MONEY Savings

Vanguard Founder Jack Bogle’s Surprising Retirement Advice

The one thing you absolutely, without question, unavoidably, simply must not do while saving for retirement.

Don’t you dare open that monthly statement you get about your retirement account, says Jack Bogle, founder of the mutual fund giant Vanguard, which now has about $3 trillion of assets under management. “You’re gonna get a statement every month,” says Bogle. “Don’t open it. Never open it. Don’t peek.” Wait until you actually get to your retirement, then you can open your statement (although, Bogle jokes, you may want to have a cardiologist on hand). Not knowing how much you have growing in a retirement account makes you less likely to want to raid it when your kids go to college or when you want to buy that shiny new car. It also makes you less likely to trade in and out of the market, which can be a fool’s errand.

You Might Also Like:

Jack Bogle Explains What Your Investment Adviser Should Do

Jack Bogle Explains How the Index Fund Won With Investors

MONEY ETFs

The Smartest Investors Are Buying These 3 ETFs Right Now

104501049
Hiroshi Watanabe—Getty Images

With more than 1,400 exchange-traded funds available, it's easy to be confused by the growing number of choices.

Part stock-like, part-mutual-fund-like, exchange-traded funds have been exploding in popularity over the past two decades. The Investment Company Institute estimates that, as of the end of 2014, there were 1,411 index-based and actively managed ETFs based in the United States. It’s not surprising, then, that many people can get confused, wondering which ETFs they should consider for their portfolios. Today, we offer three ETFs that smart investors are buying.

Selena Maranjian: When I was a less smart investor, I would easily get my head turned by some fund that had a spectacular year, sometimes investing in it only to get burned — because spectacular years are often outliers. I’d also get excited about some latest thing, such as nanotechnology, not appreciating that many of these latest things can take decades to grow in earnest. Now that I’m a smarter investor, I have more respect and appreciation for simpler investments, such as inexpensive, broad-market index funds — mainly because they’re easy and tend to outperform actively managed funds.

A solid ETF in that category is the Vanguard Total World Stock ETF VANGUARD TOTAL WORLD STOCK ETF VT -0.13% . Whereas an index fund based on the S&P 500 will expose you to about 80% of the U.S. stock market’s value, and the Vanguard Total Stock Market ETF, another worthwhile contender, will track the entire U.S. stock market, the Total World Stock gives you even more — most of the whole world’s market!

Read next: What’s the Difference Between an Index Fund, an ETF, and a Mutual Fund?

The U.S. does have a massive, powerful, and growing economy, and you can do well just investing domestically, but it’s smart to add some foreign holdings to your portfolio, too, for diversification and to capture the rapid ascent of emerging markets. The Vanguard Total World Stock ETF offers stocks from Europe (recently 22% of total assets), the Pacific (14%), and beyond, including emerging markets (9%). It gives you much of the American market as well, with North America representing 55% of assets. Indeed, as of June 30, nine of the top 10 holdings were U.S-based.

Its expense ratio (the annual fee) is a paltry 0.17%, and it offers a respectable 2.3% dividend yield. If you’re a long-term investor who can handle a little volatility and who would like a simple way to invest in the world at rock-bottom rates while earning dividend income, check out this ETF.

Jason Hall: There’s a lot of evidence that the best way to maximize your returns with ETFs and mutual funds is to avoid actively managed ones and keep fees as low as possible.

This approach has made index funds that follow a major benchmark such as the S&P 500 very popular. Of course, if you’re trying to outperform the market, you’ll never do that if you just invest in a fund that tracks the benchmark you want to beat.

Then why not invest in a fund that follows a benchmark that has historically outperformed the S&P 500? One worth taking a closer look at is the Vanguard Growth ETF VANGUARD INDEX FDS GROWTH VIPERS VUG -0.24% , which tracks the CRSP US Large Cap Growth Index. This ETF has handily outperformed both the S&P 500 and the Vanguard S&P 500 Admiral Shares that have tracked it since 2004, when the Growth ETF was created:

Why is that the case? In short, the S&P 500 consists of America’s 500 largest publicly traded companies, plenty of which have limited (or no) real growth prospects. The CRSP U.S. Large Cap Growth Index, on the other hand, is specifically made up of large companies that meet certain growth criteria.

