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 -0.35% . 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 -0.76% . 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 -0.22% , 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.

MONEY stocks

Your 3 Best Investing Strategies for 2015

Trophy with money in it
Travis Rathbone—Prop Styling by Megumi Emoto

Racking up big investing victories over the past six years was easy. Now, though, the going looks to be getting tougher. These three strategies will help you stay on the path to your goals.

There’s nothing like an extended bull market to make you feel like a winner — and that’s probably just how you felt coming into the start of this year.

Sure, the recent wild swings in the stock market may have you feeling a bit more cautious. Still, even now, the Standard & Poor’s 500 stock index has returned more than 200% since the March 2009 market bottom, while and bonds have posted a respectable 34% gain.

The question is, will the winning streak continue?

Should it persist through the current bout of volatility, the stock market rally will be entering its seventh year, making it one of the longest ever; at some point a bear will stop the party. Meanwhile, the Federal Reserve is signaling the end to its program of holding down interest rates and thus encouraging risk taking. And there’s zero chance that Congress will add further fiscal stimulus. In short, the post-crisis investing era—when market performance was largely driven by Washington policy and Fed ­intervention—is over. “As the global risks have receded,” says Jeffrey Kleintop, chief global investment strategist at Charles Schwab, “the focus is going back to earnings and other fundamentals.”

The stage is set for a reversion to “normal,” but as you’ll see, it’s a normal that lacks support for high future returns. For you, that means a balancing act. If you don’t want to take on more risk, you’ll have to accept the probability of lower returns. Following these three guidelines will help you maintain the right risk/reward balance and choose the right investments for the “new” normal.

1) Keep U.S. Stocks As Your Core Holding…

Stocks are expensive. The average stock in the S&P 500 is trading at a price of 16 times this year’s estimated earnings, about 30% higher than the long-run average. A more conservative valuation gauge developed by Yale finance professor Robert Shiller that compares prices with longer-term earnings shows that stocks are trading at more than 50% above their average.

“Given current high valuations, the returns for stocks are likely to be lower over the next 10 years,” says Vanguard senior economist Roger Aliaga-Díaz. He expects annual gains to average between 5% and 8%, compared with the historical average of 10%. Shiller’s numbers suggest even lower returns over the next decade.

That doesn’t mean you should give up on U.S. stocks. They remain your best shot at staying ahead of inflation, especially today, when what you can expect from a bond portfolio is, well, not much. “Stock returns may be lower,” says Aliaga-Díaz, “but bond returns will be much less, so the relative advantage of stocks will be the same.” And the U.S. economy, though far from peak performance, is the healthiest big player on the global field.

Your best strategy: Now is a particularly important time to make sure your stock allocation is matched to your time horizon. “The worst outcome for older investors would be a bear market just as you move into retirement,” says William Bernstein, an adviser and author of The Investor’s Manifesto. A traditional asset mix for someone in his fifties is the classic 60% stock/40% bond split, with a shift to 50%/50% by retirement. If your allocation was set for a 35-year-old and you’re 52, update it before the market does.

On the other hand, if you’re in your twenties and thirties, you should be far less worried about today’s prices. Hold 70% to 80% of your portfolio in equities. The power of compounding a dollar invested over 30 to 40 years is hard to overstate. And you’ll ride through many market cycles during your career, which will give you chances to buy stocks when they’re inexpensive.

2) …But Spread Your Money Widely

With many overseas economies barely out of recession or dragged down by geopolitical crises, international equity markets have been trading at low valuations. And some market watchers are expecting a rebound over the next few years. “Central banks in Europe, China, and Japan are making fiscal policy changes that are likely to boost global growth,” says Schwab’s Klein­- top. Oil prices, which have fallen 40% in recent months, may boost some markets as consumers spend less on fuel and step up discretionary buying.

But foreign stocks aren’t uniformly bargains. The slowdown in China’s economic growth threatens the economies of the countries that supply it with natural resources. Japan’s stimulus program to date has had mixed success, and the reason to expect stimulus in Europe is that policymakers are again worried about deflation.

