get shares in a fund absorbing the loser), costs rise and performance falls as the end nears, says Daniel Kern, president of investing firm Advisor Partners, who has studied closures.

Here’s how not to get swept away in the failures.

Stopping your losses

Seek high marks. Eight in 10 funds given five stars by Morningstar in 2002 lived to 2012; only 39% of one-star funds did, according to a study Kern co-wrote. Stewardship grades, gauging how shareholders are treated, count too: A and B funds outlast low-ranked ones, says Morningstar’s Laura Lutton.

Don’t think small. Bigger funds aren’t always better, but those that stay small or shrink too much have high failure rates. Be wary of portfolios with assets well under $250 million, says Kern’s collaborator Tim McCarthy, author of The Safe Investor.

Exit early. If you think a fund will close, sell. Funds lose an average of 3.6% in their final 18 months, Vanguard has found. Has your fund already merged into another offering? Be picky, advises San Diego planner Leonard Wright, and sell the new one if you wouldn’t have bought it otherwise.

MONEY Investing

Ford Revs Up Sales

Ford's domestic auto sales accelerated last year. 2013 Getty Images

Ford has done well to improve its sales, but can it get into luxury market and broaden its reach overseas.

The nation’s second-biggest automaker has been cruising lately, thanks largely to a series of successful vehicle redesigns that are winning over fuel- and style-conscious young buyers.

But Ford Motor Co.’s dramatic face-lift and CEO Alan Mulally’s cost-cutting efforts are old news. Investors have grown accustomed to better-than-average performance from Ford , which ranked as the world’s sixth-largest carmaker last year.

Today Wall Street wants to see whether Mulally & Co. have enough in the tank to broaden Ford’s rebound to include luxury vehicles and key foreign markets.

Sales are surging

As U.S. auto sales have come roaring back, Ford has managed to stand out. How? The company “rolled out a strong field of products over the last few years,” says Kelley Blue Book senior analyst Karl Brauer. “The Fusion, Focus, and Fiesta — combined with a resurgence of the truck market thanks to the rebound in housing — have made Ford a fascinating company to watch.” Indeed, Fusion sales rose 22% last year to nearly 300,000, almost equaling the Toyota Corolla’s popularity.

Nearly two dozen more upgrades are due out this year. The redesigns are taking place as Mulally is cutting costs by trimming the number of platforms on which vehicles are built from 27 in 2007 to nine by 2016.

But the stock is stuck

Despite the upbeat results, Ford’s stock has lagged. Execs warned that profit margins could fall in 2014 because of a record number of new product launches, such as the Lincoln MKC, a small luxury crossover.

There’s also the fact that investors have been betting on a rebound since 2009. They now want to see more. Ford’s resurgence, for instance, has yet to reach the luxury market: Its Lincoln line sold fewer cars last year than in 2012, and about 100,000 less than Cadillac.

Related: Road to Wealth

Says Edmunds.com senior analyst Jessica Caldwell: “Lincoln is trying to have a brand renaissance, but that takes time.”

And Ford trails abroad

Overseas, Ford’s outlook is decidedly mixed. The carmaker has expanded its share in Europe, where auto sales remain weak. And in China, where sales growth is robust, Ford “is definitely playing catch-up to GM,” says Matthew Stover, an analyst with Guggenheim Securities.

Still, the company is making strides. Its 936,000 sales in China last year represented nearly a 50% jump from 2012. And Ford is now the fifth-largest foreign car seller in China, having leaped over Toyota. Mulally is investing heavily in the region, with plans to increase its number of production plants and dealerships.

Will they bear fruit? That will largely depend on whether Ford’s youthful, fuel-conscious designs translate to foreign audiences.

MONEY IRAs

The Easiest Way to Juice Your Portfolio

Take best advantage of the tax code to increase your portfolio's real rate of return. Photo: Drazen/Shutterstock

There's one absolutely foolproof way to become a better investor: Don't leave free money on the table. Designing your portfolio so that it takes best advantage of the tax code is a risk-free way to boost your true, after-tax return.

The basics: Use tax-advantaged accounts first

Before you make any other investments, max out your 401(k) and Individual Retirement Account options first. Deductible traditional IRAs and 401(k)s allow you to invest pre-tax dollars now and have the money accumulate tax-free until you make withdrawals in retirement. The withdrawals are then taxed as ordinary income.

