MONEY Related Stories

Busting the 5 Myths of College Costs

Much of the playbook for taking on the $40,000 average stick price of a private school is out-of-date or just plain wrong. Learn the right moves now.

You’ve pored through financial aid forms, knocked the priciest schools off your list, reviewed borrowing options, and nudged your kid to think more about engineering and less about English lit.

So you figure you’ve got this college thing under control. Not quite. Those expensive schools you ruled out? They might actually cost you less in the long run than some cheaper private or public institutions.

The federal loans for parents you’re looking at so your kid doesn’t graduate with debt? They may not be a better choice after all. As for thinking a technical major will be more helpful to Junior than a liberal arts degree … sorry, it doesn’t always turn out that way.

Even among savvy parents, myths and misinformation abound. Yet with the average four-year tab ranging from $71,500 at in-state public colleges to $240,000 at elite private schools, the last thing you need is to pay more than necessary, borrow more than you can handle, or pass up a college that can provide a great education at an affordable price.

What follow are the straight facts you need to make smart college choices.


The myth: Saving for college will hurt your chances of getting financial aid.

The reality: Any money you’re able to save probably won’t appreciably affect your chances for aid. Here’s why: Under the federal financial aid formula, what matters most is your income, which is assessed up to 47%.

By contrast, a maximum of just 5.64% of savings in your name will be counted — after excluding retirement accounts, any small business you own, and your home equity. A savings allowance based on your age and marital status ($30,700 for a married parent age 45 for 2014-15) will also be deducted.

As a result, parental savings typically have little impact in the government calculation of expected family contribution, says financial aid expert Mark Kantrowitz of Those savings will come in handy, though, to help pay that high expected contribution from your income.

True, nearly 400 private schools additionally use their own aid formula, which may factor in home and business equity. A high earner with substantial assets might qualify for less or no need-based aid at those schools as a result. Chances are, though, any aid you’d get would be in the form of loans, not grants, so you’re still better off saving. Research from T. Rowe Price shows that each dollar you sock away could save you twice that amount in future borrowing costs.

What to do

Make friends with a 529. Only about one in four parents who save for college uses a 529 plan, says student lender Sallie Mae. Big mistake. You get more bang for your buck in a 529, since the money grows tax-free and withdrawals are tax-free, too, as long as the cash is used for school.

Look first to your state’s plan; more than half offer a tax break to residents. Other low-fee options include New York’s 529, Ohio College Advantage, and Wisconsin Edvest.

Shelter your shelter. “All schools will assess real estate that isn’t your primary residence,” says financial aid expert Kal Chany at Campus Consultants in New York City. If you own a second home or investment property, taking out a home-equity line of credit and using the money to pay down consumer debt (to avoid having loan proceeds count as assets) will temporarily reduce your equity — just make sure you can repay the loan.

Play the name game. Have assets in a taxable account in your kid’s name? Uh-oh. They’ll be assessed at a 20% rate. Fix: Use the account over time to buy stuff for your child that you’d get anyway, such as a new laptop or SAT tutoring. Then put an equivalent amount into a 529 in your name, where it will be counted at the lower parent rate, says Joe Hurley, head of


The myth: You can’t afford a private college.

The reality: Don’t confuse the eye-popping sticker prices at private schools — $39,500 a year on average vs. $18,000 for the typical public college — with the price you’d actually pay. Discounting by private colleges, especially for good students, has become the norm.

These discounts are typically awarded as merit aid and are given regardless of financial need. As the college-age population drops, schools are increasingly competing for students, sparking an awards arms race. In fact, today more students receive merit grants (44%) than get need-based aid (42%). Last year the average discount hit 45%, a record high, says the National Association of College and University Business Officers.

To be sure, Ivy League universities and some other top private schools still offer mainly need-based aid, but their definition of need often extends to higher-income families. And merit aid is available at many other high-quality colleges. For instance, Rice University offers academic grants averaging $15,000 to 22% of students; at Denison, about 46% of students get merit awards, which average $16,300.

What to do

Look for largesse. As your child begins to evaluate colleges, you’ll want to assess how generous each is with handouts. To find the percentage of students who get merit money, go to For details about a specific college’s grants, check

Run a price check. Get a sense of what a certain private college will cost your family in particular, factoring in aid, by using the school’s net price calculator. (Colleges are now required to offer this tool on their websites.)

Some schools load in merit awards based on your student’s academic profile, while others give only a rough estimate. Either way, the results will be a good starting point for a discussion with the school’s aid officer. Also compare the results with net prices at any state colleges your child is interested in; merit awards are on the rise at public schools too.

Improve your odds. Most private colleges are secretive about the formulas used to award merit aid. In general, your child has a better shot if her grades and SAT scores rank higher than the averages for a particular school, says Lynn O’Shaughnessy, head of

Other factors that may provide an edge: intended major (a less popular one can help), community service, and musical talent. Some colleges even rate your child’s interest in attending — has yours taken a campus tour?