Your best strategy: Spread your money widely. The typical investor should hold 20% to 30% of his stock allocation in foreign equities, including 5% in emerging markets, says Bernstein. Many core overseas stock funds, such as those in your 401(k), invest mainly in developed markets, so you may need to opt for a separate emerging-markets offering—you can find excellent choices on our ­MONEY 50 list of recommended mutual and exchange-traded funds. For an all-in-one fund, you could opt for Vanguard Total International Stock Index VANGUARD TOTAL INTL STOCK INDEX FD VGTSX 0.12% , which invests 20% of its assets in emerging markets.

3) Hold Bonds for Safety, Not for Income

Fixed-income investors have few options right now. Today’s rock-bottom interest rates are expected to move a bit higher, which may ding bond fund returns. (Bond rates and prices move in opposite directions.) Yet over the long run, intermediate-term rates are likely to remain below their historical average of 5%. If you want higher income, your only alternative is to venture into riskier investments.

Your best strategy: If you don’t want to take risks outside your stock portfolio, then accept that the role of your bond funds is to provide safety, not spending money. “After years of relative calm, you can expect volatility to return to the stock market—and higher-quality bonds offer your best hedge against stock losses,” says Russ Koesterich, chief investment strategist at BlackRock. Stick with mutual funds and ETFs that hold either investment-grade, or the highest-rated junk bonds. Don’t rely solely on government issues. Corporate bonds will give you a little more yield.

You may be tempted to hunker down in a short-term bond fund, which in theory will hold up best if interest rates rise. But this is one corner of the market that hasn’t returned to normal. Short-term bonds are sensitive to moves by the Federal Reserve to push up rates. The Fed has less ability to set long-term rates, and demand for long-term Treasuries is strong, which will keep downward pressure on the rates those bonds pay. So an intermediate-term bond fund that today yields about 2.25% is a reasonable compromise. Sometimes in investing, winning means not losing.

Read next:
How 2% Yields Explain the World—and Why Rates Have Stayed So Low for So Long

 

MONEY mutual funds

How MONEY Selected the 50 Best Mutual Funds and ETFs

The making of the MONEY 50, our list of the world’s 50 best mutual and exchange-traded funds

The Criteria

To create the MONEY 50 list of the best mutual funds and ETFs, MONEY editors look for solid long-term performers with these important traits:

Low fees. Below average expense ratios are a good predictor of better-than-average performance. Expenses averaged 0.94% for actively managed MONEY 50 funds, compared to 1.33% for stock funds in general.

Long tenure. Good returns don’t mean much if the manager responsible for them is no longer around. The average tenure for a MONEY 50 manager is 12.4 years, compared to 5.5 years for funds in general.

Strong stewardship. You want fund managers who put shareholders first. Sixty-four percent of actively managed MONEY 50 funds received a Morningstar stewardship grade of A or B, compared to only 13% of funds in general.

Changes to the List

While we are cautious about making switches, events can force our hand. We are replacing three funds for the 2015 list:

Out: T. Rowe Price Equity Income T. ROWE PRICE EQUITY INCOME FD PRFDX -0.51% . Longtime manager Brian Rogers is stepping down in October. His successor, John Linehan, has a wealth of experience, so shareholders needn’t sell. That said, the fund’s stellar record belongs to Rogers.

In: Dodge & Cox Stock DODGE & COX STOCK FUND DODGX 0.08% . The management team has delivered impressive returns at low cost, beating 99%, 92%, and 67% of their peers over the past three, five, and 10 years, respectively. The fund watchers at Morningstar give Dodge & Cox an “A” for how it treats shareholders, taking into account fees, disclosures, manager compensation, and other factors.

Dodge & Cox Stock is a true value fund, meaning the managers look for unpopular stocks and hang on, expecting investors to come around and bid share prices up.

“You have to understand the firm’s strategy and be willing to hold on,” says Morningstar analyst Laura Lallos. For instance, battered computer giant Hewlett-Packard is the fund’s top holding, and the nine-person management team has other big technology bets, including one on Microsoft. A recent success: buying J.P. Morgan Chase after news of the London Whale trading scandal in 2012. The stock has risen almost 70% since then. That said, the fund fared poorly during the financial crisis. But over the years it has bested the market in up months and lost less in down months.