With a Roth IRA, you pay the taxes up front — that is, unlike with a traditional IRA, your contributions aren’t deductible. But withdrawals in retirement are tax free.

There are limits to how much you can contribute to either kind of IRA, and some high earners might not be able to contribute to a deductible IRA or directly to a Roth. There is, however, a “back door” into a Roth for those above the income limits. You can contribute to a non-deductible IRA and then immediately convert to a Roth. (Caution: If you hold other money in traditional IRAs, there are potential tax consequences to this move. So read “The other way to invest in a Roth IRA” before making this move.)

Roth or traditional IRA?

In general, a traditional IRA makes sense if you think you will face a lower tax rate in retirement than you do today. But of course you can’t be 100% certain what tax rates will be when you retire, so some advisers say it makes sense to hedge your bets by holding some money in both kinds of tax-advantaged accounts.

Investments that hold down the tax bill

Once you’ve exhausted your tax-advantaged options, look for investments that minimize what you’ll owe. If you are investing in stocks, an index fund is usually a good option. Because these funds tend to hang onto the stocks they buy, they are less likely than most actively managed funds to incur lots of taxable capital gains that must be distributed to shareholders.

Income-seeking investors can consider tax-exempt municipal bonds, either directly or via a fund. These bonds are generally issued by state or local governments, and the income they pay is free from federal taxes. They may also be free from state income taxes, depending on where you live and where the bond was issued.

Road to Wealth: The college savings cheat sheet

Because the tax break is valuable, these bonds don’t have to offer yields as high as comparable fixed-income investments. That means they make the most sense for high-income investors who face relatively high income-tax rates.

Currently, however, a number of factors have combined to make municipals look attractive to a broader range of investors. In particular, the rates on other types of bonds remain low, and municipal bonds appear to have been unfairly stigmatized by a few high-profile recent crises like those in Detroit and Puerto Rico; as a result, tax-exempt munis are worth a look even if you’re not in a high tax bracket.

Location, location, location

Investors with significant assets spread across both tax-advantaged and taxable accounts should think carefully about which investments go where. Investments that pay out ordinary income, such as bond funds, may be best suited to tax-advantaged accounts, since that income faces higher rates than long-term capital gains or qualified stock dividends.

TIME Investing

Warren Buffett Richer Than Ever

Exclusive Portraits Of Berkshire Hathaway Inc. Chief Executive Officer Warren Buffett
Warren Buffett, chairman and chief executive officer of Berkshire Hathaway Inc., speaks during an interview in New York, Oct. 22, 2013. Scott Eells/Bloomberg via Getty Images Scott Eells—Bloomberg/Getty Images

Berkshire Hathaway, the investing conglomerate helmed by Warren Buffett for more than 50 years, reaped a record $19.5 billion in profits in 2013 -- far exceeding analysts' expectations of $18 billion

Warren Buffett’s investing conglomerate saw record profits in 2013 of $19.5 billion, riding a wave of economic improvement in the United States, the company said in its annual report released Saturday.

Buffett’s holding company Berkshire Hathaway exceeded analysts’ expectations of $18 billion and saw significant gains over 2012, when it posted net profits of $14.8 billion.

The company’s stellar performance depends on well-known consumer goods and services that do well in economic boom times, as Buffett chiefly invests in established, large companies like Walmart, General Motors, American Express, and Coca-Cola.

Buffett’s annual shareholder letter, known for its rustic tone, emphasized his commitment to supporting American companies for the long term.

“Who has ever benefited during the past 237 years by betting against America? If you compare our country’s present condition to that existing in 1776, you have to rub your eyes in wonder. And the dynamism embedded in our market economy will continue to work its magic,” the so-called “Oracle of Omaha” said in the letter. “America’s best days lie ahead.”

Berkshire purchased major assets of NV Energy and H. J. Heinz Geico, which “will be prospering a century from now,” Buffett said. Berkshire’s insurance company reported a $394 million operating profit in the fourth quarter.

Buffet’s conglomerate didn’t edge out the S&P 500, which grew at a phenomenal rate of 32.4% last year, while Berkshire saw a gain in per-share book value of 18.2%. Since 1965, Berkshire has seen a compounded annual gain of 19.7%, while the S&P 500 has increased 9.8%.