The myth: A liberal arts degree won’t pay the bills.

The reality: Sure, grads with business or STEM (science, technology, engineering, and math) degrees tend to earn above-average salaries. But many liberal arts majors do as well or better.

Case in point: The top-earning 25% of history majors earned a median annual lifetime income of $85,000 vs. $82,000 for computer-programming majors, per a recent analysis by the Georgetown Center on Education and the Workforce.

And in some careers, lower salaries are offset by better job security. The typical education major earns $42,000, but only 4% are out of work. Biomedical engineers pull in $68,000, but 11% are unemployed.

Major isn’t the only determinant of pay, either, notes Anthony Carnevale, the Georgetown Center’s director: “Whether your child attends grad school, changes careers, gets promoted, or loses a job has a big impact on lifetime earnings.”

Besides, many people end up in fields unrelated to their major — an analysis of alumni by Williams College math professor Satyan Devadoss found that some arts majors went into banking, engineering, and tech, while some chem majors ended up in government and education. Also, a Chronicle of Higher Education survey of employers found that previous work experience was more important than one’s major in hiring recent grads.

What to do

Focus on practical help. When comparing colleges, see what each offers to assist your child in developing work skills, says Andy Chan, VP of career development at Wake Forest University. Find out if the career office reaches out to freshmen, offers courses in résumé building, and helps students land paid internships. Some 60% of 2012 grads who held a paid internship got a job offer, according to the National Association of Colleges and Employers.


The myth: Student loans will cripple your child financially.

The reality: You’ve heard the horror stories about college grads hobbled by debt, and the facts can indeed be scary: The typical student at schools such as American University and NYU leaves with over $35,000 in loans; 2% of all student borrowers owe more than $50,000.

Rising costs are one reason for those hefty debt loads, but a less obvious problem is the increasing time young people are taking to get their degrees. Just 32% of public college students and 52% who attend a typical private school get out in four years — taking six years is more common.

At more selective schools like Davidson and Lafayette, on the other hand, 85% or more of students finish in four years. Plus, such schools tend to offer strong alumni networks that can help with job leads.

“If you can attend a good school that helps you graduate on time with great skills and contacts, borrowing can be worth it,” says O’Shaughnessy. That’s especially true if taking on a manageable amount of debt will help your child attend a better school than your family could otherwise afford. “Manageable” is the operative word.

What to do

Get your kid’s stats. Check graduation rates for the schools your child is interested in at Find the likely salary of careers he might pursue and the typical income of students who graduate from schools on his list at

Use the right benchmark. To ensure payments will be bearable, your child should borrow less than what she can expect to make in her first job, says Kantrowitz. The average grad’s $27,000 in loans would total $33,000 with interest over 10 years, if the 3.9% rate recently worked out by Congress goes into effect. (That rate is tied to 10-year Treasuries and is likely to rise in coming years for future borrowers.) If your child earns a typical starting salary of $45,000, she could afford that debt.

Don’t fight the feds. For student borrowers, government Stafford loans, which limit debt to $31,000 over four years, are the best bet. Unlike private loans, the federal program offers income-based payment and public-service debt forgiveness, says Lauren Asher, head of the Project on Student Debt.

See PLUS as a minus. Parent borrowers should just say no to federal loans. PLUS loans let you borrow the full cost of college regardless of income, at expected rates of about 7.21% (plus fees of at least 4%), which can rise to 10.5% for future borrowers under the new rate formula. “You can borrow more than you can afford at a high rate — what can possibly go wrong?” says policy analyst Rachel Fishman at the New American Foundation. A lower-rate option that limits how much you can borrow: a home-equity line of credit (4.5% to 5%).


The myth: Starting at community college, then transferring, is a great way to cut the cost of a BA.

The reality: Sure, community college is a lot cheaper than a four-year school, but students who start there are less likely to earn their bachelor’s degree..

Part of the problem: Many four-year colleges make transferring credits tough. While two-thirds of states have articulation agreements to ensure that community-college courses are accepted at specific four-year schools, loopholes abound — some allow discretion about which credits to accept, or a certain GPA may be required. And articulation agreements shouldn’t be confused with a guarantee that your child will get an open slot at a four-year college, says Stephen Handel, a College Board specialist in community colleges.

For many teens, the lack of a strong peer group also makes it hard to stay focused, says Tatiana Melguizo, a USC associate education professor; community college students tend to be older and attend part-time.

What to do

Go for ironclad. See if any community colleges in your area offer a guaranteed transfer to a four-year school. In Virginia, 23 community colleges guarantee admission for students with high GPAs into certain programs at 20 state four-year schools. Others, such as Portland Community and Portland State University in Oregon, offer co-enrollment programs that allow students to shift seamlessly into the four-year program after earning a two-year degree.

Talk to the target. Ask the admissions office at the four-year school your child wants to attend about the transfer requirements and how many two-year college students it accepts. The good news: “If your child does transfer, her odds of getting a BA are as good as those for four-year college students,” Melguizo says. Savings and a degree? Maybe you can afford grad school after all.