With an expense ratio of 0.09%, the Vanguard Growth ETF is a great way to invest in a low-cost, passive fund that has historically outperformed the S&P 500.

Dan Caplinger: One unusual favorite among savvy ETF investors in recent years has been the VelocityShares Daily Inverse VIX Short-Term ETN VELOCITYSHARES DAILY INVERSE VIX SHORT TERM ETN XIV -1% . Even its name is a mouthful, but this ETN (short for exchange-traded note) is designed to have its shares rise in value when volatility levels in the market decline. Given the relatively favorable bull market environment we’ve had for years now, the inverse-volatility ETN has produced huge returns in its short existence, with average annual gains of more than 55% over the past three years.

The reason this ETN has been so effective is that investors have expected volatility to rise but have been thwarted in that expectation. Because the inverse-volatility ETN uses futures contracts to gain exposure to the volatility market, it has profited from certain conditions in the futures markets that have essentially given the fund an incremental bump in its return every month.

Going forward, some analysts believe that the inverse-volatility ETN has already seen its biggest gains, because traders have discounted the potential for a market reversal and therefore are putting an end to the conditions that support its price for so long. Moreover, this investment is quite risky, as it can lose major portions of its value over the span of just a few days when markets hit turbulence. Still, the inverse-volatility ETN has had years of success, rewarding those who calmly assessed the potential for major downward moves in the market.

You Might Also Like:

Jack Bogle Explains How the Index Fund Won With Investors

Here’s the Best Way to Invest a Roth IRA in Your 20s

Can You Beat the Vanguard 500 Index Fund?

More From Motley Fool:

MONEY stocks

Jack Bogle Explains How the Index Fund Won With Investors

A Q&A with Vanguard Group founder Jack Bogle, the creator of the first retail index fund.

Mutual fund managers who pick stocks haven’t had much to show for their efforts (or their fees) in recent years. An investor would likely have made more money over the past decade by picking a low-cost index fund that mirrors the market as a whole. In 1976, John C. Bogle launched the first such fund for retail investors, Vanguard 500. This edited interview originally appeared in the August 2015 issue of MONEY magazine.

Q: Has the index fund won?
A: It certainly has. Vanguard has the largest share of fund assets—almost 20%—in the industry. Two-thirds of that is index funds.

But index funds had a fabulous year last year. [Vanguard’s flagship Total Stock Market Index Fund earned 12.4%, vs. an average of 7.8% for domestic stock funds.] It’s not going to happen again, maybe ever, so basically we got overly praised. You shouldn’t buy an index fund because you think it’s a hot performer. Buy it because you’re going to hold it forever.

Screen Shot 2015-07-24 at 3.15.30 PM

 

Look, all I did with the index fund was make sure you got your fair share of the market’s return. Sometimes that fair share is going to be bad, so you’re going to lose money. And that’s a great marketing message—candor as a marketing strategy. And it’s paid off. People hawking a particular fund have no idea how long it will continue to do well. They’ll say, “Our fund went up 500% in the last 10 years, and the index fund only went up 320%, so indexes are overrated.” That’s usually the end for that fund.

Q: Vanguard’s no longer the only big player in indexing. What’s the difference between buying a Vanguard fund and an index-based exchange-traded fund from, say, iShares?
A: The ETF is a different breed of cat. There are really two ETF businesses. One is huge and involves enormous amounts of trading. Then there’s the much smaller market of individual investors who aren’t trading all day long. They could just as easily be in the traditional mutual fund. [Vanguard sells its index funds in both ETF and traditional form.]

Q: So ETFs have short-term money in them. What’s wrong with that?
A: Investors will lose. It used to be you could get your money out of a fund at the close of a business day. Now you can trade in and out of the S&P 500 all day in real time. Don’t ask me what kind of a nut would want to do that. It works against investors because if you have a big collapse in the market, and you get out at noon, the odds are pretty good the market will be up by the close. In the long run, trading is just a big distraction. Warren Buffett believes this. He said that 90% of the trust he’s leaving to his wife should go in the Vanguard 500 Index Fund.