Buffett, 83, has helmed Berkshire for more than half a century and overseen its growth into a $288 billion holding company.

MONEY

Have Enough Money for the Retirement Life You Want

Choppy markets and rising health care costs needn't stop your from having the money you want. illustration: justin wood

Choppy markets and rising health care costs needn't stop you from reaching your retirement goals. Here, five of the brightest financial minds offer help for staying on an even keel.

Retirement planning is full of uncertainties: How long will you want to or be able to work? How many decades can you expect to live? What will happen in the markets in the meantime?

One way to fill the knowledge gap is with rules of thumb, nuggets of conventional wisdom, or one-size-fits-all retirement products. Do a quick Google search and you’ll find easy answers to how much you should save for retirement and how you can safely spend it. Meanwhile, mutual fund companies will happily sell you a single fund that offers a simple plan for investing your nest egg.

Too easy and too simple, says Michael Kitces, a financial planner and director of research at Pinnacle Advisory Group in Columbia, Md. “We rely too much on rough guidelines or underdeveloped knowledge instead of rigorous analysis,” he says. Kitces is one of a group of big thinkers you’ll meet in this story who say that you can do better.

New ideas about retirement are especially urgent now. Today’s markets may not be priced to deliver high returns to retirees or those in their peak savings years; at the same time, the cost of health care in retirement keeps rising.

The good news is that if you break away from the obvious answers, you’ll discover that you have options for the life you want after so many years at work.

On the pages that follow are five big ideas from some of the retirement-planning world’s sharpest minds:

Forget the 4% withdrawal rule: Wade Pfau, professor of retirement income, American College

You’ll spend less as you age: David Blanchett, director of research, Morningstar Investment Management

Plan to pay for future health costs: Carolyn McClanahan, president, Life Planning Partners

Plan for the critical first decade: Michael Kitces, partner and director of research, Pinnacle Advisory

Social Security is the best deal: Alicia Munnell, professor of management, Boston College

MONEY

Top Stock Picks from Top Pros

These top fund managers and foreign-stock specialists thrived amid global upheaval. Find out how they did it — and where in the world they see opportunities.

  • David Herro

    HIS PICKS

    Credit Suisse . Shares of all European banks have been shadowed by worries that post-crisis regulations will hurt profits. But the cloud hangs especially low over “too big to fail” institutions like Credit Suisse, Herro says, which are deemed most likely to be reined in. “People are overreacting.” The bank has gathered plenty of capital to satisfy regulators, he says. And its thriving private and investment banking operations will help grow earnings 5% to 10% for several years to come.

    Daimler . To Herro, the German carmaker is a well-oiled machine with a full tank of gas — and investors are too focused on the scratched fender. “The market doesn’t like its Europe exposure, the fact that it was behind in China, and that its margins have been lower than BMW’s,” he says. But Europe is on the mend. The company’s once-struggling China operations are gaining traction. (Sales there are up 15% in the past year.) And a big push to streamline production has boosted margins.

    AMP. Australia’s largest standalone wealth management firm, says Herro, has a vast network of financial advisers poised to help folks navigate the country’s compulsory retirement-savings system. Demand for such advice has grown since 2011, when the Reserve Bank of Australia cut interest rates, sending retirees scrambling for higher yields. But even with rates down to 2.5%, he says, Australia’s central bankers have more ammunition to stimulate growth than their counterparts in the U.S., where rates are near zero.

    HIS STRATEGY: Still betting on Europe’s recovery

    At the height of 2012′s European debt crisis, amid panicked headlines about Greek defaults and soaring Spanish borrowing rates, Herro believed a full-on banking collapse was unlikely. So he bet heavily on European financials. The sector is up 50% since then.

    Indeed Herro, named Morningstar’s international manager of the decade in 2010, has built his extraordinary record by ignoring conventional wisdom. He seeks strong companies selling at a discount because of what he sees as short-term or superficial problems. As he puts it, “We want to own what’s cheap.”

    So why, despite the run-up, has Herro remained committed to European bank stocks, including his top four holdings? “There’s still an undeserved stigma surrounding them,” he says. His confidence extends to European carmakers, technology companies, and retailers as well. Virtually nothing, meanwhile, is invested directly in emerging markets. “It’s too tough to find value there,” he says. Likewise, Herro has unwound much of his fund’s position in Japan now that economic stimulus has driven equities up by almost 75% in 13 months. For value beyond Europe? Look to Australia, he says.

