MONEY financial advice

CEO of World’s Largest Mutual Fund Company Shares His Best Financial Advice

The CEO of the world's largest mutual fund company shares the best financial advice he ever got and reveals his biggest money mistake.

MONEY fiduciary

If Humans Can’t Offer Unbiased Financial Advice to the Middle Class, These Robots Will

Wall Street says it can't be a "fiduciary" to everyone who wants financial advice. But the new breed of "robo advisers" is happy to take the job.

Fast-growing internet-based investment services known as robo-advisers have already begun to upend many aspects of the investment business. Here’s one more: Potentially reshaping the long-standing debate in Washington over whether financial advisers need to act in their clients’ best interests.

If you work with a financial adviser you may assume he or she is legally obligated to give you unbiased advice. In fact, that’s not necessarily the case. Many advisers—the ones who are technically called brokers—in fact face a much less stringent legal and ethical standard: They’re required only to offer investments that are “suitable” for you based on factors like age and risk tolerance. That leaves room for brokers to steer clients to suitable but costly products that deliver them high commissions.

The issue is especially troubling, say many investor advocates, because research shows that most consumers don’t understand they may be getting conflicted advice. And the White House recently claimed that over-priced advice was reducing investment returns by 1% annually, ultimately costing savers $17 billion a year.

Now the Labor Department has issued a proposal that, among other things, would expand the so-called fiduciary standard to advice on one of financial advisers’ biggest market segments, Individual Retirement Accounts. A 90-day comment period ends this summer.

Seems like an easy call, right? Not so fast. Wall Street lobbyists contend that forcing all advisers to put clients first would actually hurt investors. Their argument? Because advisers who currently adhere to stricter fiduciary standards tend to work with wealthier clients, forcing all advisers to adopt it would drive those who serve less wealthy savers out of the business. In other words, according to the National Association of Insurance and Financial Advisors and the U.S. Chamber of Commerce, a fiduciary standard would mean middle-class investors could end up without access to any advice at all.

(Why, you might ask, would anyone in Washington listen to business rather than consumer groups about what’s best for consumers? Well, that is another story.)

What’s interesting about robo-advisers, which rely on the Internet to deliver automated advice, is that they have potential to change the dynamic. Robo-advisers have been filling this gap, offering investors so-called fiduciary advice with little or no investment minimums at all. For instance, Wealthfront, one of the leading robo-advisers, has a minimum account size of just $5,000. It’s free for the first $10,000 invested and charges just 0.25% on amounts over that. Arch-rival Betterment has no account minimum at all and charges just 0.35% on accounts up to $10,000 when investors agree to direct deposit up to $100 a month.

Of course, these services mostly focus on investing—clients can expect little in the way of individual attention or holistic financial planning. But the truth is that flesh-and-blood advisers seldom deliver much of those things to clients without a lot of assets. What’s more, the dynamic is starting to change. Earlier this month, fund giant Vanguard launched Personal Advisor Services that will offer individual financial planning over the phone and Internet for investors with as little as $50,000. The fee is 0.3%.

The financial services industry says robo-advisers shouldn’t change the argument. Juli McNeely, president of the National Association of Insurance and Financial Advisors, argues that relying on robo-advisers to fill the advice gap would still deprive investors of the human touch. “It all boils down to the relationship,” she says. “It provides clients with a lot of comfort.”

But robo-adviser’s growth suggests a different story. Wealthfront and Betterment, with $2.3 billion and $2.1 billion under management, respectively, are still small but have seen assets more than double in the past year.

And Vanguard’s service, meanwhile, which had been in a pilot program for two years before it’s recent launch, already has $17 billion under management.

Vanguard chief executive William McNabb told me last week that, although Vanguard had reservations about the specific legal details of past proposals, his company supports a fiduciary standard in principle. Small investors, he says, are precisely the niche that robo-advisers are “looking to fill.”

 

 

 

 

 

MONEY ETFs

Humdrum ETFs Are Overtaking Racy Hedge Funds

Tortoise and the hare
Milo Winter—Blue Lantern Studio/Corbis

It's part of a gradual change in culture on Wall Street that's encouraging low costs and long-term thinking.

It’s like the investment world’s version of the race between the tortoise and the hare. And the hare is losing its lead.

Hedge funds, investment pools known for their exotic investment strategies and rich fees, have long been considered one of the raciest investments Wall Street has to offer, with $2.94 trillion invested globally as of the first quarter, according to researcher Hedge Fund Research.