This story has been updated to reflect an increase in the PLUS loan rate.

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.


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.

MONEY Markets

Unlocking a safer, smarter portfolio

With a few tweaks to your portfolio, you can still hedge against the risks that really matter. Illustration: Daniel Stolle

Building in portfolio safeguards can be easy with these common-sense moves.

RORO has made a mess of a lot of carefully designed portfolios.

RORO isn’t what George Jetson’s dog used to say. It’s trader jargon for “risk on/risk off.” Investors pile into risky assets — especially stocks, both U.S. and foreign — when the economic news is bright, and run for cover into Treasuries at the first whiff of trouble.

Even if you’re a steady buy-and-holder, RORO has left its mark in two big ways:

First, diversification is harder. A classic way to reduce your volatility is to own different kinds of assets, so that when one part of the market falls, something else may be going up — or at least falling less. RORO wrecks that. It first roared in the 2008 crisis, when not just U.S. stocks but foreign stocks, high-yield bonds, real estate, commodities, and you-name-it all crashed.

The HSBC RORO index, which tracks how closely assets correlate, or move together, kept rising from there. It stayed near historic highs through late 2012.

The mood-swing trade has tailed off this year, but that’s because U.S. stocks boomed as Europe and emerging markets dragged. So spreading your bets with international stocks didn’t help you in the crisis and isn’t boosting your returns now.

In any case, it’s too early to declare an end to RORO, says HSBC strategist Mark McDonald. With the global economy still vulnerable to crisis, a raised eyebrow from Ben Bernanke or a European finance minister may be enough to set off an undiscriminating tizzy. “Any market hiccup can cause correlations to spike again,” says McDonald.

Second, safety is getting risky. One investment that has smoothed your ride is the safe haven everyone runs to at “risk on” time: Treasuries. They’re now so popular that the yield on a 10-year note is down to less than 1.8% (When bond prices rise, their yield falls.)

That creates some problems: Yields have little room to go anywhere but up from here, which means you could experience sharp losses when interest rates, and thus yields, start to rise again. What’s more, holding bonds at these rates means you risk seeing your investment’s value eroded by even a moderate amount of inflation.

How, then, in this twitchy environment, do you build a portfolio safe enough to let you sleep at night, with returns that get you to your goals? MONEY dove into the best research on diversification and talked to some of the sharpest advisers. The big takeaway: With only a few twists, you can still hedge against the risks that really matter.

What follows are five key ideas to guide a long-term investor through a market where everything turns on the latest news flash.


Forget the short-term, protect against generational risk

The idea that other countries’ markets will move out of step with the U.S. is an important part of the pitch for international mutual funds and ETFs. (“Diversification” is literally the first word on T. Rowe Price’s “International Investing Explained” web page.) This has become a harder case to make, however.

Consider the relationship between U.S. equities and an index of developed markets. A 100% correlation means markets always move together; zero is no relationship at all. Since the ’70s, correlations have shot up from 37% to 88%.

What happened? Globalization. “As the world becomes increasingly interconnected, macroeconomic events are more often driving market movements,” says Tyler Shumway of the University of Michigan business school. Companies in Europe or Asia do much of their business here, and vice versa.

Even the fact that you can easily diversify abroad with a mutual fund makes it harder, ironically, to reap the benefits of diversification. The anxieties of investors in Florida can feed through to stock prices in Frankfurt.

Step back from the short term, though, and diversification still looks powerful. William Bernstein, a Portland, Ore., investment adviser, says it protects against risks that play out over decades — like a slump long enough to blow out the gains of a generation of investors. That happened to Japanese investors after 1989.

To be blunt: Owning overseas is a hedge against the unlikely but real possibility that you’ll someday find yourself living in the next Japan. Research from AQR Capital Management shows that while countries often fall together in the short term, long slumps are something nations often do on their own.

In a decade in which Japan fell 40%, in fact, a global portfolio rose 130%. “Global exposure helps you cut out the risks of investing in a single country,” says Gregg Fisher of advisory firm Gerstein Fisher. And that includes your own country.

How to retool: Over five years foreign equities have lost an annualized 1.4%, vs. a 4.9% gain for the S&P 500. If disappointing performance led you to lighten up on foreign shares or to stay out, this year’s divergent markets may offer a window to get in. The stocks in Fidelity Spartan International look relatively inexpensive, trading at about 13 times next year’s expected earnings, compared with 14.3 for the S&P. “Smart investors go fishing in troubled waters,” says Bernstein.

How much do you want to own? A third of your stocks is a baseline. Though the short-term diversification benefits of going abroad have declined, they haven’t disappeared. A report by Vanguard found you get most of that advantage with a 30% allocation.

The same report also revealed something surprising: “Emerging markets are almost as correlated with the U.S. as is the rest of the developed world,” says Vanguard’s Christopher Philips. These riskier markets might be attractive for their return potential, but there’s no need to add a lot just to be diversified.

