MONEY mutual funds

5 Things You Didn’t Know About the World’s Biggest Bond Fund

The Vanguard Group headquarters in Malvern, Pennsylvania
Mike Mergen—Bloomberg via Getty Images The Vanguard Group headquarters in Malvern, Pennsylvania

Vanguard Total Bond Market, which is now bigger than Pimco Total Return, is a fine fund. But it doesn't quite cover all the bonds you need.

With a whopping $117 billion in assets, Vanguard Total Bond Market Index is now the biggest bond fund in the world, overtaking the long-reigning champ Pimco Total Return, according to data reported by the Wall Street Journal. If you add in the assets held by Vanguard’s exchange-traded fund version of Total Bond Market, the fund controls about $144 billion.

While big in dollar terms, this portfolio isn’t so large in scope. Here are some things you may not know about bondland’s new 800 lb. gorilla:

Despite its name, Vanguard Total Bond Market doesn’t come close to giving you exposure to the total bond market.
Sure, this fund does give you decent market exposure, but it limits that to the universe of high-quality bonds. This means the fund can own debt issued by the U.S. government, government agencies, and “investment grade” corporations with pristine credit.

Only around one tenth of 1 percent of the fund’s assets are held in high-yielding “junk” bonds issued by companies that are considered less than “investment grade.” In the bond world, higher quality issuers can get away with paying lower yields. This explains why the average yield for this fund is a modest 2%.

This fund doesn’t even give you adequate exposure to high-quality corporate bonds.
While Vanguard Total Bond Market does own high-quality corporate securities, they represent less than one quarter of the fund’s assets. With more than 75% of its assets in Treasuries and U.S. agency-related debt, this is more of a government bond fund than anything else.

This is why MONEY has recommended supplementing this fund (which is in our MONEY 50 list of recommended mutual and exchange-traded funds) with a corporate-centric portfolio, such as iShares iBoxx Investment Grade Corporate ETF (which is also in the MONEY 50).

This fund gives you extremely little foreign exposure.
Technically, Vanguard Total Bond Market does own a tiny amount of international debt. But the biggest weighting is to Canada, which makes up less than 1.7% of the fund. In fact, bonds based in the U.K, Germany, Mexico, and France each make up less than 1% of the fund’s total assets.

To really gain foreign exposure, you will have to further supplement this fund with an international fixed income fund, such as Vanguard Total International Bond Index fund, which is also in the MONEY 50.

Unlike the past champ, Pimco Total Return, this fund runs on autopilot.
As its name would indicate, Vanguard Total Bond Market Index is an index fund. This means that instead of being controlled by a star manager who picks and chooses which bonds to buy and sell, this fixed-income portfolio passively tracks a fixed-income market benchmark. In this case, that’s the Barclays Capital U.S. Aggregate Float-Adjusted Index.

Vanguard Total Bond became the biggest bond fund sort of by default.
While Total Bond has been consistently gaining investors in recent years, it didn’t win the crown so much as Pimco Total Return lost it. At its peak, Pimco Total Return wasn’t just the biggest bond fund, it was the largest mutual fund in the world. Yet after approaching nearly $300 billion, Pimco Total Return lost more than half its assets as investors fled amid infighting at Pimco which eventually led to the departure of famed fixed income manager Bill Gross. Today, Pimco Total Return is down to around $117 billion.

MONEY Ask the Expert

Have Mutual Funds Lost a Key Advantage Over ETFs?

Investing illustration
Robert A. Di Ieso, Jr.

Q: ETFs seem to be taking the place of mutual funds, but my understanding is that mutual funds are still your best option if you want to reinvest dividends. Is that true? — Bill from Florence, S.C.

A: Once upon a time, there was some truth to this. But the popularity of dividend-focused exchange-traded funds has prompted most brokerages to tweak their policies to accommodate dividend reinvestors.

“From an investor standpoint the experience should be similar, though the process behind the scenes is different,” says Heather Pelant, a personal investor strategist with BlackRock, which manages mutual funds as well as ETFs via the firm’s iShares division.

Before ETFs became widely adopted, some brokerages charged ETF investors a transaction cost for dividend reinvestments, says Pelant. Hence the notion that mutual funds are a better vehicle for reinvesting dividends. “These platforms have since come up with procedures and features that are parallel to mutual funds,” she says.

Today, most large brokerages give investors the option of depositing dividend payouts into their cash accounts or automatically reinvesting dividends back into the security – be it an individual stock, mutual fund, or ETF. You should be able to make this choice on a fund by fund basis, change your preference at any time, and reinvest your dividends for free.

Still, it’s always a good idea to double check your broker’s own policy, lest you get dinged with additional fees.

One way ETFs are different (slightly) from mutual funds is the timing of reinvestments. Mutual fund dividend payouts are reinvested at a fund’s net asset value on the ex-dividend date, which is essentially the cutoff date for new shareholders to collect that dividend.

ETF investors, on the other hand, have to wait for all transactions to settle, typically a few days, to repurchase shares. If share prices swing widely during that short window of time, it could make a difference — for better or for worse.