Despite their mystique and popularity, though, hedge funds are about to be eclipsed by a far cheaper and less exclusive investment vehicle: exchange-traded funds.

According to ETF researcher ETFGI, exchange-traded funds — index funds that have become favorites of financial planners and mom and pop investors — have climbed to more than $2.93 trillion. ETFs could eclipse hedge funds as early as this summer, according to co-founder Debbie Fuhr.

In some ways the milestone is one that few people outside the money management business might notice or care about. But even if you don’t pay much attention to the pecking order on Wall Street, there’s reason to take notice.

The fact that ETFs have caught up with hedge funds reflects broader trends toward lower costs and a focus on long-term passive investing, both of which benefit small investors.

Exchange-traded funds, which first appeared in the 1990s and hit the $1 trillion mark following the financial crisis, have gained fans in large part because their ultra-low cost and hands-off investing style.

While there are many varieties of ETFs, the basic premise is built on the notion that investors get ahead not by picking individual stocks and securities but by simply owning big parts of the market.

Index mutual funds have been around for a long time. (Mutual funds control $30 trillion in assets globally, dwarfing both ETFs and hedge funds). But ETFs allow investors to trade funds like stocks, and they can be more tax efficient than mutual funds. Both ETFs and traditional index funds are known for ultra-low fees, sometimes less than 0.1% of assets invested. That means investors keep more of what they earn, and pay less to Wall Street.

Hedge funds by contrast exist for elaborate investment strategies. They are investment pools that in some ways resemble mutual funds, but they can’t call themselves that because they aren’t willing to follow SEC rules designed to protect less sophisticated investors.

Because of their special legal status, hedge funds aren’t allowed to accept investors with less than than $1 million in net worth, hence the air of wealth and exclusivity.

But hedge fund managers also enjoy a lot more freedom in how they invest, for instance, sometimes requiring shareholders to lock up money for months at a time or taking big positions in complex derivatives.

Hedge funds aren’t necessarily designed to be risky — they get their name from a strategy designed to offset not magnify market swings. But hedge fund investors do expect managers to deliver something the market cannot. Otherwise why pay the high fees? Hedge funds typically charge “two and twenty.” That is 2% of the amount invested each year, plus 20% of any gains above some benchmark. No that is not a typo.

Of course, hedge funds’ rich fees wouldn’t be a problem if they delivered rich investment returns. The industry has long relied on some fabulously successful examples to make its case. But critics have also suspected that, like the active mutual fund industry in its 1990s’ heyday, this could be a case of survivorship bias, with a few rags-to-riches stories distracting from more common stories of mediocre performance.

Hedge funds’ performance in recent years seems to be bearing that out. (By contrast ETFs, whose returns are typically tied to the stock market, have benefited from one of the longest bull markets in history.)

Why should you care if a bunch of rich guys blow their money chasing ephemeral investment returns? One reason, is you might be among them, even if you don’t know it. Pension funds are among the biggest hedge fund investors.

The good news: They too are embracing indexing, if not specifically through ETFs. Calpers, the giant California pension fund, said last year that it was dumping hedge funds, while also indexing more of its stock holdings.

Unlike ETFs, hedge funds — because they need to justify their rich fees — often suffer from short-term focus. In recent years, one popular strategy has been so-called “activist investing,” where a hedge fund buys a big stake in an underperforming company and demands changes.

While the stock market often rewards those moves in the short-term, many investors worry moves like cutting costs and skimping on research ultimately make those businesses weaker, hurting long-term investors. It’s no surprise then that one of activist investing’s most outspoken critics is BlackRock Inc. As the largest ETF provider, BlackRock represents the interests of millions of small investors.

And finally, there are those fees. The surging popularity of low-cost investments such as ETFs will inevitably focus more attention on fees, putting pressure on active investment managers — and even hedge funds themselves — to slash prices. And in the the end, that benefits everybody.

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 mutual funds

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

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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 Currency

How the Cheap Euro Is Hurting Your Investments

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Dieter Spannknebel—Getty Images

The plunging euro may be good for U.S. consumers. But it has all but wiped out returns of foreign stock mutual funds.

A weak euro could make it cheaper to take that long-planned trip to Paris. Just don’t sell your foreign-stock mutual funds to pay for it.

On Wednesday, the euro hit a 12-year low against the dollar—it’s getting close to $1-to-€1 parity (so figuring the exchange rate on that trip will be easier too.) The currency is tanking thanks in part to a weak European economy, as well as the European Central Bank’s efforts to stimulate growth with looser monetary policy.