A broad international fund with around 15% in such countries, like MONEY 70 picks Dodge & Cox International Stock or Vanguard Total International Stock gives you plenty of exposure.

Key Idea No. 2: Some stocks beat others


Markets may move in sync, but some stocks beat others

The demise of easy stock diversification (at least in the short run) means there’s one less obvious strategic edge available to individual investors. A bulwark against disaster is good — but is there any way to actually capture a better return along the way?

Research into the history of financial markets has found few strategies that offer a long-term advantage. Two that might: owning small-company and value stocks, or shares that trade at a deep discount to earnings or business value. Small-caps beat blue chips by an annualized two percentage points since 1927, according to Morningstar data; large value beat pricier large growth stocks by about as much. Stocks that are small and cheap won even bigger.

The idea of tilting your portfolio toward some corners of the market pushes against the idea of spreading yours bets as widely as possible.

However, Larry Swedroe of Buckingham Asset Management says you can use tilt as part of a strategy to lower your overall exposure to risky assets. He’s found that since 1970, a portfolio with 50% in bonds and the rest split evenly between an S&P 500 index fund and a U.S. portfolio of small value stocks would have matched the long-run return of a fund with all of its assets in the S&P, with less volatility.

Two big caveats: First, the future might not look like the past. Second, this approach takes guts, even with a bigger bond stake. The reason small caps deliver better performance is that they clearly are risky. And although value investing is often thought of as conservative, stocks are often cheap when the market sees trouble ahead.

Besides, when bull markets take hold and “go-go” growth stocks soar, being a value investor can make you feel like a chump. “Way more important than your specific mix of assets is your commitment to keep your money invested through thick and thin,” says investment adviser Rick Ferri of Portfolio Solutions.

Sticking to a tilted portfolio, which is bound to be out of step at times, requires extra commitment.

How to retool: You don’t have to go whole hog on this strategy. Adding even a style-focused ETF like Vanguard Small Cap Value gets you some tilt. Or, says Daniel Solin, also a Buckingham adviser, you could add the value and small-cap factors separately, with Vanguard Value Index and Vanguard Small Cap Index .

If more than 50% of your overall stock mix is in value, and more than 10% is in small caps, you’re tilted. A similar strategy can also be applied to your foreign holdings using iShares MSCI EAFE Value and iShares MSCI EAFE Small Cap .


Bonds are your frenemy

While correlations within the stock market have risen over the years, Treasuries, the core of many bond portfolios, are now negatively correlated with equities — they often move in the opposite direction. That would be great, if their sub-2% yields didn’t make them such unappealing investments.

“You’re not necessarily being compensated enough for the interest rate risk looming around the corner,” says Peter Palfrey of Loomis Sayles Core Plus Bond Fund, putting it mildly. The duration, or interest rate sensitivity, of a 10-year Treasury is 8.8 years, meaning a one percentage point spike in rates would cut its price 8.8%.

The lack of yield is a big enough worry that veteran investment adviser Charley Ellis, a longtime advocate of a passive buy-and-hold approach to investing, told MONEY in an interview last month that his best advice is to not own bonds.

The tough question is, What would you do instead? Adding a lot of equities can’t be the answer. As the Cyprus crisis earlier this year showed, the global economy is hardly out of the woods yet; bonds will probably still be a cushion in future stock shocks. Cash or CDs are an option for safety, but that means living with yields from barely over zero to 1%.

How to retool: Although not as safe from a rate spike as cash, Treasuries with durations below three years still offer a reasonable amount of protection from a rate turn.

Wealth manager Chris Cordaro of RegentAtlantic Capital also suggests that you diversify with some highly rated corporate bonds. They don’t add much risk of default, and the higher yields they pay give you an extra cushion against an interest rate move. Vanguard Short Term Bond , a low-cost ETF, is mostly Treasuries, but keeps about 20% of its portfolio in high-grade corporate bonds.

Also look beyond the U.S. “Foreign bonds give you good value today, with better yields than Treasuries for income and protection against interest rate risk,” says Bohemia, N.Y., financial planner Ronald Rogé. He suggests that you make foreign bonds about 10% of your bond stake. Pimco Foreign Bon d is a solid choice that employs hedges against currency risk — the possibility that falling foreign currency knocks out some return.

Finally, if going shorter leaves you hungry for income, consider a change on the stock side of your portfolio. “Many good-quality stocks can get you 3% or 4% yields right now,” Rogé says. SPDR S&P Dividend , an ETF, currently yields 2.8%; the Vanguard Value Index Fund’s yield is 2.5%.


Inflation is worth fighting

Shortening-up addresses the interest rate risk in your bond portfolio. Another risk remains on the table: inflation.

Rising prices haven’t been much of an issue in this slow-growth economy — and many economic experts say they may not be for some time — but a diversified portfolio isn’t about protecting against what’s likely to happen. It is insurance against painful shocks.