MONEY Investing

Winning at Investing Made Simple

Served on a silver platter: the right portfolio strategy and investing well for retirement. illustration: tavis coburn

Here are just a few of the ways Wall Street pros try to eke out an edge in the market. You can’t do any of them:

With a subscription to the Bloomberg online news service (price: about $20,000 a year), traders can instantly see anything from the location of oil tankers around the globe to supply-chain maps of a company’s vendors and customers.

Hedge fund managers who invest in drug and technology companies tap into “expert networks” of executives and scientists paid for their specialized knowledge. In some cases, it’s been charged, traders have also illegally gotten inside information through these contacts.

Half of stock trades are made by automated “high-frequency” programs; it takes 7/10,000ths of a second to buy or sell on the New York Stock Exchange, says the Tabb Group, down from a horse-and-buggy 10 seconds eight years ago.

You can’t get a jump on this crowd. You can’t even compete with them. Chances are, the professional managers you hire via a mutual fund, for 1% of assets or more per year, won’t be able to stay ahead either.

In October, Ray Dalio, one of the most successful hedge fund managers in the world, told a conference audience that “going forward, most investors are not going to be able to produce alpha.” “Alpha” is finance jargon for outperforming the market after accounting for risk. In truth, the search for alpha has always been something of a snipe hunt; the word was first used in a 1967 article that showed that most mutual funds didn’t deliver it, especially after subtracting fees.

Two things have changed since then: More pros admit the alpha game is over, and perhaps more important for you, investing has never been better for those willing to stop playing. In the words of Tadas Viskanta, editor of the finance blog Abnormal Returns, there’s wisdom in reaching for “investment mediocrity.”

Today, just as in 1967, most professionals can’t beat an index that tracks the stock market. “The paradox,” says Viskanta, “is that the less effort you put in, the better off you are.” And recently, he notes, perfect mediocrity has grown more attainable, as index-based investing has moved steadily closer to free.

For as little as 0.04% of assets per year — that’s $4 for every $10,000 you’ve invested — and often with no broker commission, you can buy an exchange-traded fund, or ETF, that follows most of the U.S. stock market and delivers its return.

This year’s Investor’s Guide starts from the idea that index funds and a buy-and-hold stance should be the default approach for long-term wealth builders. With that in mind, MONEY has rebuilt our basic investing tool set: Our list of recommended funds is now the MONEY 50, streamlined from 70. Not all the funds are index trackers, but the core choices are low-cost, highly diversified portfolios for the long run. For many investors, a portfolio balanced among one broad U.S. stock fund, an international fund, and one or two bond funds is all you need. The MONEY 50 makes building that portfolio easy.

Yet even if you decide to stick with a simplified strategy, that doesn’t mean every investment puzzle you’ll face has been solved. The stories in this guide will help you think through your approach to the three biggest questions you still face as you save for retirement.

Question No. 1: Buy and hold what exactly?

You can build a simple portfolio for any level of risk. Stretching for high returns? You could put all your money in the Schwab U.S. Broad Market , or crank up risk and return potential further by adding funds like Vanguard Small-Cap or Vanguard FTSE Emerging Markets . Need safety? Stash more in Vanguard Total Bond Market or iShares Barclays TIPS Bond to add inflation protection.

These funds make security selection automatic, but they don’t help at all with the question of how much risk you want to take. The standard rule of thumb says you should start out with a high allocation to equities and gradually “glide” that down as you age. These days fund companies often focus less on their stock-picking prowess and more on designing all-in-one “target date” funds that do this asset allocating for you. Yet as you’ll see in “How much should you hold in stocks?,” the theory and practice of lifetime asset allocation are all over the map.

Question No. 2: What if high stock and bond returns are really over?

If you’re a just-own-the-market purist, you don’t ask if stocks are cheap or expensive. You assume it’s too hard to outwit the hive-mind intelligence of the crowd. Over the short run that’s almost certainly true. But there’s evidence that the price of stocks relative to measures of their value like earnings and assets can provide a clue about returns over the course of a decade.