For most investors, however, this nuance matters far less than all the other factors that go into deciding whether to invest via an ETF or fund.

Meanwhile, dividend reinvesting is a great tool to stay fully invested and systematically buy additional shares over time, says Pelant. Over the long term, these payouts really can add up.

Of course, because different funds will have different payouts, automatically reinvesting dividends could eventually throw off your allocations — even more reason to make sure you periodically rebalance your portfolio.

MONEY stocks

14 Simple Ways to Be a Smarter (and Richer) Investor

brain made out of gold bars
Hiroshi Watanabe—Getty Images

Picking stocks is hard—and you still might not beat throwing darts at the stock pages. Here some easier ways to get yourself an edge.

1. Don’t pay 33% of your money in fees. Mutual fund charges look small, but the cost of paying an extra 1% a year in fees is that you give up 33% of your potential wealth over the course of 40 years. An index fund like Schwab Total Stock Market SCHWAB TOTAL STOCK MARKET SWTSX -1.23% can keep your expenses below 0.1%, compared with over 1% for many stock funds.

2. Mix your own simple plan. Four very low-cost index funds, recommended in the Money 50, deliver all the world’s major markets. (See graphic below.) The more aggressive you are, the more you can tilt toward stocks.

Source: MONEY research

3. Or pick just one fund. You don’t have to be fancy to be an effective investor. A classic balanced mix (about 60% stocks/40% bonds) provides plenty of equities’ upside, with less pain during crashes. The Vanguard Wellington VANGUARD WELLINGTON INV VWELX -0.75% balanced fund has earned an annualized 8% over a decade.

4. Or hire a robo-adviser. Outside of a 401(k), if you want a plan that’s more tailored to you, web-based automated investment services can put you in a mix of low-cost index funds and then rebalance as you go. Betterment and Wealthfront stand out as low-cost options, charging 0.35% of assets or less.

5. Patch the holes in a 401(k). Many workplace plans offer at least an S&P 500 or total stock market index fund as a low cost option for buying U.S. stocks. But if your plan doesn’t offer good choices in other asset classes, such as bonds and foreign stocks, diversify elsewhere. Save enough to get the company match. Then fund an IRA, where you can choose which bond funds or foreign funds to go with.

6. While you’re at it, dump company stock. About $1 out of every $7 in 401(k)s is invested in employer shares. But your income is already tied to that company. Your retirement shouldn’t be too.

7. Pick an asset, any asset. You can get into trouble by being too clever by half. The average investor has barely beaten inflation in the past 20 years as a result of buying trendy assets high and selling low. Forget all that. As the chart below shows, you’re better off buying and holding almost any major asset class.

Sources: Bloomberg, Morningstar, DalbarNotes: Returns are through Dec. 31, 2013.

8. Be patient with funds. Some well-known bargain-minded funds, such as Dodge & Cox Stock DODGE & COX STOCK FUND DODGX -1.2% , have struggled this past year. That doesn’t mean you should flee. True value funds refuse to buy popular—read expensive—stocks, so they often lag in frothy times. But over the past 15 years, Dodge & Cox has outperformed its peers by 2.5 percentage points a year and the S&P by more than four points.

9. Be stingy with funds. Cheapskates know index funds aren’t their only options. Actively managed blue-chip stock funds with an expense ratio of 0.35% or less have returned 8.5% over the past decade. That’s 0.5 percentage point better annually than the S&P 500. A great option: Vanguard Equity-Income VANGUARD EQUITY INCOME INV VEIPX -1% , charging 0.29%, has outpaced the market’s gains by 3.5 points annually over the past 15 years.

10. Rebalance? Maybe not. Routinely resetting your stocks and bonds to their original levels “is a nice idea in theory,” says planner Phil Cook. But “if you rebalance too often, you can give up a lot of potential returns.” In your twenties and thirties, when you’re almost all in stocks, you can skip it. As you age, though, gradually increase the frequency of rebalancing to every few years.

11. Break up with your high-cost adviser. Stock and bond returns are expected to be muted in the coming decade, so cutting advisory fees—often 1% of assets—matters. Vanguard Personal Advisor Services charges just 0.3% of assets. Some tech-based services, such as Betterment and Wealthfront, charge even less.

12. Put your portfolios together… If you hold a third of your 401(k) in bonds, your mix may be riskier than you think if your spouse is 100% in stocks. Coordinating also improves your options. If your spouse’s plan has a better foreign fund, focus your international allocation there.

13. …and your assets in the right place. Once you’ve maxed out your IRAs and 401(k)s, use taxable accounts for the most tax-efficient investments in your mix. They include index and buy-and-hold equity funds that trade infrequently and generate few capital gains distributions.

14. Take a fresh look at a classic. You’ve now built up enough assets that advisers will be eager to sell you clever ideas to beat the market. Before you bite, read the 2015 edition of A Random Walk Down Wall Street. Burton Malkiel has updated his skeptical investment guide to take on the latest new flavor, “smart” ETFs. If a fund has a greater return, says Malkiel, it’s probably because it’s taking on more risk.

