MONEY mutual funds

Here’s What You Need to Know About the Pimco Stampede

The headquarters of investment firm PIMCO is shown in Newport Beach, California.
The headquarters of PIMCO, in Newport Beach, California. Lori Shepler—Reuters/Corbis

$10 billion left mutual fund giant Pimco in one day after "bond king" Bill Gross announced his departure. Should you head for the exits too?

The Wall Street Journal has reported that investors on Friday pulled out $10 billion from funds run by Pacific Investment Management Co., or Pimco. The redemptions came after news of the departure of Bill Gross, the company’s chief investment officer and manager of the $220 billion Pimco Total Return bond mutual fund.

For a sense of scale: Pimco is a huge, $2 trillion money manager, so that’s 0.5% of its assets. Even so, it’s a lot of money to go out the door in one day, and the company has been struggling to hang on to investors for some time, largely as a result of Total Returns’ recent mediocre performance.

Pimco’s funds are widely held in many 401(k) retirement plans. If you don’t watch Wall Street regularly, but are tuning in now because there’s a Pimco fund in your plan, don’t be too alarmed. Mutual funds don’t necessarily decline in value just because a lot of people sell.

A fund is designed to allow investors to redeem shares each day for the value of underlying assets, and its shares don’t rise and fall based on investors’ demand for the fund. You shouldn’t worry about getting out of Pimco “too late,” and nor is there any opportunity to be had in buying “on the dip.” (A nerdish caveat: A wave of redemptions can impact performance if it forces a fund to sell investments at a bad time in order to raise cash, but managers generally design their portfolios to handle the possibility of redemptions.)

Analysts expect even more money to leave Pimco. Thomas Seidl, who follows Pimco’s parent company Allianz for Bernstein Research, predicts that between 10% and 30% of the money Pimco runs for outside clients (that is, not related to Allianz) may eventually leave the company. That adds up to $170 billion to $530 billion.

Why is the departure of one man, even a star once known as the “bond king,” triggering so many to get out Pimco?

One reason for people to go is quite rational. As Money’s Penelope Wang argued on Friday, there isn’t a great case for buying an actively managed bond fund such as Pimco Total Return, as opposed to a low cost index fund that simply tracks the wider market.

The returns on bonds don’t vary as widely as they do on stocks, which gives even the best funds less room to outperform the market average. That means a fund that keeps annual expenses low, as index funds do, starts with a big built-in advantage. Gross’s departure from Pimco is a good time for current Total Return shareholders to reassess whether they want to spend the extra money for a manager who tries to outwit the rest of the market.

But not everyone running from Pimco is going the index route. DoubleLine funds, run by Jeff Gundlach, is reporting big inflows. Gundlach is the bond world’s new hot manager. The institutional share class of his DoubleLine Total Return Bond fund earned over 5% in the past 12 months, vs. 3.5% for the comparable Pimco Total Return fund. Other investors may go to Janus, Gross’s new employer.

Bernstein’s Seidl thinks most of the outflows he anticipates will come from retail investors concerned about performance. Although Pimco has a deep management bench and impressive research capabilities, most investors picking a bond fund are making a bet on a manager’s judgement and feel for the markets. With Gross leaving Pimco, investors may not feel they have much to go on in deciding whether to hold Pimco Total Return. “Performance builds up over time — it takes a number of years,” says Seidl.

Of course, that’s assuming even performance is a helpful guide. Gross built up a brilliant record, and then misjudged the bond market in 2011, and then again in 2013. Bad luck for him, but even more so for the typical Pimco Total Return investor. As the Journal‘s Jason Zweig observes, much of the money in Gross’s fund came in after his best years, and just in time for his mediocre ones.

In short, it may make sense to go now, if you want to get costs down and taxes aren’t an issue. (Your trade won’t trigger taxes if the fund is inside a 401(k) or IRA). But think twice about trying to find the next new bond star.

MONEY mutual funds

What Investors in Pimco’s Giant Bond Fund Should Do Now

One-time star manager Bill Gross is leaving. The case for choosing an index fund for your bonds has never looked better.