Stocks are now priced at about 21 times the five-year average of their earnings. According to research from the Leuthold Group advisory firm, when the market’s price-to-earnings ratio is between 20 and 25, over the next 10 years stocks have delivered an annualized return of only 3% after accounting for inflation.

Combine that with a gloomy outlook for bonds. Current yields are an indicator of future returns, and with the 10-year Treasury at 2.8%, you may be lucky to carve out 1% after inflation. “Stocks, Bonds? In 2014, Think Cash,” will help you think through your strategy so that you can thrive in a world where today’s high-asset prices could repress tomorrow’s returns.

Question No. 3: Can I ever do better?

Maybe. Even some advocates of index investing say there may be ways to outperform. But the extra bump doesn’t come from tearing into company balance sheets or, as famed Fidelity manager Peter Lynch used to say, “buying what you know.” It comes from “tilting” a portfolio of hundreds of securities to take advantage of anomalies that have shown up in historical stock returns.

One is the value effect, the tendency of stocks with low prices relative to their earnings or asset value to outperform over time. Likewise, there seems to be a small-company premium. For a shot at earning these boosts, you don’t buy a portfolio of 40 or 50 small-caps or bargain stocks. Instead, you buy an index or index-like fund that gives more weight to such shares.

You’ll need nerve: Larry Swedroe of Buckingham Asset Management, who recommends tilting, says the strategy trailed the S&P 500 badly in the late 1990s; in the past decade, though, an index of small value stocks earned an extra 2% annualized. “You have to be able to live through it,” he says.

“The New Faces of Stock Picking” profiles a pioneer in low-cost, tilted portfolios as well as other quantitatively driven thinkers searching for ways investors can carve out advantages. Instead of hunting for the inside scoop, they crunch data and use insights into investors’ behavioral blind spots. A caution: Now that star fund managers have faded, Wall Street is cranking out lots of ETFs. For every robust new idea, there’s likely to be a dozen more that are nothing but savvy marketing tied to a hot short-term trend.

Investing may be simple now, but you’ll still need the discipline not to chase the latest market beater, plus the patience to stick to a long-term strategy even when it’s out of favor. Simple? Yes, but not always easy.

OWN THE WORLD, FOR NEXT TO NOTHING

You can build a solid portfolio with just three investments. Here are examples using ETFs and index mutual funds:

The ETF route:

Schwab U.S. Aggregate Bond : 40%
Schwab U.S. Broad Market: 40%
Schwab International Equity: 20%

The index fund route:

Vanguard Total Stock Market Index: 40%
Vanguard Total Bond Market Index: 40%
Vanguard Tax Managed International : 20%

Either way you go, your costs will be far, far less than most active fund managers charge…

Annual fee:

ETF portfolio: 0.05%
Index fund portfolio: 0.08%
Three average active funds: 1.22%

… and you’ll be diversified across the globe.

Number of stocks:

ETF portfolio: 3,144
Index fund portfolio: 4,823
Three average active funds: 289

SOURCE: Morningstar

MONEY

Help! My Wife’s Dad Puts Her Money at Risk

Did you ever want to be a personal-finance advice columnist? Well, here’s your chance.

In our “Readers to the Rescue” department, we publish questions from readers seeking help with sticky financial situations, along with advice from other readers on how to solve those problems. Here’s our latest reader question:

My father-in-law still manages my wife’s investments. She is very cautious and conservative. He is reckless, but has been able to make money. What should I do about this situation, if anything?

Got a good answer? Submit it to us in the form below. We’ll publish selected reader advice in an upcoming issue. (Your answer may be edited for length and clarity.)

Please include your contact information so we can get in touch; if we use your advice in the magazine, we’d like to check with you first, and possibly run your picture as well.

Thanks!

To submit your own question for “Readers to the Rescue,” send an email to social@moneymail.com.

To be notified of future “Readers to the Rescue” questions and answers, find MONEY on Facebook or follow MONEY on Twitter.

MONEY Investing

How Detroit’s Breakdown Will Hit You

Detroit’s July bankruptcy is the tragic culmination of 60 years of decline.

Indeed, among localities still coping with fallout from the recession and housing bust, the Motor City stands alone in awfulness: 78,000 blighted structures, 18% unemployment, a $327 million operating deficit last year. Yet with the city looking to cut pensions and restructure debt, Detroit’s comeback bid could have ramifications beyond Michigan’s borders.