Adapted from “101 Ways to Build Wealth,” by Daniel Bortz, Kara Brandeisky, Paul J. Lim, and Taylor Tepper, which originally appeared in the May 2015 issue of MONEY magazine.

MONEY Ask the Expert

The Best Way to Own Gold and Silver

Investing illustration
Robert A. Di Ieso, Jr.

Q: I’m looking for information on adding gold and silver to my investments. What are the advantages and disadvantages of buying coins? What about gold and silver stocks or mutual funds?

A: “We think gold and other precious metals can play a part in a well-diversified portfolio, but our preference is to own the stocks or the mutual funds that would give you that exposure,” says Joe Franklin, a certified financial planner and president of Franklin Wealth Management in Hixson, Tenn.

The trouble with coins, he says, is that dealers charge a premium. And the price you pay isn’t based purely on the value of the underlying gold, silver or platinum. There are other factors at play, such as historical value or the costs associated with minting commemorative pieces.

If do buy coins, you can start by searching the U.S. Mint’s site for an authorized purchaser in your region, then do additional research to make sure that the outfit is reputable. This is an area rife with scams.

Another consideration with owning the actual metal is storage: If you pay a third-party to hold the coins for you, there are additional fees. If you store it in a safe at home, there are additional risks. A bank safe deposit box may be your best bet, but annual fees range from about $20 to more than $200 depending on the size.

The fees and logistics of owning coins are only part of the problem, says Franklin. “Gold in and of itself doesn’t have a lot of utility,” he adds. “It doesn’t pay interest or dividends, and while it can go up in value it tends to be a fear trade.”

If you’re interested in pure exposure to gold, a better bet is an exchange-traded fund, such as the SPDR Gold Trust (ticker: GLD), which aims to track the spot price of gold bullion. “There’s more liquidity and transparency with a fund,” he says. “But you’re still going to see dramatic swings.”

For that reason, Franklin’s preferred strategy is a diversified natural resource mutual fund, which has the flexibility to invest in precious metals — namely via shares of mining companies, some of which pay dividends — energy concerns, and other commodities.

“Managers of these funds have a lot more latitude to pick their spots,” he explains. While he isn’t a proponent of market timing, Franklin warns that commodities tend to go through long periods of over- and under performance. “They’re either really in favor,” he says, “or really out of favor.”

MONEY 401(k)s

Terrible Advice I Hope Young People Ignore

incorrect road signs
Sarina Finkelstein (photo illustration)—John W. Banagan/Getty Images (1)

Please, invest in a 401(k).

I like James Altucher. He’s a sharp writer and a smart thinker. It’s just those kinds of people — people who know what they’re talking about — who deserve to be called out when they say something silly.

Altucher did a video with Business Insider this week pleading with young workers not to save in a 401(k).

It is — and I’m being gracious here — one of the most misguided attempts at financial advice I’ve ever witnessed. It deserves a rebuttal.

Altucher begins the video:

“I’m going to be totally blunt. Are you guys in 401(k)s? OK, you’re in 401(k)s. I honestly think you should take your money out of 401(k)s.”

Why? His rant begins:

“This is what is actually happening in a 401(k): You have no idea what’s happening to your money.”

Everyone who has a 401(k) can see exactly what’s happening with their money. You can see exactly what funds you’re investing in, and what individual securities those funds invest in. These disclosure requirements are legal obligations of the fund sponsor and the managers investing the money.

You might choose not to look, but the information is there. An investor’s ignorance shouldn’t be confused with an advisor’s scam.

Altucher lobs another complaint:

“And, by the way, if you want that money back before age 65, which is 45 years from now, you have to pay a huge penalty.”

You can take money out of a 401(k) without penalty starting at age 59-and-a-half. You can also roll 401(k) money into an IRA and use it for a down payment on a first home or for tuitionwithout penalty.

A lot of companies also offer Roth 401(k) options, where you may be able to withdraw principal at any time without taxes or penalty.

According to the Census Bureau, 91.2% of Americans currently of working-age will turn 65 in less than 45 years.

Another gripe:

“They’re doing whatever they want with your money. They’re investing wherever they want.”

There are no 401(k)s where someone does “whatever they want with your money.”

All 401(k)s are heavily regulated by the Department of Labor and have to abide by strict investment standards under the Employee Retirement Income Security Act of 1974.

Part of those rules require that you, the worker, have control over how your money is invested. Here’s how the Department of Labor puts it (emphasis mine):

There must be at least three different investment options so that employees can diversify investments within an investment category, such as through a mutual fund,and diversify among the investment alternatives offered. In addition, participants must be given sufficient information to make informed decisions about the options offered under the plan. Participants also must be allowed to give investment instructions at least once a quarter, and perhaps more often if the investment option is volatile.

A lot of companies still offer subpar investment choices, but check out this article on how to lobby your employer for a better 401(k). Someone at your company has a legal duty to provide choices that are in your best interest.

“They’re paying themselves salaries.”

It’s true: Mutual fund managers earn a salary.

You know who else takes a salary from the stuff you buy?