Boston University economist Zvi Bodie notes that the long-run forecast for inflation is about 2.5% a year. “But I am highly uncertain,” he adds. “I would not be very surprised if it turns out to be 4% or 5%.”

The good news is that the U.S. Treasury sells really effective insurance against inflation in the form of bonds called TIPS, which adjust their principal value in line with rising consumer prices. The bad news is that the yields on them are really lousy — in fact, they are now -0.64%. In other words, you are guaranteed to lose a bit of money on them if you hold to maturity.

Who’d take the government up on an offer like that? You might, once you know that -0.64% represents the real, or after-inflation, yield. Buy a normal 10-year bond yielding 1.73% and you will lose just as much if inflation runs a moderate 2.37%. If it’s higher, you’ll lose more. Although TIPS can’t fix the fact that yields on all kinds of Treasuries are low, they do deliver truth in advertising and probably better real yields than savings accounts or CDs.

How to retool: TIPS are as vulnerable to interest rate risk as any Treasury, so for the most part short is the way to go. Pick the low-cost Vanguard Short-Term Inflation Protected Securities or buy short-maturity TIPS directly at

As for how much you need to hold in TIPS, consider your life stage. “The average person might have half TIPS and half Treasuries,” says Swedroe. (So if you have a bond fund that’s mostly regular Treasuries, you’d dial back that investment to add a TIPS fund.) He adds that older people will want a bit more, since inflation poses the most serious threat to those dependent on investments for income. Younger people still in the workforce need fewer TIPS.

Unlike with regular Treasuries, there’s a case for owning longer TIPS, but individually, not in a fund. If you need to protect money with no chance of a surprise loss, a TIPS bond protects purchasing power (minus that negative yield). That’s provided, of course, you know for sure you will hold until maturity.


The new diversification tools Wall Street sells are already rusty

Wall Street’s response to high correlations and lousy bond yields has been to sell “alternatives” — a mixed bag of everything from commodity futures to hedge fund strategies. Avoid these often expensive funds.

The diversification and return potential of alternatives is overstated, argues William Bernstein in the e-book Skating Where the Puck Was.

Commodities futures, for example, had amazing records a decade ago. They beat bonds and stocks, and correlated with neither. But new indexes, funds, and ETFs now mean that anyone can pile into futures — and they have. As the market has become crowded, returns have been lower, and correlations have risen too. When investors were running for the exits in 2008 and 2009, they dumped their futures bets along with their stocks. “The moment you securitize an asset, you begin to destroy its diversification benefits,” says Bernstein.

The same applies to hedge-fund-like strategies such as “absolute return” and “market neutral.” By the time such strategies get to retail, they may be too well-known to work.

There’s no magic combination of assets that will make you a winner every year. Cover the big dangers — a long slump, a rate turn, and inflation — and leave RORO worries to Wall Street’s hyperactive set.

MONEY Ask the Expert

Investing Beyond Your Target-Date Fund

Many investors combine their target-date fund with one or more other investments. illustration: paul blow

Q. “I already invest in a target-date retirement fund. What should my next fund be?”– Errick Chiasson, Baldwinsville, N.Y.

A. Target-date funds are designed to provide not only a fully diversified portfolio in a single fund, but also an investing strategy. Their mix of stocks and bonds gradually becomes more conservative as you age, protecting your savings as you near retirement. So in theory these funds work best if you put your entire 401(k) into one.

In the real world, however, many savers don’t take such an exclusive approach. A recent Vanguard survey found that just under half of target-date investors in its 401(k) plans combine target funds with one or more other investments, in some cases even another target fund.

While mixing another fund with a target fund can be a reasonable choice, you have to be careful that doing so doesn’t leave you with an unruly mishmash instead of a coherent portfolio.

Straying from the target

One good reason for going beyond a target fund is to adjust how much risk you’re taking.

Let’s say you’re a young investor who likes the target-date concept because it frees you from having to create a portfolio on your own, but you’re anxious about having 90% of your money in stocks, a typical allocation for investors in their twenties and thirties. Transferring, say, 20% of your target fund’s balance into a diversified bond fund would give you a considerably less volatile portfolio.

Conversely, you could make a similar shift into a total stock market index fund to boost your 401(k)’s growth potential. This add-on strategy is a more effective way to tweak risk than picking a target fund with a later or earlier retirement date.

Once you get beyond this sort of simple fine-tuning, however, things can get hairy. Some investors employ a “core and explore” strategy in which they use a target fund as a foundation and then add funds that focus on certain sectors, such as emerging markets or real estate.

Problem is, most target funds already spread their assets widely both here and abroad. So you could end up doubling down on niche markets.

Besides, you may not enjoy enough extra return to make up for the added time and trouble of monitoring and re-balancing a considerably more complicated portfolio.

If you do go that route, plug all your retirement investments, including those outside your 401(k), into Morningstar’s Portfolio X-Ray tool (available free at That way you can see your overall allocation and make sure you’re not inadvertently overweighting any areas.