For many bond fund investors, star fixed-income manager Bill Gross’s sudden leap from Pimco to Janus is a moment to rethink. Gross’s flagship mutual fund, Pimco Total Return long seemed like the no-brainer fixed-income choice. Over the past 15 years, Gross had steered Total Return to a 6.2% average annual return, which placed it in the top 12% of its peers. And based on that track record it became the nation’s largest fixed income fund.

But much of that performance was the result of past glory. Over the past five years, Pimco has fallen to the middle of its category, as Gross’s fabled ability to outguess interest rates faded. It ranks in the bottom 20% of its peers over the past year, and its return of 3.9% lags its largest index rival, $100 billion Vanguard Total Bond Market, by 0.5%.

Nervous bond investors have yanked nearly $70 billion out of the fund since May 2013. Those outflows are driven not only because of performance but also because of news stories about Gross’s behavior and personal management style. Still, Pimco Total Return holds a massive $222 billion in assets, down from a peak of $293 billion, and it continues to dominate many 401(k)s and other retirement plans as the core bond holding.

If you’re one of the investors hanging on to Pimco Total Return, you’re probably wondering, should I sell? Look, there’s no rush. Your portfolio isn’t in any immediate trouble: Pimco has a lot of other smart fixed-income managers who will step in. And even if you can’t expect above-average gains in the future, the fund will likely do okay. The bigger issue is whether you should hold any actively managed bond fund as your core holding.

The simple truth is most actively managed funds fail to beat their benchmarks over long periods. Gross’s impressive record was an outlier, which is precisely why he got so much attention. That’s why MONEY believes you are best off choosing low-cost index funds for your core portfolio. With bond funds, the case for indexing is especially compelling, since your potential returns are lower than for stocks, and the higher fees you pay to have a human guiding your fund can easily erode your gains.

Our MONEY 50 list of recommended funds and ETFs includes Harbor Bond, which mimics Pimco Total Return, as an option for those who want to customize their core portfolio with an actively managed fund. When issues about Pimco Total Return first began to surface, we recommended hanging on. But with Gross now out of the picture, we are looking for the right replacement.

If you do choose to sell, be sure to weigh the potential tax implications of the trade. Here are three bond index funds to consider:

*Vanguard Total Bond Market Index, with a 0.20% expense ratio, which is our Money 50 recommendation for your core portfolio.

*Fidelity Spartan U.S. Bond, which charges 0.22%

*Schwab Total Bond Market, which charges 0.29%

All three funds hold well-diversified portfolios that track large swaths of the bond market, including government and high-quality corporate issues. Which one you pick will probably depend on what’s available in your 401(k) plan or your brokerage platform. In the long-run, you’re likely to get returns that beat most actively managed bond funds—and without any star manager drama.

MONEY portfolio strategy

Why Rats, Cats, and Monkeys are Smarter than Investors

Ms. Kleinworth goes short in the Treasury Bond market.
Ms. Kleinworth goes short in the Treasury Bond market. Nora Friedel—RatTraders.com

A performance artist in Austria piles on to the case against "active management" by finding yet another animal that seems to invest better than humans.

An Austrian performance artist claims to be breeding and training rats to be able to beat the investment returns of highly educated and paid professional investors.

The artist, Michael Marcovici, says he trained the rodents to trade in foreign exchange and commodities. He did so by converting market information into sounds and rewarded the rats with food when they predicted price movements correctly and inflicted a small electric shock when they didn’t. (If only hedge fund managers could be compensated in similar fashion.) The rats are placed in a Skinner Box with a speaker, red and green lights, a food dispenser and an electrical floor to deliver the shock.

Marcovici says rats can be trained in three months, are able to learn any segment of the market and “outperform most human traders.” This may seem like an outlandish claim, but this kind of thing isn’t altogether new.

UK’s The Observer held a challenge in 2012 between a “a ginger feline called Orlando,” a pack of schoolchildren and a few wealth and fund managers to see which could produce the biggest returns over the course of the year.

The cat won.