Plumbers, accountants, electricians, doctors, nurses, construction workers, shoe salesman, car mechanics, pilots, dentists, receptionists, gas station attendants, TV anchors, the guy behind the counter at the coffee shop, the lady who scans your groceries, me, and — at some point in his life — probably James Altucher.

Look, a lot of fund managers are overpaid. It’s an injustice. But skipping a 401(k), the employer match, and decades of tax-deferred returns because they draw a salary is madness. The employer match, in many cases, offers a risk-free and immediate 100% return on any money contributed to a 401(k). A mutual fund manager’s salary likely eats up a fraction of 1% annually.

Plus, fees have come way down in recent years. Here’s a report by the Investment Company Institute:

The expense ratios that 401(k) plan participants incur for investing in mutual funds have declined substantially since 2000. In 2000, 401(k) plan participants incurred an average expense ratio of 0.77 percent for investing in equity funds. By 2013, that figure had fallen to 0.58 percent, a 25 percent decline.

What does Altucher say to do with your money instead of saving in a 401(k)?

“Hold on to your money. Put your money in your bank account.”

Haha, OK. I shouldn’t invest in a 401(k) because mutual fund managers take a salary. I’m sure the bankers where I have my checking account work for free?

His biggest beef is that people just don’t make money in 401(k)s:

“The average 401(k) — they won’t really tell you this — probably returns, like, one-half percent per year.”

There’s a reason they “won’t really tell you” that: It’s nonsense.

According to a study of 401(k) investors by Vanguard, “Five-year [2008-2013] participant total returns averaged 12.7% per year.”

The average return from 2002 to 2007 was 9.5% per year.

Even from 2004 to 2009, which is one of the worst five-year periods the market has ever produced, the average 401(k) investor in Vanguard’s study earned 2.8% annually.

This is Vanguard, the low-cost provider. But even if you subtract another percentage point from these returns to account for higher-fee providers, you won’t get anywhere close to half a percent per year.

There’s actually a good reason to think investors will do better in a 401(k) than in other investments.

The rules designed to make it difficult for people to take money out of a 401(k) until they’re retired create good behavior, where investors leave their investments alone without jumping in and out of the market at the worst possible times. Automatic payroll deductions also help keep long-term investing on track.

Take this stat from Vanguard:

Despite the ongoing market volatility of 2009, only 13% of participants made one or more portfolio trades or exchanges during the year, down from 16% in 2008. As in prior years, most participants did not trade.

The majority of 401(k) investors dollar-cost average every month and never touch their investments again. That is fantastic. If you could recreate this behavior across the entire investment world, everyone would be rich.

Altucher has another problem with tax deferment:

“You don’t really make money in a 401(k). It’s just tax-deferred. When you’re in your 20s, what does tax-deferred really mean?”

What does it really mean? About a million freakin’ dollars.

Save $10,000 a year in a 401(k) — half from you and half from your employer — and in 45 years (Altucher’s preferred timeframe, here), the difference between taxable and tax-deferred at an 8% annual return is massive:

You can play around with the assumptions as you’d like with this calculator.

Here’s his final takeaway:

“What you should do in your 20s and 30s is invest in yourself. Building out multiple sources of income, investing in getting greater skills, and so on.”

Great advice! But you can do all of that and still invest in a 401(k). And virtually everyone should.

** James, are you reading this? Let’s do a video together and duke this out in person! My email is mhousel@fool.com **

For more on this topic:

MONEY Investing

Why Wary Investors May Keep the Bull Market Running

running bull
Ernst Haas—Getty Images

Retirement investors are optimistic but have not forgotten the meltdown. That's good news.

Six years into a bull market, individual investors around the world are feeling confident. Four in five say stocks will do even better this year than they did last year, new research shows. In the U.S., that means a 13.5% return in 2015. The bar is set at 8% in places like Spain, Japan and Singapore.

Ordinarily, such bullishness following years of heady gains might signal the kind of speculative environment that often precedes a market bust. Stocks in the U.S. have risen by double digits five of six years since the meltdown in 2008. They are up 3%, on average, this year.

But most individuals in the market seem to be on the lookout for dangerous levels of froth. The share that say they are struggling between pursuing returns and protecting capital jumped to 73% in this year’s Natixis Global Asset Management survey. That compares to 67% in 2013. Meanwhile, the share of individuals that said they would choose safety over performance also jumped, to 84% this year from 78% in 2014.

This heightened caution makes sense deep into a bull market and may help prolong the run. Other surveys have shown that many investors are hunkered down in cash. That much money on the sidelines could well fuel future gains, assuming these savers plow more of that cash into stocks.

Still, there is a seat-of-the-pants quality to investors’ behavior, rather than firm conviction. In the survey, 57% said they have no financial goals, 67% have no financial plan, and 77% rely on gut instincts to make investing decisions. This lack of direction persists even though most cite retirement as their chief financial concern. Other top worries include the cost of long-term care, out-of-pocket medical expenses, and inflation.

These are all thorny issues. But investing for retirement does not have to be a difficult chore. Saving is the hardest part. If you have no plan, getting one can be a simple as choosing a likely retirement year and dumping your savings into a target-date mutual fund with that year in the name. A professional will manage your risk and diversification, and slowly move you into safer fixed-income products as you near retirement.