Your town may feel freer to slice retiree benefits. With so many state and local pensions facing funding shortfalls, cutting back retirement benefits — or trying to — is nothing new. What worker advocates fear is that bankruptcy-court approval of pension changes for Detroit, where pension protection is part of the state constitution, would embolden government leaders elsewhere to seek deeper cuts.

Related: Just how generous are Detroit’s pensions?

In Detroit, pension changes are most likely to follow the national trend: eliminate cost-of-living adjustments and convert current workers to defined-contribution plans, says area financial planner Leon LaBrecque, rather than reduce payments.

The muni market could take a hit. Detroit has proposed treating certain general obligation bonds as “unsecured,” instead of backed by city taxing power, and offering investors just 10 cents on the dollar.

The odds are long, but if Detroit succeeds, the precedent would shake up the bond market.

Also at risk: retiree health care, which lacks the same protections as pensions. Detroit would shift retirees to new federal exchanges or Medicare, a move other governments are studying.

Related: Detroit’s stealth business boom

Still, for most of the country, “credit quality remains quite strong,” says John Bonnell, a fixed-income manager for USAA. The five-year default rate in the $3.7 trillion muni bond market is less than one-half of 1%, reports Moody’s; 93% of municipal issuers are rated single A or higher.

Michigan muni funds already have. Funds that specialize in the state’s bonds are down as much as 17% this year, but at this point you shouldn’t rush to sell, says Chris Ryon of Thornburg Funds. Even funds with big stakes in Detroit primarily hold the water and sewer bonds that Detroit is still fully backing, not the unsecured debt the city is defaulting on.

But the real story on bonds is … Munis are less liquid than the Treasury market, and thus have taken a bigger hit as interest rates have risen of late. But David Kotok, chairman of money manager Cumberland Advisors, thinks the fear has been overplayed.

“High-grade munis are remarkable bargains,” says Kotok. Still, stick with a short-term fund, such as Fidelity Short-Intermediate Muni Income (recent yield: 1.77%), to cushion any losses as rates rise.

MONEY

Balance Out a Lopsided Index Fund

Critics point out that stock index funds have a knack for loading up on frothy investments at the worst possible times. Photo: Kevin Van Aelst

How much of your portfolio should be invested in index funds has long been a weighty question. Or rather, a question of weights.

An index fund, of course, buys and holds all the stocks listed on an index, like the S&P 500 — but it’s not quite that simple. Most indexes are weighted by capitalization so that they hold more of whatever the market assigns the most value to. That makes them, in part, a popularity contest.

Critics have long pointed out that stock index funds have a knack for loading up on frothy investments at the worst possible times. Now a related critique is coming from a source who is hard to dismiss.

Vanguard founder Jack Bogle, who started the first retail index mutual fund, has recently been critical of bond market indexes. Again, it comes down to weighting. He says indexes have forced so-called total bond market funds to hold too much U.S. Treasury and government-related debt just when those securities are yielding next to nothing.

The fact that Bogle is questioning the suitability of an index investment that millions of investors use prompts the question, Is it time for you to rethink indexing?

MONEY has long been an advocate of low-cost index funds. After reexamining the case for passive investing and looking especially hard at its weak points, three guiding principles emerged:

No. 1: With U.S. stocks, indexing is very, very tough to beat.

Despite weighting issues, indexing starts with two huge advantages. The first is that investing is a zero-sum game of sorts. The investors who manage to outsmart the market have to be matched by other investors who got outsmarted. Over time, in this highly competitive game, it is very hard to identify fund managers who will be consistent winners.

The second is that index funds keep costs extremely low — you can buy a traditional cap-weighted index exchange-traded fund for under 0.1% a year, vs. more than 1% for the average actively managed domestic stock fund.

Most managers can’t beat the market by enough to surpass their fee. Over the past three years, just 14% of large-cap funds pulled it off.

Action plan: Use total stock market index funds for your core holdings in equities. You can cover the broad spectrum of domestic and foreign stocks with just two funds: Schwab Total Stock Market Index (expense ratio: 0.09%) and Vanguard FTSE All-World ex-U.S. ETF ( 0.15%).

Related: Money 50: Best Mutual Funds and ETFs

You can even add stakes in more targeted index funds that help you meet specific needs.