Out: Primecap Odyssey Aggressive Growth PRIMECAP ODYSSEY AGGRESSIVE GROWTH POAGX 0.71% . After posting top returns for a decade and seeing an influx of money, the fund closed to new investors. That’s a positive for shareholders as management decided to go with its best ideas rather than find ways to deploy more cash.

In: iShares iBoxx $ Investment Grade Corporate Bond ISHARES TRUST IBOXX USD INVT GRD CORP BD LQD 0.13% . Instead of replacing Primecap with an­other stock fund, we bulked up our fixed-income selection at a time when Treasuries, the go-to bond investment, pay so little.

Low-fee LQD buys the debt of such household names as Verizon, Goldman Sachs, and General Electric and has outperformed its peers. While blue-chip debtors are unlikely to default, corporate bonds are more volatile than Treasuries, so this fund should supplement, not replace, your core bond holding.

Out: Harbor Bond HARBOR BOND FUND INST HABDX 0.08% Why? In a name, Bill Gross. The co-founder of Pimco left the bond giant in the fall for Janus. Investors have been pulling money from Harbor, a sister fund to Pimco Total Return, as Gross’s recent bets against Treasuries failed to pay off. Harbor has trailed 72% of its peers over the past 12 months, although the fund has a solid long-term record. Still, given management uncertainty at Pimco, we replaced Harbor.

In: Fidelity Total Bond Fund FIDELITY TOTAL BOND FTBFX 0.09% . An experienced team led by Ford O’Neil has given investors a smooth ride at a lower cost than Harbor. The fund can invest up to 20% of its assets in non-investment-grade debt. Those “junk” holdings are one-seventh of the portfolio now. The idea is to add yield without significantly increasing risk.

Funds Under Review

While we seek out portfolios that beat their average competitor over five years, we don’t immediately eject funds on the list when their returns lag. Contrarian-minded managers can post subpar results before the market vindicates their thinking. That said, continued under­performance bears scrutiny. We’re watching the following funds:

Delafield DELAFIELD FUND INC DEFIX -0.28% Managers J. Dennis Delafield and Vincent Sellecchia have whipped the average competitor that invests in midsize value stocks by 2.5 percentage points a year since 1999, but they’ve struggled the past two years, in part due to large holdings in industrials and basic materials, sectors that have lagged the broader market. Still, Delafield has finished in the top 15% of similar funds in three of the past six years.

Weitz Hickory WEITZ HICKORY FUND WEHIX -0.12% Run by Omaha’s second-most-­famous value investor, Wally Weitz, this fund has trailed competitors badly over the past three- and 10-year periods, thanks to performance laggards such as security firm ADT. Plus, a large cash allocation meant Weitz didn’t fully capitalize on the bull market. Nevertheless, the fund ranks in the top 13% of peers over the past five years.

Wasatch Small Cap Growth WASATCH SMALL CAP GROWTH WAAEX 0.46% Jeff Cardon, the manager since 1986, tries to find companies that have low levels of debt and can double their earnings in five years. While the fund’s 15-year record is impressive, Wasatch has trailed almost 60% of its peers over the past five years, thanks in part to its bet on energy stocks, which have fallen as oil prices decline.

See the full MONEY 50 list

MONEY mutual funds

MONEY 50: The World’s Best Mutual Funds and ETFs

illustration
Angus Greig

Our list of the world’s best mutual and exchange-traded funds can steer you safely toward your goals—even when the going gets rough.

Over the past five years of impressive stock and bond returns, the rising tide lifted nearly all boats. Alas, tides ebb, and the markets have been high for longer than usual. It’s time to look at what matters to you not only when seas are calm, but also when they’re stormy.

That’s the thinking behind the MONEY 50, our selection of the world’s best mutual and exchange-traded funds. Note that we didn’t say “top-performing” or “hottest.” Instead, by sticking to low-cost portfolios run by rock-solid management, the MONEY 50 is meant to give you the best shot possible at outperformance over dec­ades, not months or years.

How to use the list? The funds are broken into three basic categories — building-block, custom, and single-decision — each of which is meant for a different purpose.