If you are modestly more hands-on, you can get diversification and low costs through a single global stock index fund like iShares MSCI All Country or Vanguard Total World, both of which are exchange-traded funds (ETFs). You can also choose a handful of stock and bond index funds if you prefer a bit more involvement. (You can find good choices on our Money 50 list of recommended funds and ETFs.) Such strategies will keep you focused on the long run, which for retirement savers never goes out of fashion.

Read next: Why a Strong Dollar Hurts Investors And What They Should Do About It

MONEY mutual funds

The Easy Way Even Newbies Beat 86% of Professional Money Managers This Year

150313_INV_SmartMoney_1
Hiroshi Watanab/Getty Images

And there's an easy way to be on the winning side.

Mutual funds generally fall into one of two camps: On the one hand, there are actively managed portfolios that are run by stock pickers who attempt to beat the broad market through skill and strategy. Then there are passive funds, which are low-cost portfolios that simply mimic a market benchmark like the S&P 500 by owning all the stocks in that index.

The question for individual investor is, which one to go with.

On Thursday, yet more evidence surfaced demonstrating just how hard it is for actively-managed funds to win.

S&P Dow Jones Indices releases a report every six months which keeps track of how well actively-managed funds in various categories perform against their particular benchmark. The “U.S. S&P Indices Versus Active Funds (SPIVA) Scorecard” came out yesterday and told a familiar tale: active fund managers struggled mightily.

Last year only 14% of managers running funds that invest in large U.S. companies beat their benchmark. That means 86% of professionals who get paid to beat the market lost out to novices who simply put their money in a fund that owned all the stocks in the market.

It’s further proof that the genius you invest your money with isn’t that smart — or isn’t smart enough.

It’s not that professional stock pickers don’t have skills. The problem is, actively managed funds come with higher fees than index funds, often charging 1% or more of assets annually. And those fees come straight out of your total returns.

What this means is that even if your fund manager is talented enough to beat the market, he or she would have to consistently beat the market by at least one to two percentage points — depending on how much the fund charges.

A similar rate of futility appeared even if you extend the investing horizon to five or ten years. If you look at all U.S. stock funds, 77% of them lost out to their index.

International funds fared no differently. Only 21% of global active managers enjoyed above-index returns over ten years. Active managers also fell short in most fixed-income categories, for instance 92% underperformed in high-yield bonds.

One area where active managers have outperformed over the past one, three, five, and 10 years is in investment-grade intermediate-term bonds.

MONEY has warned investors against indexing the entire U.S. bond market because so much of such fixed-income indexes are made up of government-related debt, which happens to be very expensive right now.

So where should you put your money?

Look to MONEY’s recommended list of 50 mutual and exchange-traded funds. With a few of our “building block” funds you can cover achieve broad diversification in domestic and foreign stocks and bonds.

To be fair, our list also includes several actively managed funds, which can help you customize your portfolio by tilting toward certain factors that tend to outperform over time, such as value stocks.

Still, the bulk of your portfolio belongs in low-cost index funds.

MONEY mutual funds

Mutual Funds: Not Dead Yet

tombstone proclaiming that Mutual Funds aren't dead yet
Zachary Zavislak

ETFs pose a real threat, but mutual funds can still play a key role in your portfolio. Here are 3 ways to put them to good use.

In many industries, new competition is disrupting the way business is conducted. Think department stores and cable television. Now the $12 trillion mutual fund industry is threatened too.

Since 2007, mutual fund assets have grown less than 50%, while the collective amount invested in exchange-traded funds—baskets of securities that can be traded like individual stocks—has more than tripled, to $2 trillion.

Traditional mutual funds are suffering from the growing popularity of low-cost passive investing. Last year investors poured nearly 10 times as much money into index portfolios, which simply buy and hold all the securities in a sliver of the market, as they put into actively managed funds. And the vast majority of ETFs are index portfolios, many charging lower expenses than mutual funds.

Meanwhile, ETF-like investments could gain traction in the realm of active management.

So far, few actively managed ETFs have been launched because the Securities and Exchange Commission requires them to divulge their holdings in real time — something stock pickers are wary of doing.

However, the SEC recently greenlighted an ETF-like vehicle that solves the disclosure problem. Exchange-traded managed funds, or ETMFs, will be required to reveal their holdings only a few times a year, like traditional mutual funds.

Eaton Vance, which won approval for its NextShares ETMF structure and is licensing it to other money managers, expects to launch its first ETMFs this year.

Because ETFs and ETMFs are traded on an exchange and don’t require back-office and marketing functions, they can charge less. Eaton Vance expects that on average a NextShares ETMF could cost about 0.63 percentage points less than a mutual fund version. So while the average actively managed mutual fund charges $133 a year for every $10,000 you invest, ETMFs may cost just $70 a year.

Still, mutual funds have been around for 91 years and aren’t going the way of the dinosaur tomorrow.