Long before Orlando’s victory, Princeton economist Burton Malkiel wrote that “a blindfolded monkey throwing darts at a newspaper’s financial pages could select a portfolio that would do just as well as one carefully selected by experts,” in his book “A Random Walk Down Wall Street.”

Add this to the overwhelming evidence that largely unmanaged index funds — that simply buy and hold all the securities in a market — often outperform professional stock pickers.

Just this month S&P Dow Jones Indices Versus Active funds scorecard for the first six months of the year, which showed that 60% of actively managed domestic large cap funds underperformed their benchmarks.

That’s in addition to 58% of domestic mid-cap and 73% of small cap funds losing out. If you extend the record out five years, more than “70% of domestic equity managers across all capitalization and style categories failed to deliver higher returns than their respective benchmarks.”

What does this mean for your portfolio? As Morningstar.com’s John Rekenthaler noted in a recent article, active funds may not have much of a future.

Passively managed mutual funds and exchange-traded funds, Rekenthaler points out, enjoyed 68% of the net sales for U.S. ETFs and mutual funds over the past year. That leaves 32% for active funds. Meanwhile, target-date funds account for $30 billion of the $134 billion in inflows for active funds over the past 12 months. Even on this front, passive target date funds sales are growing.

In fact, the only real growth area for actively managed funds are in so-called alternatives that invest in things like currencies and that charge annual fees of close to 2% of assets. That’s a lot of cheese.

You’re generally better off staying clear of professional security pickers.

No, this doesn’t mean you should find a rat, cat, or monkey to manage your 401(k). Instead, go the passive index route and select three basic building block funds from our MONEY 50 selection (like say Vanguard Total Bond Market Index, Schwab Total Stock Market Index and Vanguard Total International Stock Index) and you can achieve basic diversification at a price that won’t make you as poor as a church mouse.

MONEY stocks

WATCH: What’s the Point of Investing?

In this installment of Tips from the Pros, financial advisers explain why you need to invest at all.

MONEY 401(k)s

How Do I Choose Investments for My 401(k)?

What's the the right mix of stocks and bonds for your retirement account? Financial planners explain.

MONEY

Why People Love Risky Investments

Shark Tank production still
As Shark Tank viewers know, an individual company can make for a compelling story. But investing in that story has its risks. Michael Ansell—ABC

Some of the safest-looking places for putting your money are more hazardous than they appear. Here's why that's true.

Which investment involves lower risk: Putting your money in one company? Or buying shares in an S&P 500 index fund?

Nearly all financial advisers and many clients know that the index fund is much more diversified and therefore has less risk. Yet it is easy for clients to forget this basic fact when the chance to invest in a particular company presents itself.

When clients ask me to evaluate opportunities to invest in a private company, the stories are often compelling at first. Clients have brought me opportunities ranging from a marketing company looking to lower its costs by buying in bulk to a niche social media company looking to grow its user base. Almost all of the investments come from a trusted source, such as a long-time friend. But once I dig deeper into a company, I usually find major red flags.

Most of the time, I convince clients to pass on individual company investments. Occasionally, we agree that a small investment is acceptable. And sometimes a client will choose, despite the risks, to invest more in a small company than I would recommend.

Why does this happen?

Why Clients are Tempted to Invest in Private Companies

I see a few reasons why concentrated investments in private companies may tempt clients — even those who fully understand the importance of diversification. A personal connection is powerful. If you believe someone to be a good person overall, you’re more likely to trust him and assume that he’ll make a successful business partner too. While viscerally reassuring, this familiarity may make investors overconfident in a company’s prospects. Even with good intentions, skill, and an attractive market, unforeseen problems can still ruin individual company investments.

Clients can also get a skewed perception of the success rate of individual-company investing for the same reason that it seems like your Facebook friends are always on vacation or eating great meals: It’s fun to talk about your winners. You can see this tendency on display in the TV show Shark Tank. After a wealthy “shark” invests in a company, the producers provide updates that highlight the successes but don’t mention the failures.