But once you’re investing in so many other funds that your target fund essentially becomes a bit player, you may be better off simply building a portfolio from scratch.

MONEY Ask the Expert

What’s Your Real Risk Tolerance for Investing?

Q. What’s my risk tolerance? I’m 31 and 90% in stocks, but I’m not willing to take a 50% hit. Craig Carlson — Omaha, Neb.

A. Considering how often the term “risk tolerance” is bandied about in the investment world, you’d be surprised how much confusion surrounds it.

Many people believe that your appetite for risk rises and falls — that is, you’re more willing to take on risk during bull markets, less so during bears.

Not true, says Geoff Davey, director of FinaMetrica, an Australian firm that creates risk-profiling systems.

You have a set amount of risk that you’re comfortable with. When you feel the urge to bail after a meltdown, your temperament didn’t change; you misjudged the risks you were taking.

“People underestimate risk when markets are booming and overestimate it when there’s a bust,” says Davey.

So how can you get a better handle on this crucial concept and develop an investing strategy?

For starters, think seriously about how much you could watch your savings drop before you panic.

From the market’s 2007 peak to the 2009 trough, stock values plunged more than 50%, while intermediate-term government bonds rose roughly 6%. A portfolio of 90% stocks and 10% bonds fell 45%; a fifty-fifty mix was down about 22%.

If you think 20% or so is the most heat you could stand, a 50% stock stake is probably close to your upper limit, even though that’s far less than what’s often suggested for someone your age.

You could also fill out one of the many risk-tolerance questionnaires available online. The problem is, most tend to focus on how much risk you ought to take with your investments, not the swings you’re prepared to handle.

A notable exception is FinaMetrica’s questionnaire (Cost: $45), which gives you a numerical risk-tolerance score on a scale of 1 to 100 that corresponds to the percentage of risky assets that’s appropriate for someone like you.

You may, however, discover a gap between the amount of risk you can tolerate and the amount you must embrace to reach your goals.

Say you prefer a fifty-fifty stock/ bond split but, given what you’re saving, you need upwards of 70% in stocks to generate the necessary returns. You could buy more stocks in hopes of higher gains, but investing too far outside your comfort zone could backfire. You could end up selling at a big loss during a downturn.

The better option: Adhere to a portfolio you can handle and make other adjustments, such as saving more, working longer, or scaling back your retirement lifestyle.

Finally, most people become less tolerant of risk as they age. But even if you’re okay with the same stock-heavy mix at 65 that you had in your thirties, you’ll probably still want to dial back. The same loss you shook off in your youth could so deplete your nest egg in retirement that it might never recover.


Investing rules of thumb: Why they don’t always work

I’ve always heard that 100 minus your age gives you the percentage of your retirement portfolio that you should invest in stocks. Do you recommend that rule of thumb as a good way to invest? — John Noel

There’s no question that rules of thumb — or “heuristics,” as behavioral economists call them — can simplify activities many people find confusing, such as investing. Easy-to-follow rules can even sometimes produce better results than more sophisticated methods.

For example, researchers found that small business owners who were taught basic rule-of-thumb techniques for estimating profits and calculating revenues improved results more than those who were trained in the fundamentals of traditional financial accounting (which may come as no surprise to anyone who’s struggled through an accounting course).

Still, I’d be wary about relying exclusively on rules of thumb when it comes to investing, or for that matter, any other aspects of retirement planning, including the 70% rule for estimating how much income you’ll need in retirement and the 4% rule for gauging the amount you can safely withdraw from your nest egg after retiring.

One reason you need to be cautious about applying a rule of thumb is that many times there’s no real consensus about what the standard is. For example, when I arrived at MONEY Magazine nearly 30 years ago as a (relatively) fresh-faced writer who still had a full head of hair, 100%-minus-your age was the widely accepted gauge for determining how much stock one should have in a retirement portfolio.

But as investors became more enamored of stocks in the bull market of the late 1980s, you began to see references to a 110-minus-your-age benchmark. And by the time the “Stocks for the Long Run” culture really began to dominate, 120 minus your age was being touted as a more appropriate standard.

Related: Six secrets to a dream retirement

So if you were, say, 30 years old, you could end up with anywhere from 70% of your savings in stocks (100% minus 30) to 90% (120% minus 30), depending on which version of the rule you applied.

But even aside from the question of which benchmark is the accepted one, there’s the even more important issue of whether you should be basing your retirement investing strategy on any rule of thumb. After all, by its nature a rule of thumb is a metric that’s meant to apply to the average person or typical situation.

You’re not an average, though, and your finances may not be typical. You are you, a specific person who has distinct financial needs and preferences.

For example, if you’re age 65 and ready to retire, applying the 100-minus-your-age standard would give you a stock stake of 35% of your savings. That may be perfectly fine for many 65-year-olds. But if you have a relatively modest nest egg and you’re likely to bail out of stocks if the Dow drops 20%, then investing 35% in equities could be too racy for you.