A big reason is that 401(k) plans, which control more than $4.4 trillion in assets, have yet to embrace ETFs. Until that happens—and until ETMFs arrive in full force—here are ways you can still put traditional funds to good use.

Satisfy Your Core Stocks
When it comes to the bulk of your equity portfolio, it doesn’t matter if you use index ETFs or index mutual funds as long as you pick a cheap option. “Low cost is low cost, period,” says Dave Nadig, chief investment officer of ETF.com.

Case in point: MONEY 50 pick Schwab S&P 500 Index mutual fund charges 0.09% annually, the same as SPDR S&P 500 ETF .

As you can see from the chart below, though, not all index mutual funds charge rock-bottom prices.

150306_INV_2

Fix the Bond Problem
MONEY has warned of the risks of putting all your bond money into traditional index funds and ETFs. Those portfolios are obliged to load up on what are now the most expensive parts of the fixed-income market: U.S. Treasuries and agency-backed mortgage debt that the Federal Reserve bought in droves to stimulate the economy.

Jeff Layman, chief investment officer at BKD Wealth Advisors, says his firm has switched from passive core bond funds to active managers, who have the leeway to diversify into less frothy parts of the market. With few exceptions, most actively managed high-grade bond portfolios are mutual funds. A good option is MONEY 50 pick Dodge & Cox Income DODGE & COX INCOME FUND DODIX -0.07% , which charges just 0.43% in annual fees.

Fill a Niche
For narrowly focused assets, Samuel Lee, editor of Morningstar ETFInvestor, says you can find traditional mutual funds with deft active managers who have the flexibility to “avoid horrendous transaction costs.” Surprisingly, some of these funds charge lower expenses than ETFs. For example, he prefers Vanguard High Yield Corporate VANGUARD HIGH-YIELD CORPORATE INV VWEHX -0.17% , an actively managed fund that charges 0.23% a year, over SPDR Barclays High Yield ETF, which charges 0.40%.

Commodities are another area where mutual funds may make more sense. ETFs that invest in physical commodities or futures contracts are less tax-efficient than a regular fund that owns commodity-related stocks.

Collectively these investments represent just a minority of your overall portfolio. Still, it means the death of the fund may be exaggerated—for now.

MONEY stocks

The Problem With Stock Market Games? They Aren’t Boring Enough

150221_INV_game_1
Alamy

If you think investing is fun, you're probably doing it wrong.

People often say the stock market is a game, but a growing number of companies are taking that literally. A slew of new apps, like Ivstr, Kapitall, and Bux (the latter isn’t yet available in the U.S.), say they can teach you about investing by turning it into a short-term competition, complete with scoreboards and points.

The apps keep everything simple by having users compete to predict whether a stock, or portfolio stocks, will go up or down in the next few hours, days, or weeks. (Ivstr goes up to a year.) A few try and crank up the excitement a little further with head-to-head “battles” against friends and little encouragements like “OMG!” after a player completes a trade. It’s all fake money at first, but Bux and Kapitall let users move on to real dollars.

These ideas all sound kind of fun. But do they really teach what you need to know about investing? Stock market apps tend to center around choosing a group of stocks and trading frequently based on their performance.

The trouble is, you’ll do better with your real-life money if you skip all the trading and just buy and hold a low-cost, diversified fund. Research has shown even hedge funds run by market pros can’t beat the market in the long term. Mutual funds mostly don’t beat the index either. Warren Buffett is currently winning his $1 million bet that an S&P 500 index fund will outperform a fund of hedge funds, net of all fees and expense, over just one decade.

You can actually measure how much investors as group cost themselves by trading. According to the mutual fund research group Morningstar, the average U.S. equity mutual fund earned an annualized 8.2% over the 10 years from 2004 through 2013. But the the typical fund investor (as measured by adjusting for cash flows in and out of funds) earned only 6.5%, thanks to poorly timed fund trades. Its hard to imagine retail stock traders are any better at guessing market trends.

Still, maybe there is something to this whole investing as a game idea. We just need to tweak it a little.

Allow me to introduce MONEY’s forthcoming iPhone app, RspnsblFnnclPlnnr. Here’s how it works:

  • Instead of having users pick stocks and watch the market, you spend the first hour looking for funds with the lowest fees and setting up a scheduled deposit. Then it would close.
  • The game will let you come back to check your accounts once a year, to rebalance your stock and bond allocations. But each additional viewing would cost 1000 Investo-Points.
  • Every time you try to trade a stock, the game’s in-app avatar will shake its head at you and ask if you really, really want to do that.
  • You can compete with friends! Thirty years from now, you’ll all get badges showing your huge balances, which you can post on Facebook. Because there will definitely still be a Facebook.

Okay, I suspect my app will have trouble getting past the first round of venture funding. It’s not exactly the most exciting game in the world. Except for the parts where you get to send your kids to college and retire with a decent nest egg. That part is pretty fun.

MONEY stocks

China’s Boom Is Over — and Here’s What You Can Do About It

Illustration of Chinese dragon as snail
Edel Rodriguez

The powerhouse that seemed ready to propel the global economy for decades is now stuck in a period of slowing growth. Here’s what that means for your portfolio

Every so often an investment theme comes along that seems so big and compelling that you feel it can’t be ignored. This happened in the 1980s with Japanese stocks. It happened again with the Internet boom of the 1990s. You know how those ended.