Unless you are frequent currency trader, these exchange-rate ups and down may feel pretty remote from your portfolio. But they’re not. If you hold a foreign-stock mutual fund in your 401(k) or IRA, you will have significant exposure to European stocks. And since those stocks are denominated in euros, their value to a typical American investor has taken a hit.

Consider: Over the past year, the MSCI All-Cap World EX-USA index is up 14.6% in local currency terms through Feb. 28. But according to Morningstar, the average foreign stock mutual fund—with roughly half its assets in Europe —has pretty much sucked wind, falling 0.06%.

What gives?

Just as the falling dollar makes European hotel rooms and airplane tickets relatively cheaper when their euro-based prices are translated into dollars, foreign stocks get knocked down in dollar terms too. When a U.S. mutual fund calculates its value at the end of the day, it converts the euro price of European stock back into dollars. So if the euro is falling fast enough, you can see loss in dollars even if the stock is climbing on the local stock exchange.

The same effect holds for bonds, or any other asset traded in another currency.

To be sure, it is possible for canny fund managers to use financial instruments, such as futures contracts, to “hedge” away currency fluctuations. Some do exactly that. Pimco, for instance, offers both hedged version of its foreign bond fund (up 10.8% over the past 12 months) and an unhedged version (down 5.7%).

Does hedging make sense? With foreign stock funds, the answer is generally no—which is why comparatively few funds do it. It drives up cost, and over the long run currency fluctuations tend to be less important than the economic fundamentals driving stock returns. The Euro’s recent plunge may be dramatic, but it’s also relatively unusual.

It’s slightly more common with bond funds. Vanguard, for instance, hedges the returns of its flagship foreign bond index fund, but not its flagship foreign stock fund. The reason it has given for hedging bonds: Since the underlying returns of bonds are usually fairly steady, currency fluctuations can an have outsized impact on your final return.

Of course, whatever the investing strategy you pick, the thing to remember about short-term currency moves is that they are just that, short-term. Think of it this way: When the dollar starts to weaken again, those foreign stocks will look like winners. In the end, holding some funds whose stocks are valued in foreign currencies provides extra diversification, helping smooth the overall return of your portfolio in the long run.

Now, if you can just find another way to fund that trip to Paris.

MONEY Markets

What the Greek Crisis Means for Your Money

Global markets seem safe enough for now, but a so-called “Grexit” could have unpredictable effects.

As government officials in Greece and the rest of the European Union continue to haggle over the terms of its bailout agreement, you may be wondering: Does this have anything to do with me?

If you are investing in a retirement account like a 401(k) or an IRA, the answer is likely “yes.” About a third of holdings in a fairly typical target-date mutual fund, like Vanguard Target Retirement 2035, are in foreign stocks. Funds like this, which hold a mix of stocks and bonds, are popular choices in 401(k)s.

Of those foreign stocks, only a small number are Greek companies. Vanguard Total International Stock (which the 2035 fund holds), for example, has only about 0.1% of assets in Greek companies. But about 20% of the foreign holdings in a typical target date fund are in euro-member countries, and if Greece leaves the euro, that could affect the whole continent.

What’s the worst that could happen? For one, investors and citizens in some troubled economies like Spain and Italy could start pulling their euros out of banks. Also, borrowing costs could go up, and that could hurt economic growth and weigh down stock prices. And if fear of European instability drives investors to seek out safe assets like U.S. Treasuries, then bond yields and interest rates could keep staying at their unusually low levels.

There are some market watchers who see a potential upside to the conflict over Greece, however.

“If you believe the euro is an average of its currencies, it could actually rise if Greece leaves,” says BMO Private Bank chief investment officer Jack Ablin. A higher euro would make European stocks more valuable in dollar terms.

Additionally, he says, if Athens is thrown into pandemonium, then it’s actually less likely other countries will want to follow Greece out of the currency union.

The Greek situation will also have an impact on the bond market. If fear of European instability drives investors to seek out safe assets like U.S. Treasuries, then many bond funds will do well, and yields and interest rates would stay at their unusually low levels.

Perhaps the most insidious thing right now, says Ablin, is uncertainty. Again, a Greek exit from the euro would be unprecedented, and that makes the effect unpredictable—and potentially very scary for the global market. So investors would be wise to keep in mind the possibility of “black swans,” a term coined by statistician Nassim Taleb to describe market events that seem unimaginable (like black swans used to be) until they actually occur.

MONEY stocks

How I Plan for the Stock Market Freakout…I Mean Selloff

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Mike Segar—REUTERS A trader works on the floor of the New York Stock Exchange (NYSE).