Financial advisers can sometimes share the blame for clients’ interest in individual company investing. We know that it’s important to focus on the big things in clients’ lives, such as how much they save and their overall asset allocation. As a result, we spend so much time talking about markets in the abstract that we sometimes forget to emphasize that markets and indices are composites of many individual companies. We talk about the forest, but clients don’t see any of the trees.

Refocusing on a Diversified Portfolio

If people are inclined to believe that the market as a whole is overvalued, it can be hard to convince them to invest broadly without telling a good story, with identifiable characters. Even if you allocate to broad index funds, that doesn’t mean there’s no story to discuss. Individual companies like Apple, Exxon or Procter & Gamble are large components of the S&P 500 that can easily make the investing story relatable for clients. While one company’s impact on a portfolio is likely negligible, discussing it in more detail can improve clients’ understanding of their investments and remove the false impression that private companies are the only ones that prosper.

If a client is insistent on a more concentrated portfolio, adding a small stake in a private equity fund might be an attractive alternative to directly investing in a private company. Although these funds are riskier than mutual funds, they still incorporate professional management and some diversification.

If a client wants to pursue individual company investments because they’ve gotten wrapped up in a compelling story, remind them that the most interesting investing stories can often result in expensive lessons. Discuss the specific investment’s risks, mention the biases that may be influencing their behavior, and — if all else fails — consider telling a better story.

—————————————-

Benjamin Sullivan is a manager at Palisades Hudson Financial Group, where he helps the firm’s high-net-worth clients with their personal financial planning, investment and tax planning needs. He is a certified financial planner certificant, an IRS enrolled agent, and a member of the New York chapter of the Financial Planning Association.

MONEY Investing

13 Things to Do with $100,000 Now

domino stacks of $10,000 bills
Ralf Hettler—Getty Images

Oh, if only six figures landed in your lap tomorrow. Hey, you never know. In case it does—or in case you're lucky enough to have 100 grand put away already—you'll want to have these smart moves in your back pocket.

1. Say “yes” to a master
Unless you live in one of the few areas where the real estate market hasn’t come to life, the decision of whether to move or improve is likely tipped in favor of remodeling, says Omaha appraiser John Bredemeyer. A new bedroom, bath, and walk-in closet may cost you $40,000 to $100,000. But it’s unlikely you’d find a bigger move-in-ready abode with every­thing you want for only that much more, especially after the 6% you’d pay a Realtor to sell your current home.

2. Burn the mortgage
If you’re within 10 years of retiring, paying off your house can be a wise move, says T. Rowe Price financial planner Stuart Ritter. You’ll save a lot of interest—$24,000, if you have a $100,000 mortgage with 10 years left at 4.5%. Eliminating the monthly payment reduces the income you’ll need in retirement. And as long as you’re not robbing a retirement account, erasing a 4.5% debt offers a better return than CDs or high-quality bonds, says Ritter.

3-5. Buy a business in a box
One hundred grand won’t get you a McDonald’s (for that you’ll need 10 or 15 friends to match your investment)—but there are a number of other good franchises you can buy around that price, says Eric Stites, CEO of Franchise Business Review. Here are three that get top raves in his company’s survey of owners:

  1. Qualicare Family Homecare (a homecare services firm)
  2. Window Genie (a window and gutter cleaning service)
  3. Our Town America (a direct mail marketing service)

6. Tack another degree on the wall
On average, someone with a bachelor’s degree earns $2.3 million over a lifetime, vs. $2.7 million for a master’s and $3.6 million for a professional degree. The payoff varies by field: In biology a master’s earns you 100% more, vs. 23% in art. So before applying, find out how much more you could earn a year, research tuition, and determine how long it’ll take you to recoup the investment.

7. Make sure you won’t be broke in retirement
More than half of Americans worry about running out of money in retirement, Bank of America Merrill Edge found. Allay your fears with a deferred-income annuity: You pay a lump sum to an insurance company in exchange for guaranteed monthly payments starting late into retirement. Because some buyers will die before payments start, you get more income than with an immediate annuity, which starts paying right away. A 65-year-old woman who puts $100,000 into an annuity that kicks in at age 85 will get $3,500 a month, vs. $600 for one that starts this year. In the future you could see deferred annuities as an investment option in your retirement plan; the Treasury Department just approved them for 401(k)s.