Today history appears to be repeating itself in China.

Just a decade ago, China was hailed as the engine that would single-handedly drive the global economy for years to come. That seemed plausible, as a billion Chinese attempted something never before accomplished: tran­sitioning from an agrarian to an industrial to a consumer economy, all in a single generation.

Recently, however, this ride to prosperity has hit the skids. A real estate bubble threatens to crimp consumer wealth; over-investment in a wide range of industries is likely to dampen growth; and the transition to a developed economy is stuck in an awkward phase that has trapped other emerging markets.

No wonder Chinese equities—despite a strong rebound last year—are down around half from their 2007 peak.

iSCH1

Like the Japan and dotcom manias before it, China looks like an old story. “Do you have to be in China?” asks Henrik Strabo, head of international investments for Rainier Investment Management in Seattle. “The truth is, no.”

If you’ve bought the China story—and since 2000 hundreds of thousands of U.S. investors have plowed $176 billion into emerging-markets mutual and exchange-traded funds, which have big stakes in China—that’s a pretty bold statement.

In fact, even if you haven’t invested directly in Chinese stocks and simply hold a broad-based international equity fund, China’s Great Slowdown has an impact on how you should think about your portfolio. Here’s what you need to understand about China’s next chapter.

China Has Hit More Than a Speed Bump

After expanding at an annual clip of more than 10% a decade ago, China’s economy has slowed, growing at just over 7% in 2014. That’s expected to fall to 6.5% in the next couple of years, according to economists at UBS. And then it’s “on to 5% and below over the coming decade,” says Jeffrey Kleintop, chief global investment strategist at Charles Schwab.

Why is this worrisome when gross domestic product in the U.S. is expanding at a much slower 3%?

For starters, it represents a steep drop from prior expectations. As recently as three years ago, economists had been forecasting that China would still be growing at roughly an 8% clip by 2016.

The bigger worry is that the slowdown means that China has reached a phase that frustrates many emerging economies on the path to becoming fully “developed,” a stage some economists refer to as the middle-income trap.

On the one hand, a growing number of Chinese are approaching middle-class status, which means wages are on the rise. That sounds good, but rising labor costs chip away at China’s competitive advantage in older, industrial sectors. “You’re seeing more and more manufacturers look at other, cheaper markets like Indonesia, Vietnam, and the Philippines,” says Eric Moffett, manager of the T. Rowe Price Asia Opportunities Fund.

At the same time, the country’s new consumer-centric economy has yet to fully form. About half of China’s urban population is thought to be middle-class by that nation’s standards, but half of Chinese still live in the countryside, and the vast majority of those households are poor. Couple this with the deteriorating housing market—which accounts for the bulk of the wealth for the middle class—and you can see why China isn’t able to buy its way to prosperity just yet.

This in-between stage is when fast-growing economies typically downshift significantly. After prolonged periods of “supercharged” expansion, these economies tend to suffer through years when they regress to a more typical rate of global growth, according to a recent paper by Harvard professors Lawrence Summers and Lant Pritchett.

In some cases, like Brazil, this slowdown prevents the economy from taking that final step to advanced status. Brazil had been expanding 5.2% a year from 1967 to 1980, but that growth slowed to less than 1% annually from 1981 to 2002.

No one is saying China will be stuck in this trap for a generation, like Brazil, but China could be looking at a long-term growth rate closer to 4% to 5% than 8% to 10%.

iSCH2

Your best strategy: Go where the growth is—at home. A few years ago the global economy was ex­pected to expand at an annual pace of 4.2% in 2015, trouncing the U.S.  Today the forecast is down to 3.1%, pretty much the same pace as the U.S. economy, which is expected to keep accelerating through 2017.

In recent years, some market strategists and financial planners have instructed investors to keep as much as 40% to 50% of their stocks in foreign funds. But ­dropping that allocation to 20% to 30% still gives you most of the diversification benefit of owning non-U.S. stocks.

The Losers Aren’t Just in Asia

China’s rise to power lifted the fortunes of its neighboring trade partners too, so it stands to reason that a broad swath of the emerging markets is now at risk. “China is still the beating heart of Asia and the emerging markets,” says Moffett. “If it slows down, all the other countries exporting to and importing from China will see their growth prospects affected.”

The country’s biggest trading partners in the region are Hong Kong, Japan, South Korea, and Taiwan, and all are slowing down. Economists forecast that the growth rates in those four nations will slip below 3% next year.

Beyond Asia, “you have to be careful with the commodity exporters,” says Rainier’s Strabo. China’s slowdown over the past five years is a big reason commodity prices in general and oil specifically have sunk more than 50% since 2011.

China consumes about 40% of the world’s copper and 11% of its oil. As the country’s appetite for commodities wanes, natural resource producers such as Australia, Russia, and Latin America will feel the blow.