  • Building-block: Use these as your core holdings. These are 14 low-fee index funds — both traditional mutual funds and ETFs, which you buy and sell like stock — that closely track market benchmarks such as the S&P 500. The goal with here is broad diversification.
  • Custom: Use these to augment your core holdings with alternative investments such as real estate or natural resources. You can also use them to tilt your portfolio toward asset classes that tend to outperform the market over the long run, such as the stocks of smaller companies or “value” stocks, which are cheap relative to their earnings per share.
  • Single-decision: For those who want to make just a single investment decision, these two target ­retirement-date fund offerings grow more conservative as you get older.

Two final notes: First, for help with some of the terminology in the MONEY 50, you’ll find a glossary below the tables; and second, for more about how we choose the MONEY 50 funds, and how the list changed this year compared to last, read this.

And now, the world’s 50 best mutual and exchange-traded funds:

Building-Block Funds

These funds and ETFs, which offer you exposure to big chunks of the stock and bond markets, should be used for the core part of your portfolio that you’ll hold on to for years. because you’re seeking broad market exposure, low-cost diversified index funds are your best bet.

Large Cap Style Expense Ratio YTD Return 5 yr Return Initial Investment
Schwab S&P 500 Index Blend 0.09 13.5% 15.9% $100
Schwab Total Stock Market Index Blend 0.09 11.9% 16.2% $100

Midcap/Small-Cap Style Expense Ratio YTD Return 5 yr Return Initial Investment
iShares Core S&P Mid-Cap ETF Blend 0.14 8.1% 17.1% N.A.
iShares Core S&P Small-Cap ETF Blend 0.14 2.4% 17.7% N.A.

Foreign Style Expense Ratio YTD Return 5 yr Return Initial Investment
Fidelity Spartan International Large Blend 0.20 -2.6% 6.1% $2,500
Vanguard Total International Stock Large Blend 0.22 -2.1% 5.0% $3,000
Vanguard FTSE All-World ex-U.S. Small-Cap Small/Mid Blend 0.40 -4.4% 6.6% $3,000
Vanguard Emerging Markets Stock Emerging Markets 0.33 2.2% 2.6% $3,000

Specialty Style Expense Ratio YTD Return 5 yr Return Initial Investment
Vanguard REIT Index Real Estate 0.24 28.4% 17.6% $3,000

Bond Style Expense Ratio YTD Return 5 yr Return Initial Investment
Vanguard Total Bond Market Index Intermediate Term 0.20 5.3% 3.9% $3,000
Vanguard Short-Term Bond Index Short Term 0.20 1.2% 1.8% $3,000
Vanguard Inflation-Protected Securities Inflation-Protected 0.20 3.8% 3.8% $3,000
Vanguard S/T Inflation-Protected Sec. ETF Inflation-Protected 0.10 -0.6% N.A. N.A.
Vanguard Total International Bond Index World 0.23 7.9% N.A. $3,000

Custom Funds

Supplement your core holdings with these funds to give your portfolio a tilt toward certain kinds of stocks and bonds, diversify more broadly, or play a hunch.

Large Cap

Style Expense Ratio YTD Return 5 yr Return Initial Investment
Dodge & Cox Stock Value 0.52 10.4% 16.0% $2,500
PowerShares FTSE RAFI U.S. 1000 ETF Value 0.39 11.6% 16.4% N.A.
Sound Shore Value 0.93 11.9% 15.4% $10,000
Primecap Odyssey Growth Growth 0.66 15.1% 17.1% $2,000
T. Rowe Price Blue Chip Growth Growth 0.74 9.6% 17.7% $2,500

Mid-Cap Style Expense Ratio YTD Return 5 yr Return Initial Investment
The Delafield Fund Value 1.22 -6.0% 11.9% $1,000
Ariel Appreciation Blend 1.13 7.1% 16.7% $1,000
Weitz Hickory Blend 1.22 0.8% 17.3% $2,500
T. Rowe Price Div. Mid-Cap Growth Growth 0.91 10.1% 17.1% $2,500

Small-Cap Style Expense Ratio YTD Return 5 yr Return Initial Investment
Royce Opportunity Value 1.17 -4.1% 15.7% $2,000
Vanguard Small-Cap Value ETF Value 0.09 8.3% 17.0% N.A.
Berwyn Blend 1.20 -7% 14.9% $3,000
Wasatch Small Cap Growth5 Growth 1.24 0% 15.5% $2,000