For example, if you’re older and seeking income, you may tilt toward dividend-paying stocks by adding to your core Vanguard Value ETF (0.10%), which holds lower-priced stocks with an average yield of 2.5%.

“Pick your own asset-allocation strategy, and then you can use index funds to implement it,” says New York City financial planner Lew Altfest.

No. 2: Index funds can still get into bubble trouble.

“What a traditional cap-weighted index represents is the market’s equilibrium — the prices buyers and sellers have agreed on for every security in the market,” says Joel Dickson, a senior strategist with Vanguard. Yet the market sometimes collectively gets things wrong. Think back to the tech bubble in the late 1990s, when that sector grew to be more than a third of the entire U.S. stock market as a result of the mania in Internet stocks.

Today, a worry has arisen about emerging-markets index funds, which recently held nearly half of their assets in companies based in the so-called BRIC economies — Brazil, Russia, India, and China. There’s no telling whether the market’s current judgment will seem wise in hindsight. But it’s fair to say that a broad emerging-markets index concentrates risk in a narrow group of countries.

Action plan: Avoiding lopsided exposure is straightforward on the international side. Advisers recommend spreading your bets beyond just the BRICs into other markets, such as Indonesia and Mexico.

To do that, keep your current investment in a broad emerging-markets fund. With new money, though, add a fund that weights differently, such as iShares MSCI Emerging Markets Minimum Volatility (0.25%) with a third less in the BRICs than the standard emerging-markets index.

How to avoid bubble exposure in U.S. indexes is less settled. Some index critics have designed their own alternative “fundamental” indexes, which are supposed to correct the tendency to load up on hot stocks.

For example, PowerShares FTSE RAFI U.S. 1000 (0.39%) weights not by a company’s stock market value, but by dividends, sales, and other indicators of business strength. Rob Arnott of Research Affiliates, which oversees the RAFI index, says his benchmark “has a pronounced value tilt” — that is, to stocks that are relatively unloved.

In theory, this should mute the effects of momentum-driven bubbles. Yet fundamental funds ran into their own problems in 2008 — they were loaded up on financial stocks heading into the crisis. They are also more expensive than their traditional counterparts.

You can almost as easily tilt away from go-go stocks by adding an indexer restricted to value, such as the Vanguard Value ETF , or small companies, like Vanguard Small Cap ETF (0.10%). (Bubbly stocks don’t stay small for long.)

No. 3: Handle bond indexes with care.

Indexing fixed income has never been as simple as it is with equities. For starters, “you’ve got the ‘bums’ problem,” says Paul Kaplan, director of research at Morningstar Canada and an indexing expert.

With stocks, capitalization weighting means loading up on the market’s biggest winners. With bonds, this approach calls for betting big on the market’s biggest debtors. Global bond index funds end up overweighting government bonds from Japan and Western Europe.

Here at home, U.S. Treasuries and government-related debt now make up more than 70% of the Barclays U.S. Aggregate bond index, with corporates representing less than 25%. Bogle thinks the Barclays aggregate bond index is flawed because it reflects not only bond purchases of investors but also those of foreign governments like China that are buying Treasuries more for policy purposes, not just because they think Treasuries are a great investment.

He argues that once you strip away government and central bank purchases of Treasury debt, government securities probably make up about a third of the U.S. debt market.

Action plan: A simple solution is to take half of your stake in a total bond market index fund and use that to buy a corporate bond index fund, such as Vanguard Intermediate-Term Corporate Bond Index (0.12%). The combination of the two will give you a portfolio that’s about two-thirds corporates and one-third governments. Alternatively, consider an active fund with a long track record of spotting bond values, such as Loomis Sayles Bond ( 0.92%).

Overseas, it’s a tougher challenge. There are few index funds that give you exposure to the broad array of governments and corporates in both the developed market and the emerging world.

As a result, you’re better off anchoring your overseas bond holdings with an actively managed fund like MONEY 50 recommendation Templeton Global ( 0.89%), whose top weightings are in low-debt nations like Poland, Mexico, South Korea, and Ukraine. Compare that with the Barclays Global non-U.S. Treasury index, whose top holdings are from Japan, with a sky-high debt-to-GDP level of about 212%. Talk about lopsided.

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