8. Get a power car that runs on 240v
For just over $100,000 (after a $7,500 tax rebate), you can be the proud owner of an all-electric Tesla Model S P85, with air suspension, tech, and performance extras. Yes, that’s a pretty penny. But you’ll help the planet, eliminate some $4,000 a year in gas bills—and get a ride that gets raves. “The thing has fantastic performance,” says Bill Visnic of Edmunds.com. It goes from 0 to 60 in 4.2 seconds and drives 265 miles on a charge, which requires only a 240-volt outlet.

9-12. Put hotel bills in your past
Think you missed the window on a vacation-home deal? True, the median price has jumped 39% since 2011, according to the National Association of Realtors. “But while you can’t buy just anything, anywhere, for 100 grand anymore, there are still decent deals out there in appealing ­places,” says Michael Corbett of Trulia.com. Here are four markets where the price of a two-bedroom condo goes for around that amount:

  • Sunset Beach, N.C./$96,000
  • Fort Lauderdale/$116,000
  • Colorado Springs/$117,000
  • Reno/$117,000

13. Tone up your core
The average American saving in a 401(k) has nearly $100,000 put away ($88,600, to be exact, according to Fidelity). With this core money, you’re likely to do better with index funds vs. active funds, says Colorado Springs financial planner Allan Roth. “The stock market is 90% professionally advised or managed, and outside Lake Wobegon, 90% can’t be better than average.” His three-fund portfolio: Vanguard’s Total Stock Market Index, Total International Stock Index, and Total Bond Market.

Related: 35 Smart Things to Do With $1,000

Related: 24 Things to Do with $10,000

Tell Us: What Would You Do With $1,000?

MONEY

Tell Us: What Would You Do With $1,000?

$1000 bill
Travis Rathbone

See how other readers would use a grand—then share your own grand ideas by tweeting with the hashtag #ifihad1000.

In coming up with 35 Smart Things to do with $1,000, MONEY put the question out to our readers via Facebook: What smart—or not so smart—thing have you done with that amount of money? What would you recommend someone else do with those funds? Or, what would you do if by some amazing stroke of luck, a grand fell magically into your lap today?

Some of your answers follow, but we’ll also be adding to this post in the next few days. So you still have a chance to share your money move, be it spending or saving, in earnest or good fun. Share your $1K fantasy with us on Twitter, using the hashtag #ifIhad1000.

“The first thing anyone should do before investing $1000 is to pay off revolving credit (credit cards) that’s a 15% to 20% return.”
—Danny Day
……….
“For a $1000, I purchased Bank of America stock.”
—Natalie TGoodman
……….
“It’s all about goals. Fund an emergency savings account, pay off debt, fund a retirement plan at least up to the employers match, pay down/off mortgage, save for college, etc. Needs before wants.”
—Nereida Mimi Perez Brooks
……….
“$1,000 would go into my money market as it really isn’t that much.”
—Paul Mallon
……….
For about $1,000 we purchased a last-minute 5-day Bahamas cruise for our family of four during the off-season month of September.”
—Marc Hardekopf
……….
“Put it in a casino and it doubled.”
—Norma Sande
……….
“I was given $1000 from my grandpa when I went to college. I started trading stocks in ’10 and made about $10,000 from it. Then in 2011 I bet it all on one stock with no stop loss, and it crashed overnight when the FDA shut them down. Lost 90%.”
Jaycob Arbogast
……….
“I would bank it to have savings for a rainy day.”
—Naomi Young Hughes
……….
“With $1000, all small debts were paid, which then made cash available to pay off a larger debt.”
Ana Chinchilla
MONEY 401(k)

3 Things to Know About Your 401(k)’s Escape Hatch

ladder leading to a bright blue sky
Alamy

More and more 401(k)s offer a formerly rare option—a brokerage window. That's raising questions from Washington regulators. Here's what you should watch out for.