Foreign Style Expense Ratio YTD Return 5 yr Return Initial Investment
Dodge & Cox International Stock Large Blend 0.64 3.3% 8.8% $2,500
Oakmark International5 Large Blend 0.98 -2.6% 10.6% $1,000
Vanguard International Growth Large Growth 0.48 -2.7% 7.7% $3,000
T. Rowe Price Emerging Markets Emerging Markets 1.25 3% 2.9% $2,500

Bond Style Expense Ratio YTD Return 5 yr Return Initial Investment
Dodge & Cox Income Fund Intermediate Term 0.43 5.4% 5.1% $2,500
Fidelity Total Bond (FTBFX) Intermediate Term 0.45 5.3% 5.3% $2,500
Vanguard Short-Term Investment Grade Short Term 0.20 1.7% 2.8% $3,000
iShares iBoxx $ Inv. Grade Corp. Corporate 0.15 7.9% 6.8% N.A.
Loomis Sayles Bond Multisector 0.92 4.9% 8.5% $2,500
Fidelity High Income High Yield 0.72 1.8% 8.5% $2,500
Vanguard Intermediate-Term Tax-Exempt Fund Investor Shares Muni Nat’l Intermediate 0.20 6.9% 4.4% $3,000
Vanguard Limited-Term Tax-Exempt Fund Muni Nat’l Short 0.20 1.9% 1.9% $3,000
Templeton Global Bund Fund4 World 0.88 2.7% 6.1% $1,000
Fidelity New Markets Income Emerging Markets 0.86 5.7% 7.4% $2,500

One-Decision Funds

Don’t want to put together a portfolio on your own? Then use one of these professionally managed funds that hold a diversified mix of stocks and bonds.

Fund Name Style Expense Ratio YTD Return 5 yr Return Initial Investment
Fidelity Balanced Balanced 0.56 10.1% 12.0% $2,500
Vanguard Wellington Fund Balanced 0.26 10.1% 11.5% $3,000
T. Rowe Price Retirement 2020 Fund Target Date 0.67 6.0% 10.7% $2,500
Vanguard Target Retirement 2035 Fund Investor Shares Target Date 0.18 7.4% 11.8% $1,000
NOTES: 1. Net prospectus expense ratios were used. 2. Total return figures are as of Dec. 8. 3. Five-year returns are annualized. 4. 4.25% sales load. 5. Shares available only through fund company. ETFs do not have a minimum initial investment. SOURCES: Lipper and fund companies

Fund glossary

Large-cap: Invests in shares of firms with stock market values, or market capitalizations, of $10 billion or more

Small-cap and midcap: Invest in smaller companies

Specialty: Invests in assets that don’t move in sync with the broad stock or bond market

Target date: Provides exposure to a mix of stocks and bonds appropriate for your age—and gradually grows more conservative over time

Balanced: Offers you exposure to a mix of stocks and bonds, but doesn’t grow more conservative over time

Value: Looks for stocks that are selling at bargain prices

Growth: Focuses on companies with fast-growing earnings

Blend: Owns both growth- and value-oriented stocks

Short term: Owns bonds that mature in about two years or less

Intermediate term: Owns bonds that mature in two to 10 years

Multisector: Can buy foreign or domestic bonds of any maturity

Inflation-protected: Owns bonds whose value at least keeps pace with the consumer price index

Read next: How MONEY Selected the 50 Best Mutual Funds and ETFs

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MONEY

5 Ways to Prosper in 2015

fortune cookie with money inside
Gregory Reid—Prop Styling by Megumi Emoto

The U.S. shines amid global worries. Here are five strategies for profiting from the economy's relative health in your investing, spending, and saving.

The pace of U.S. growth may be more minivan than Ferrari, but the economy is nonetheless motoring along. Gross domestic product is forecast by the International Monetary Fund to grow 3.1% in 2015. That will put the U.S. ahead of most of its peers, which are facing serious headwinds: Europe may slip into its third recession since the financial crisis, and Japan’s stimulus effort hasn’t revved up its economic engines. China, meanwhile, is trying to maneuver slowing growth into a soft landing.