Advising people not to dump their stocks in downturn is easy. Actually persuading them not to do so is harder.

I got an email from Nate, a client, linking to a story about the stock market’s climb. “Is it time to sell?” he asked me. “The stock market is way up.”

Hmmmm.

If I just tell Nate, “Don’t sell now,” I think I might be missing something.

At a recent conference, Vanguard senior investment analyst Colleen Jaconetti presented research quantifying the value advisers can bring to their clients. According to Vanguard’s research, advisers can boost clients’ annual returns three percentage points — 300 basis points in financial planner jargon. So instead of earning, say, 10% if you invest by yourself, you’d earn 13% working with an adviser.

That got my attention.

Jaconetti got more granular about these 300 basis points. Turns out, much of what I do for clients — determining optimal asset allocations, maximizing tax efficiency, rebalancing portfolios — accounts for about 1.5%, or 150 basis points.

The other 150 basis points, or 1.5%, comes from what Jaconetti called “behavioral coaching.” When she introduced the topic, I sat back in my seat and mentally strapped myself in for a good ride. One hundred fifty basis points, I told myself — this is going to be advanced. Bring it on!

Then she detailed “behavioral coaching.” I’m going to paraphrase here:

“Don’t sell low.”

Don’t sell low? Really? The biggest cliché in the world of finance? That’s worth 150 basis points?

But it isn’t just saying, “Don’t sell low.”

It’s actually that I have the potential to earn my 150 basis points if I can get Nate to avoid selling low. That means I need to change his behavior. Wow. Didn’t I give up trying to change other people’s behavior January 1?

Inspired by Nate and the fact that the stock market is high (or maybe it’s low; the problem is we don’t know), I decided to think like a client might think and do a deeper dive into the research. Why not sell now? Why do people sell low? How can I influence, if not change, client behavior? I’ve got nothing to lose and clients have 1.5% to gain.

One interesting thing I learned in my research: Not everybody sells. In another study, Vanguard reported that 27% of IRA account holders made at least one exchange during the 2008-2012 downturn. In other words, 73% of people didn’t sell.

Current research on investing behavior, called neuroeconomics, includes reams of studies on over-confidence, the recency effect, loss aversion, herding instincts, and other biases that cause people to sell low when they know better.

Also available are easy-to-understand primers explaining why it’s such a bad idea to get out of the market.

The question remains, “How do I influence Nate’s behavior?” The financial research ends before that gets answered.

Coincidentally, I recently had a tennis accident that landed me in the emergency room. While outwardly I was calm, cracking lame jokes, inwardly I was freaked out.

Despite my appearance, the medical professionals assumed I was in high anxiety mode, treating me appropriately. The emergency room personnel had specific protocols. Quoting research and approaching panicked people with logic weren’t among them.

They answered my questions with simple sentences and gave me some handouts to look at later.

Selling low is an anxiety issue. And anxiety about the stock market runs on a continuum:

Anxiety Level Low Medium High
Client behavior Don’t notice the market Mindfully monitor it. “Stop the pain. I have to sell.”

That brought me to a plan, which I’m implementing now, to earn the 150 basis points for behavioral coaching.

During normal times, when clients are in the first two boxes, I make sure to reiterate the basics of low-drama investment strategy.

When I get a call from clients in high anxiety mode, however, I follow a protocol I’ve adapted from the World Health Organization’s recommendations for emergency personnel. Seriously. Here’s what to do:

  • Listen, show empathy, and be calm;
  • Take the situation seriously and assess the degree of risk.
  • Ask if the client has done this before. How’d it work out?
  • Explore other possibilities. If clients wants to sell at a bad time because they need cash, help them think through alternatives.
  • Ask clients about the plan. If they sell now, when are they going to get back in? Where are they going to invest the proceeds?
  • Buy time. If appropriate, make non-binding agreements that they won’t sell until a specific date.
  • Identify people in clients’ lives they can enlist for support.

What not to do:

  • Ignore the situation.
  • Say that everything will be all right.
  • Challenge the person to go ahead.
  • Make the problem appear trivial.
  • Give false assurances.

Time for some back-testing. How would this have worked in 2008?

In 2008, Jane, who had recently retired, came to me because her portfolio went down 10%. The broader market was down 30-40%, so I doubt her old adviser was concerned about her. Jane, however, didn’t spend much and had no inspiring plans for her estate. She hated her portfolio going down 10%.