While 401(k)s are known for their limited menu of options, more and more plans have been adding an escape hatch—or more precisely, a window. Known as a “brokerage window,” this plan feature gives you access to a brokerage account, which allows you to invest in wide variety of funds that aren’t part of of your plan’s regular menu. Some 401(k)s also allow you to trade stocks and exchange-traded funds, including those that target exotic assets such as real estate.

No question, brokerage windows can be a useful tool for some investors. But these windows carry extra costs, and given the increased investing options, you also face a higher risk that you’ll end up with a bad investment. All of which raises concerns that many employees may not fully understand what they’re getting into with these accounts. Earlier this week the U.S. Labor Department, which has been fighting a long-running battle to make retirement plans cheaper and safer for investors, asked 401(k) plan providers for information about brokerage windows.

You may wonder if a brokerage window is something you should use in your 401(k). To help you decide, here are answers to three key questions:

How common are brokerage windows?

Not long ago these features were rare. As recently as 2003, just 14% of large plans included offered a brokerage window, according to benefits company Aon Hewitt. But they’ve grown steadily more popular over the past decade, with about 40% of plans offering this option as of 2013. Interestingly, the growth has taken place even as more 401(k)s have opted to take investment decisions out of workers’ hands by automatically enrolling them in all-in-one investments like target-date funds.

Those two trends aren’t necessarily at odds. Experts say companies often add brokerage windows in response to a small but vocal minority of investors, who, rightly or wrongly, believe they can boost returns by actively picking investments. But overall just 5.6% of 401(k) investors opt for a window when it is offered. The group that is most likely use a brokerage window: males earning more than $100,000, about 9% of whom take advantage of the feature, according to Hewitt. (Not surprisingly, this group also tends to have the corporate clout to persuade HR to provide this option.) By contrast, only about 4% of high-earning women use a window.

When can brokerage windows make sense for the rest of us?

That depends in part on whether the other offerings in your 401(k) meet your needs. If you want an all-index portfolio, for example, a brokerage window may come in handy. Granted, more plans have added low-cost index funds, especially if you work for a large or mid-sized company. Today about 95% of large employers offer a large-company stock index fund, such as one that tracks the S&P 500, according to Hewitt.

Workers at small companies are less likely to enjoy the same access, however. These index funds are on the menu only about 65% of the time in plans with fewer than 50 participants, according to the Plan Sponsor Council of America, a trade group.

Moreover, even in large plans investors seeking to diversify beyond the broad stock and bond market can find themselves out of luck. Only about 25% of plans offer a fund that invests in REITS. And only about two in five offer a specialty bond fund, such as one that holds TIPS.

But even if a window allows you to diversify, you need to consider the additional costs. About 60% of plans that offer a brokerage window charge an annual maintenance fee for using it, according to Hewitt. The average amount of the fee was $94. And investors who use the window typically also pay trading commissions, just like they do at a regular brokerage.

Where does that leave me?

Before you decide to opt for a brokerage window, check to see if the fees outweigh the potential benefits. Here are some back-of-the-envelope calculations to get you started:

If you have, say, $200,000 socked away for retirement, paying an extra $100 a year to access a brokerage window works out to a modest additional fee of 0.05%. While the brokerage commission would increase that somewhat, you can minimize the damage by trading just once a quarter or once a year.

If your plan includes only actively managed mutual funds with annual investment fees in the neighborhood of 1%, the brokerage window could allow you to access ETFs charging as little as 0.1%. That means you could end up paying something like 0.15% instead of 1%.

If your plan has low-cost broad market index funds, however, a brokerage window offers less value. Say you want to add more more specialized investment options, such as a REIT or emerging market fund. Even if you have $200,000 in your 401(k), you’ll probably only invest a small amount in these more exotic investments—perhaps $5,000 or $10,000. So a $100 brokerage fee would increase your overall costs on that slice of your portfolio to 1% to 2%. Plus, you’ll pay brokerage commissions and fund investment fees. In that case, better to leave the escape hatch shut.

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