Your best strategy: Keep your emerging-markets stake to around 5% of your total portfolio. If your only foreign exposure is a total international equity fund, then you’re probably already there. If, however, you’ve tacked on an emerging-markets “tilt” to your portfolio to try to boost returns, unwind those positions, starting with funds focusing on Asia, Latin America, or Russia.

Here’s another bet that’s now played out: A popular strategy in the global slowdown was to take fliers on Western companies with the biggest exposure to China—companies such as the British spirits maker Diageo (think Johnnie Walker and Guinness) and Yum Brands (KFC and Pizza Hut)—solely because of their China reach. And for a while, that paid off.

Now, though, the stocks of Yum and Diageo have stalled, and major global companies such as Anheuser-Busch InBev and Unilever have reported disappointing results recently in part owing to subpar sales in China as well as in other emerging markets.

Demographic Problems Will Only Make Things Worse

For years, China’s sheer size was seen as a massive competitive advantage. Indeed, China has three times as many workers as the United States has people.

Yet as the country’s older workers have been retiring, China’s working-age population has been quietly shrinking in recent years. Economists say this will most likely lead to labor shortages over the coming years, putting even more pressure on wages to rise.

iSCH3

China’s demographic problem has been exacerbated by the country’s “one-child” policy, which has prevented an estimated 400 million births since 1979. But China isn’t the only emerging market suffering from bad demographic trends.

Birthrates are low throughout East Asia. The ratio of people 15 to 64 to those 65 and older will plummet from about 7 to 1 to 3 to 1 in the next 15 years in Taiwan, South Korea, and Hong Kong, dragging down growth.

Your best strategy: If you’re a growth-focused investor who wants more than that 5% stake in emerging markets, concentrate on developing economies with more youthful populations and more potential to expand. One fund that gives you that—with big holdings in the Philippines, Saudi Arabia, Egypt, and Colombia—is Harding Loevner Frontier Emerging Markets HARDING LOEVNER FRONT EM MKTS INV HLMOX 0.23% . Over the past five years, the fund has gained around 7% a year, more than triple the return of the typical emerging-markets portfolio.

Another option is EGShares ­Beyond BRICs EGA EMERGING GLOBA EGSHARES BEYOND BRICS ETF BBRC 0.67% . Rather than investing in the emerging markets’ old-guard leaders—Brazil, Russia, India, and China—this ETF counts firms from more consumer-driven economies, such as Mexico and Malaysia, among its top holdings.

The Parallels Between China and 1990s Japan are Alarming

For starters, China is facing a real estate crisis similar to Japan’s, says Nariman Behravesh, chief economist at IHS. With easy access to cheap credit, developers have flooded the major cities with excess housing. Floor space per urban resident has grown to 40 square meters, compared with just 35 square meters in Japan and 33 in the U.K.

Not surprisingly, prices in 100 top Chinese cities have been sliding for seven months. Whether China’s property bubble bursts or not, falling home values chip away at household net worth; that, in turn, drags down consumer sen­timent and spending, Behravesh says.

Other unfortunate similarities between the two nations: Excess capacity plagues numerous sectors of China’s economy, ranging from steel to chemicals to an auto industry made up of 96 car­ brands.

Also, Chinese officials face political pressure to focus on short-term growth rather than long-term fixes. This type of thinking has resulted in the rise of so-called zombie companies, much like what Japan saw in the ’90s. “These are companies that aren’t really viable but are being kept alive,” Behravesh says. Yet for the economy to get back on track, inefficiently run businesses have to be allowed to fail, market strategists say.

Your best strategy: Focus on the few major differences between the two countries. Unlike Japan, for instance, China is still a young, emerging economy. Slowdown or not, “the growth of the middle class will continue in China, and that will absorb some of the overhang in the economy, which is something Japan couldn’t count on,” says Michael Kass, manager of Baron Emerging Markets Fund.

What’s more, when Japan’s bubble burst in late 1989, stocks in that country were trading at a frothy price/earnings ratio of around 50. By contrast, Chinese shares trade at a reasonable P/E of around 10.

To be sure, not all Chinese stocks enjoy such low valuations. As competition heats up to supply China’s population with basic goods, valuations on consumer staples companies have nearly doubled over the past four years to a P/E of around 27.

At the same time, the loss of faith in the Chinese story means there are decent values in industries that cater to the established middle and upper-middle class, says Nick Niziolek, co-manager of the Calamos Evolving World Growth Fund. Health care and gaming stocks in particular suffered setbacks last year. And Chinese consumer discretionary stocks are trading at a P/E of just 12, down from 20 five years ago.

You can invest in such businesses through EGShares Emerging Markets Domestic Demand ETF EGA EMERGING GLOBA EGSHARES EMERGING MKTS DOME EMDD -0.7% , which owns shares of companies that cater to local buyers within their home countries, rather than relying on exports. Chinese shares represent about 17% of the fund, led by names such as China Mobile.

That one of the world’s great growth stories is now best viewed as a place to pick up stocks on the cheap might seem a strange twist—until you remember your Japanese and Internet history.

Your browser is out of date. Please update your browser at http://update.microsoft.com