Jane didn’t belong in the market. She didn’t care about models showing CD-only portfolios are riskier. She sold her equity positions. She lost $200,000!

The protocol would have worked great because we could have worked through the questions to get to the root of the problem. Her risk tolerance clearly changed when she retired. She and her adviser hadn’t realized it before the downturn.

Then there was Uncle Larry.

Like a lot of relatives, although he may ask my opinion on financial matters, Larry has miraculously gotten along well without acting on much of it.

Larry is in his 80s and mainly invested in individual stocks. This maximizes his dividends, which he likes. The problem was that his dividends were cut. The foibles of a too-big-to-fail bank were waking him up at 3:00 a.m. Should he sell?

When he called, I suggested that Uncle Larry look at the stock market numbers less and turn off the news that was causing him anxiety. I reassured him that he wouldn’t miss anything important. We discussed taking some losses to help him with his tax situation.

Although he listened, I didn’t get the feeling this advice was for him. Actually, the emergency protocol would predict this; the protocol doesn’t include me giving advice!

Uncle Larry and I discussed his plan. He ended up staying in the market because he couldn’t come up with an alternative. He also thought, “If I had invested in a more traditional way, I’d probably have ended up at the same point that I am at now anyway. So this is okay.”

He’s now thrilled he didn’t sell and, at 87, is still 100% in individual stocks.

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

Listen to the most important stories of the day.

MONEY IRAs

The Best Way to Tap Your IRA In Retirement

Ask the Expert Retirement illustration
Robert A. Di Ieso, Jr.

Q: I am 72 years old and subject to mandatory IRA withdrawals. I don’t need all the money for my expenses. What should I do with the leftover money? Jay Kahn, Vienna, VA.

A: You’re in a fortunate position. While there is a real retirement savings crisis for many Americans, there are also people with individual retirement accounts (IRAs) like you who don’t need to tap their nest egg—at least not yet.

Nearly four out of every 10 U.S. households own an IRA, holding more than $5.7 trillion in these accounts, according to a study by the Investment Company Institute. At Vanguard, 20% of investors with an IRA who take a distribution after age 70 ½ put it into another taxable investment account with the company.

The government forces you to start withdrawing your IRA money when you turn 70½ because the IRS wants to collect the income taxes you’ve deferred on the contributions. You must take your first required minimum distribution (RMD) by April of the year after you turn 70½ and by December 31 for subsequent withdrawals.

But there’s no requirement to spend it, and many people like you want to continue to keep growing your money for the future. In that case you have several options, says Tom Mingone, founder and managing partner of Capital Management Group of New York.

First, look at your overall asset allocation and risk tolerance. Add the money to investments where you are underweight, Mingone advises. “You’ll get the most bang for your buck doing that with mutual funds or an exchange traded fund.“

For wealthier investors who are charitably inclined, Mingone recommends doing a direct rollover to a charity. The tax provision would allow you to avoid paying taxes on your RMD by moving it directly from your IRA to a charity. The tax provision expired last year but Congress has extended the rule through 2014 and President Obama is expected to sign it.

You can also gift the money. Putting it into a 529 plan for your grandchildren’s education allows it to grow tax free for many years. Another option is to establish an irrevocable life insurance trust and use the money to pay the premiums. With such a trust, the insurance proceeds won’t be considered part of your estate so your heirs don’t pay taxes on it. “It’s a tax-free, efficient way to leave more to your family,” Mingone says.

Stay away from immediate annuities though. “It’s not that I don’t believe in them, but when you’re already into your 70s, the risk you’ll outlive your capital is diminished,” says Mingone. You’ll be locking in a chunk of money at today’s low interest rates and there’s a shorter period of time to collect. “It’s not a good tradeoff for guaranteed income,” says Mingone.

Beyond investing the extra cash, consider just spending it. Some retirees are reluctant to spend the money they’ve saved for retirement out of fear of running out later on. With retirements that can last 30 years or more, it’s a legitimate worry. “Believe it or not, some people have a hard time spending it down,” says Mingone. But failure to enjoy your hard-earned savings, especially while you are still young enough and in good health to use it, can be a sad outcome too.

If you’ve met all your other financial goals, have some fun. “There’s something to be said for knocking things off the bucket list and enjoying spending your money,” says Mingone.

Update: This story was changed to reflect the Senate passing a bill to extend the IRS rule allowing the direct rollover of an IRA’s required minimum distribution to a charity through 2014.

Do you have a personal finance question for our experts? Write to AskTheExpert@moneymail.com

Read next: How Your Earnings Record Affects Your Social Security

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