To make sure growth here doesn’t stall out, the Fed will likely wait till late 2015 to raise rates, and any increase is expected to be small and gradual. That’s still good news, though. “The U.S. economy is in a position to withstand the beginning of interest rates rising—something our trade partners can’t do yet,” says Chun Wang, senior analyst at the Leuthold Group.

Our relative health should continue to lure global investors to U.S. stocks and bonds. That in turn should support the almighty buck. After rising about 5% against a basket of currencies of our major trade partners this year, the dollar could gain another 5% in 2015, Wang says.

A stronger dollar means cheaper overseas travel and cheaper imports—and the latter should keep inflation from picking up momentum as well.

Here’a five-step action plan for profiting off U.S. versus them.

Move to the middle on bonds. While bonds that mature in less than three years are usually considered the safest, “short-term high-grade bonds could be the most vulnerable in 2015 if the Fed starts raising rates as expected,” says Lisa Black, interim chief in­vestment officer for the TIAA General Account. Because the recovery here has been so much stronger than in the rest of the world, global investors will continue to favor 10-year Treasuries, putting upward pressure on prices and keeping a lid on yields. Thus short-term rates, over which the Fed has more influence, are likely to see a much bigger rise relative to their current level.

If you’ve kept a big chunk of bond money in short-term mutual or exchange-traded funds recently—­either to hedge inflation risk or to get more yield on cash—get back to an intermediate strategy in 2015. MONEY 50 fund Dodge & Cox Income ­DODGE & COX INCOME FUND DODIX 0.07% yields 2.5%, vs. less than 0.8% for Vanguard’s Short-Term Bond Fund.

Bet on cyclical stocks. LPL chief investment strategist Burt White—who forecasts a mid- to high-single-digit return for the U.S. stock market in 2015—­expects to see above-average performance in sectors that do better when consumers and businesses have more money to spend. In particular, he says, industrial and technology stocks should benefit if the strong economy motivates corporations to invest in systems upgrades. He recommends Industrial Select SPDR ETF INDUSTRIAL SELECT SECTOR SPDR ETF XLI 0.07% , as well as PowerShares QQQ ETF POWERSHARES QQQ NASDAQ 100 QQQ 0.18% , which tracks the tech-heavy Nasdaq 100.

Eke more out of your cash. In 2014 the average money-market account paid a mere 0.08%, and that yield isn’t likely to grow in any meaningful way in 2015. But don’t just give up on your savings.

Move cash you need accessible—like emergency funds—to an online bank such as MySavingsDirect, which yielded 1.05% re­cently, suggests Ken Tumin of DepositAccounts.com. If you have $25,000-plus to deposit, you can earn 1.25% at UFB Direct. Use the rest of your savings to build a CD ladder. Divide the sum into five buckets and deposit equal amounts in one- to five-year CDs. As each comes due, roll it into a five-year to benefit from rising rates. Based on current yields, you’ll earn an average 1.6%.

Head south. The dollar now buys nearly 8% more euros and 13% more yen than a year ago. That will make travel to Europe and Japan less expensive, but it still won’t be cheap. For great value—and some stunning photos besides—consider Costa Rica, says Anne Banas, editor of SmarterTravel.com.

The dollar is up 7% against the colon in the past year, making the country more of a bargain than it already was. Located in the rainforests of Arenal Volcano National Park on the Pacific Coast, the five-star Tabacon Grand Spa Thermal Resort—one of TripAdvisor’s 2014 winners for luxury—starts at $260 a night, for example. And flights from major U.S. cities can be found for $400.

Expect the unexpected. When stocks were spooked in September by Ebola reaching U.S. shores and increased U.S. airstrikes against ISIS, the S&P 500 fell 7% but European shares sunk 13%. U.S. stocks continued to lead when investors returned to focusing on economic growth.

While it’s impossible to predict what will rattle the markets in 2015, what you can do is take stock of your fortitude. If you persevered and profited from this recent snap back, plan for another in 2015 and bet on U.S. outperformance.

On the other hand, if you panicked and sold stocks, dial back your equity ex­posure by, say, five percentage points if it will keep you hanging on to your allocation in rough seas. Redirect that money to U.S. Treasuries. Jack Ablin, chief in­vestment officer for BMO Private Bank, says that these should benefit from a crisis: “It’s remarkable how Treasuries and the U.S. dollar are the newly appointed safe-­haven vehicles for the world.”