If, on the other hand, you’ve got a huge pot of savings that can continue to throw off sufficient income even if the market tanks, or if Social Security and a pension cover enough of your expenses that large fluctuations in your retirement balances don’t faze you, then it may make sense for you to boost your stock holdings well beyond 35%.

So what do I propose instead of going with a rule of thumb?

Well, when investing for retirement you want to create a stock-bond allocation that can get you the returns you need without subjecting yourself to a level of risk that you can’t handle.

One way to arrive at an acceptable tradeoff between those two aims is to go to a good retirement calculator, plug in your financial information and test run a variety of stock-bond mixes. That will give you an idea of how your chances of achieving a secure retirement may change as you increase or decrease your exposure to stocks.

Related: Social Security’s role in your portfolio

Once you’ve arrived at a blend of stocks and bonds that seems appropriate, you can then go to Morningstar’s Asset Allocator tool to see how far that mix might drop over the course of three months if the market tanks. You could also do a quick back-of-the-envelope calculation to determine how large a loss a given blend might have sustained in severe downturns in the past.

From late 2007 to early 2009, for example, stocks lost roughly 50%, while the broad bond market gained about 15%. So an 80-20 mix of stocks and bonds would have sustained a loss of 37% vs. a setback of only 17.5% for a portfolio split equally between stocks and bonds.

Of course, there’s no assurance that the future will unfold exactly like the past. It probably won’t. But going through the exercises I just described can at least give you a sense of what the possibilities are for different allocations of stocks and bonds — and offer a much better guide for investing your retirement savings than any rule of thumb.

MONEY Investing

Where To Put Your Retirement Money

From the years you spend tending to your portfolio to the time when you finally get to enjoy sweet success, you face questions about what to do. Ace these and prosper.

This story is part of Money magazine’s story 5 retirement choices: Get ‘em right, live well which covers big decisions that can dramatically boost your income in retirement.

Once you determine how much of a saver you are, you have several more decisions to make — including how you invest your portfolio.

Decision No. 2: How should you divide up your money?

The decision: Once you’ve amassed a portfolio worth more than five figures, you may wonder whether you should branch out from plain-vanilla stock and bond funds.

To hear some advisers tell it, you can’t have a truly diversified portfolio unless you spread your money among virtually every asset class, sector, and subsector under the sun: hedge funds, currency, single-country funds, precious metals, exotic ETFs.

Why it’s important: You can capture more than enough of the benefits of diversification — solid returns while minimizing risk — with a relatively simple stocks/bonds mix.

Related: Betting your retirement on stocks

Start by making sure you own a broad swath of U.S. stocks and bonds. Then add developed and emerging foreign markets.

For inflation protection, you might pick up some real estate and TIPS. Adding more to this basic blend isn’t likely to appreciably boost your performance.

In fact, stocking up on a dozen or more different assets may work against you. One reason is the phenomenon that asset-allocation expert William Bernstein refers to as “overgrazing” — as more and more investors plow money into a newly discovered alternative investment, the lower its expected return.

Related: Investing in TIPS – Can retirees beat inflation?

“The first ones in get sirloin, but the latecomers get hamburger or worse,” says Bernstein. Many nontraditional assets also come with hefty fees.

As you pile on more investments, monitoring and managing them become harder.

“If you’ve got upwards of 20 different investments in 401(k)s, IRAs, and taxable accounts, you’re talking about a blizzard of trading every time you rebalance,” says Wealthcare Capital Management CEO David Loeper.

Best move: The simplest way to create this mix is by using index funds or ETFs from our MONEY 50 list. Aside from simplicity, they have the advantage of certainty: These funds strictly follow defined benchmarks, so you know exactly how they’ll invest.

Most important, though, resist the urge to jump onto the alternative investments bandwagon. Says Bernstein: “Wall Street needs to sell them, but you don’t need to buy them.”


MONEY Savings

5 Retirement Choices: Saving vs. Investing

From the years you spend tending to your portfolio to the time when you finally get to enjoy sweet success, you face questions about what to do. Ace these five and prosper.

Making better decisions can dramatically boost your income in retirement, a new study finds. That’s not exactly earth-shattering news. What may surprise you are which decisions matter most, according to researchers at Morningstar.

They are not the kinds of choices you may obsess about, like whether to buy Apple stock or where to find the next hot emerging market. Rather, the most crucial decisions involve more fundamental issues, like how you manage your 401(k) plan.

The idea of making savvy choices applies to all phases of planning. So, based on what I’ve learned writing my Ask the Expert column, I came up with these five big decisions you need to get right before and after you retire.

1. Are you a saver or an investor?
2. How should you divide up your money?
3. How much help do you really need?
4. What’s the best use of tax-deferred plans?
5. How much can you draw from your savings?

Decision No. 1: Are you a saver or an investor?

The decision: When you sign up for a retirement plan or use an online calculator to track your retirement progress, you must decide how much to save and how to invest those savings. It may seem counterintuitive, but your savings rate is by far more crucial.