MONEY mutual funds

Why Mutual Fund Managers Are Having a Bad Year

140618_money_gen_9
iStock

Eighty-five percent of stock-pickers at large-cap funds are trailing their benchmark indexes — likely their worst performance in three decades.

Stock-picking fund managers are testing their investors’ patience with some of the worst investment returns in decades.

With bad bets on financial shares, missed opportunities in technology stocks and too much cash on the sidelines, roughly 85% of active large-cap stock funds have lagged their benchmark indexes through Nov. 25 this year, according to an analysis by Lipper, a Thomson Reuters research unit. It is likely their worst comparative showing in 30 years, Lipper said.

Some long-term advocates of active management may be turned off by the results, especially considering the funds’ higher fees. Through Oct. 31, index stock funds and exchange traded funds have pulled in $206.2 billion in net deposits.

Actively managed funds, a much larger universe, took in a much smaller $35.6 billion, sharply down from the $162 billion taken in during 2013, their first year of net inflows since 2007.

Jeff Tjornehoj, head of Lipper Americas Research, said investors will have to decide if they have the stomach to stick with active funds in hopes of better results in the future.

“A year like this sorts out what kind of investor you are,” he said.

Even long-time standout managers like Bill Nygren of the $17.8 billion Oakmark Fund and Jason Subotky of the $14.2 billion Yacktman Fund are lagging, at a time when advisers are growing more focused on fees.

The Oakmark fund, which is up 11.8% this year through Nov. 25, charges 0.95% of assets in annual fees, compared with 0.09% for the SPDR S&P 500 exchange traded fund, which mimics the S&P 500 and is up almost 14% this year, according to Morningstar. The Yacktman fund is up 10.2% over the same period and charges 0.74% of assets in annual fees.

The pay-for-active-performance camp argues that talented managers are worth paying for and will beat the market over investment cycles.

Rob Brown, chief investment strategist for United Capital, which has $11 billion under management and keeps about two thirds of its mutual fund holdings in active funds, estimates that good managers can add an extra 1% to returns over time compared with an index-only strategy.

Indeed, the top active managers have delivered. For example, $10,000 invested in the Yacktman Fund on Nov. 23, 2004, would have been worth $27,844 on Nov. 25 of this year; the same amount invested in the S&P 500 would be worth $21,649, according to Lipper.

Even so, active funds as a group tend to lag broad market indexes, though this year’s underperformance is extreme. In the rout of 2008, when the S&P 500 fell 38%, more than half of the active large cap stock funds had declines that were greater than those of their benchmarks, Lipper found. The last time when more than half of active large cap stock managers beat their index was 2009, when the S&P 500 was up 26%. That year, 55% of these managers beat their benchmarks.

Unusually Bad Bets

In 2014, some recurring bad market bets were made by various active managers. Holding too much cash was one.

Yacktman’s Subotky said high stock prices made him skeptical of buying new shares, leaving him with 17% of the fund’s holdings in cash while share prices have continued to rise. He cautioned investors to have patience.

“Our goal is never to capture every last drop of a roaring bull market,” Subotky said

Oakmark’s Nygren cited his light weighting of hot Apple shares and heavy holdings of underperforming financials, but said his record should be judged over time. “Very short-term performance comparisons, good or bad, may bear little resemblance to long term results,” he said.

Shares of Apple, the world’s most valuable publicly traded company, are up 48% year to date. As of Sept. 30, Apple stock made up 1.75% of Oakmark’s assets, compared with 3.69% of the SPDR S&P 500 ETF.

Investors added $3.9 billion to Nygren’s fund through Nov. 19, Lipper said.

Still, some managers risk losing their faithful.

“We have been very much believers in active management, but a number of our active managers have let us down this year, and we are rethinking our strategy,” said Martin Hopkins, president of an investment management firm in Annapolis, Md. that has $4 million in the Yacktman Fund.

Derek Holman of EP Wealth Advisors, in Torrance, Calif., which manages about $1.8 billion, said his firm recently moved $130 million from a pair of active large cap funds into ETFs, saying it would save clients about $650,000 in fees per year.