Why it’s important: Even though history shows that tilting a portfolio toward equities generates higher returns, loftier gains are hardly guaranteed — witness the 3.4% annualized loss you would have suffered by investing in the S&P 500 index from March 1999 to March 2009. And investing too aggressively leaves you more vulnerable to downturns like the near 60% drop in the 2007-09 bear market. Ratcheting up the amount you sock away is a surer way to improve your chances of achieving a secure retirement.

Increasing how much you save every year has a much bigger impact on your eventual retirement security than investing more aggressively does. The reason: While shifting more savings to stocks enhances return potential, it also increases volatility, which dilutes the effectiveness of a stock-heavy portfolio.

Saving more has another benefit: You can afford to invest more conservatively. By saving 20% a year for 30 years — a high bar, for sure — you can trim stock holdings to 60% and still have the same high chance of success you would have with an 80/20 mix.

Best move: Aim to save 15% or more a year. You’ll improve your odds of retiring in comfort and be less vulnerable to the vagaries of the markets.

MONEY Ask the Expert

Betting Your Retirement: Stocks vs. bonds

Q. I’m 35 years old and a diligent saver. I’m torn, however, about whether someone my age should own bonds. If the stock market has never had a negative 10-year span, shouldn’t I invest 100% of my savings in stocks and keep it there until I’m within a decade or so retiring? — Mark N., Austin, Texas

A. With stocks on a roll in recent months, investors who were shunning equities just last year are feeling positively ebullient about them now. But before you plow all your retirement savings into stocks, I have two words of caution for you: Downton Abbey.

What, you may ask, could a soap opera set in England in the early 20th century possibly have to do with your retirement planning? Rather a lot, actually.

As viewers of Downton’s third-season premiere will recall, Lord Grantham’s lawyer informed him that the Canadian railway into which he had sunk the bulk of his wife Cora’s fortune stood on the verge of bankruptcy, jeopardizing the financial health of his estate.

Upon hearing this news, the Earl of Grantham thundered, “Every forecast was certain. Rail shares were bound to make a fortune…It wasn’t just me. Everyone said we couldn’t lose!”

I’m not saying that putting 100% of your retirement savings in stocks is as rash as Lord Grantham’s decision to invest so heavily in just one stock. But tying your retirement prospects to the performance of a single asset class — and a very volatile one at that — wouldn’t exactly qualify as a prudent move either.

One reason is that while losses in stocks over long stretches are rare, they do happen, despite your supposition to the contrary.

Related: Can retirees beat inflation?

For the 10 years from 1999 through 2008, for example, large-company stocks lost 13% of their value. There have also been a handful of 10-year and even 20-year spans during which stocks had positive returns yet still lagged bonds.

So while I think it’s reasonable to expect stocks to outperform bonds over the long term in most instances, there’s enough variation so that it pays to hedge. The investing world is too uncertain for all-or-nothing bets.

Besides, you shouldn’t be basing your investing strategy solely on expected returns. You’ve also got to consider your risk tolerance, or how you’ll likely react if the market tanks (as it inevitably will many times between now and when you retire).

It’s one thing to say you think you should be 100% in stocks because you believe that over long periods equities will rack up the highest gains. It’s quite another to stick to that strategy when a plunging stock market zaps the value of your 401(k) by 50% or more, and it’s anyone’s guess how long it will take for your account to bounce back.

My suggestion: Go to a good online retirement calculator and plug in such information as your age, when you think you might retire, how much you already have tucked away in retirement accounts and how much you plan to save going forward. Then run scenarios with different investing strategies –100% stocks, 90% stock/10% bonds, 80%/20%, etc. — and see how the probability of achieving a secure retirement changes as you reduce the percentage of your savings you devote to stocks.

Related: 4 ways the market could really surprise you

If you’re really the diligent saver you say you are, you may find that you don’t have to resort to a high-octane stock mix to have a good shot at a comfortable retirement. You may be able to get by with a more conservative stocks-bonds blend. You might also find that after a certain threshold — say, 70% or 80% stocks — adding more equities doesn’t improve the odds very much at all.

Of course, it’s also true that the more you invest in stocks, the better you’ll do if the markets do well. But that upside isn’t a given, and even if it materializes it can come with some frightening spills and chills along the way. So it can pay to sacrifice some upside in return for a less jarring ride.

As you near and enter retirement, you’ll probably want to gradually scale back the amount you devote to stocks. Research shows that risk tolerance tends to decrease with age. Besides, the consequences of aggressive investing can be more dire later in life. Once you’re retired, you no longer have a chance to make up for investment losses by saving more.

That means a big hit to your nest egg could result in you running out of money before you run out of time. For guidance on how you might shift from stocks to bonds as you age, check out this illustration of a target-date retirement fund “glide path.”

But whatever you do, don’t go all stocks on the mistaken notion that equities are a definite win as long as you remain invested in them at least 10 years. If you do, you may later find, as Lord Grantham did, that no forecast, regardless of how certain it may seem, can ever guarantee that you can’t lose.

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