Holman said his firm still uses active funds for areas like small-cap investing, but it is getting harder for fund managers to gain special insights about large companies.

For those managers, he said, “it’s getting harder to stand out.”

MONEY funds

George Soros Bets $500 Million On Bill Gross

George Soros
Rex Features via AP Images Billionaire George Soros, 84, is giving Bill Gross $500 million to invest for him.

Hedge fund titan George Soros is wagering half a billion dollars that bond king Bill Gross will excel in his new role at Janus.

Things are looking rosy for star bond fund manager Bill Gross, whose September departure from PIMCO—the fund company he founded—was accompanied by reports of tensions between Gross and other executives at the firm.

Now that Gross has moved to Janus Capital, where he manages the $440 million Global Unconstrained Bond Fund, it seems he’s getting a fresh start—plus some.

Not only did Janus see more than a billion dollars of new investments flow in last month, following Gross’s arrival, but the company also announced Thursday that hedge fund titan George Soros would be investing $500 million with Gross.

Quantum Partners, a vehicle for Soros’s investment, will see its money managed in an account that’s run parallel to but separate from the Unconstrained Bond Fund. That’s so Soros will be protected from sudden inflows or outflows caused by other investors, S&P Capital IQ mutual-fund research director Todd Rosenbluth told the Wall Street Journal.

Gross tweeted: “I & my team will manage your new unconstrained strategic acct. 24h/day. An honor to be chosen & an honor to be earned as well.”

Watch this video to learn more about what bond fund managers do:

MONEY financial advisers

What Is a Fiduciary, and Why Should You Care?

Your investments are at stake, explains Ritholtz Wealth Management CEO Josh Brown (a.k.a. The Reformed Broker).

MONEY mutual funds

Why Your Money Is Still Not Safe Enough in Money Funds

The Securities and Exchange Commission's new rules to keep share prices stable help pros more than retail investors.

The law of unintended consequences often comes into play when regulations get too complex. Take the Securities and Exchange Commission’s new rules to reduce the risk of runs on money-market mutual funds.

A money fund is a strange animal. Unlike other mutual funds whose share prices rise and fall along with the value of their assets, a money fund is designed to act like a bank account: Every dollar you put in buys a share, and you’re supposed to be able to take out your money at least dollar for dollar no matter what happens in the market. For that reason, money funds typically hold safe, short-term investments.

Still, sometimes losses in a money fund’s underlying assets make each share worth less than a dollar. When that happens, a sponsor must fork over its own money to prop up the fund (as has happened many times) or it can “break the buck” and stick investors with a sudden, unexpected loss.

This unique structure gives investors a strong incentive to pull money out at the first sign of trouble. They can get their dollar while imposing even bigger losses on those left behind. (If they stay, they risk others imposing losses on them.) So they run. That happened during the 2008 financial crisis, when a large money fund broke the buck and triggered massive runs that stopped only when taxpayers stepped in with a bailout.

RACE TO THE BOTTOM

In response, the SEC could have required all money funds to act like other mutual funds and pay out only what their shares were actually worth. Or the agency could have let money funds keep a stable value only if fund sponsors backed it up with their own capital. Instead, faced with intense industry lobbying, the SEC has split the baby. Effective October 2016, money funds used by big institutions will have floating share values. Retail funds can maintain their $1 per share price, but they won’t have to commit capital to support the buck. Rather, the SEC decided to discourage runs by letting fund sponsors deny investors access to their money for up to 10 days or charge them a fee of as much as 2% to redeem their shares should assets fall precipitously. (This while the average money fund yields, well, almost nothing.)

To its credit, the SEC also mandated better disclosure, including daily publication of the market value of funds’ underlying assets. Alas, here comes the law of unintended consequences: Better information also increases the risk of runs because sophisticated holders will bail out before gates or fees are imposed if the value of a fund’s assets are falling.

So protect yourself, and if you need ready access to your money, keep it in an FDIC-insured bank account or use a good financial website to find a fund investing only in short-term government securities that carry almost zero risk of default. Safety first.

Sheila Bair is former chairman of the Federal Deposit Insurance Corp.

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