Q: If he’d asked, would you have suggested the more diverse Vanguard Total Stock Market Fund instead?
A: Yeah! I wrote him about that. I didn’t hear back from him. An even more interesting question is why he doesn’t use international. Everybody’s talking about how you have to have international, but I don’t know why.

Q: Why not? More than half of the stocks you could buy, by market capitalization, are outside the U.S.
A: In the long run, market returns are created by business returns. And I think American business and the American economy are going to be the strongest in the world. I think we have more innovation. I think we have better technology. And I know we have a better legal structure, better shareholder protections. Some foreign nations are fine, but not all.

I’ve said if you want to hold non-U.S. stocks, go to 20%. Now people are saying 40%. You know, if you go from 20% to 40%, and foreign stocks out-perform by two percentage points per year—which would be astonishing—that’s a 0.40 percentage point benefit. So my own view is it’s not worth it.

Q: What about the benefits of diversification or the idea that going abroad can lower overall risk because markets aren’t correlated?
A: Diversification is certainly true, but noncorrelation is bunk. It’s applying higher mathematics to something I don’t think requires it. We’ve overanalyzed the whole thing. I’m always the apostle of simplicity and lower costs.

Q: Since 2000, fees charged by mutual funds have been coming down. Have you won that argument too?
A: Forty or so of the 50 largest fund groups are owned by publicly traded companies. They are in business to earn a return on capital for that company’s investors, and that’s the great conflict. They become great big marketing companies. They hold the line on fees, conceding only where they have to or for PR purposes. The cost structure of the industry is insane—50% profit margins are not unknown.

Q: You set up Vanguard so that it’s owned by its own funds, which in turn are owned by fund investors. It seems to me that idea is as important to you as indexing.
A: The conflict of interest in the industry isn’t about indexing vs. active management. It’s cost. The point of the Vanguard structure is to eliminate the management company’s profit. Compare what investors pay at Vanguard to what they pay at a competitor, and we’re saving shareholders a total of $14 billion a year.

Q: What’s that mean, to cut out the profit? Vanguard keeps costs low, but people must certainly be making financial services industry salaries.
A: I never said we have low costs. I’ve said we have low expense ratios. That’s very different. If you multiply Vanguard’s average 0.14% expense ratio by its $3 trillion in assets, that’s total expenses of about $4 billion. Go back to when we had about $1 trillion in assets, charging 0.21%—that’s about $2 billion. So Vanguard’s costs have gone from $2 billion to $4 billion. When you have 20 million shareholder accounts, it costs money. When you’re employing 15,000 people all over the world, it costs money. We don’t disclose executive compensation anymore, which I think is a little strange. [Bogle stepped down as Vanguard’s senior chairman in 1999.] I designed the best company that I could design. But there are ways to make it better.

Q: What are some things you would have done differently?
A: I would have made it mandatory that we continue to disclose executive compensation. And maybe make the company’s financial statements more broadly available. I think openness is important if you’re a company like Vanguard because these people own not only your funds but the management company too. They’re entitled to any information they want. If it’s painful to disclose, well, that’s too bad.

Q: Okay, index funds win, but I still have to decide how much to invest in stocks. Should I worry that stock prices look high?
A: For most investors, if you’re around the norm of 60% stocks and 40% bonds, I wouldn’t vary it much now. But based on today’s low stock dividend yields and bond yields, be prepared for a period of low returns compared to history.

Q: So then why bother with stocks?
A; Well, put your money in a money-market account, and you get 0.1%. You have to invest, but you can’t control the returns. And you should know that if you do stretch for higher returns, you’ll be taking on extra risk.

Q: One critic of indexing, money manager David Winters, says that because index funds own a stock no matter what, corporate boards have no incentive to rein in executive pay.
A: He just doesn’t know what he’s talking about. There is, as far as I can tell, no difference between the corporate governance activity of actively managed funds and index funds. They’re both very low. But think through the logic of it: The old Wall Street rule was, if you don’t like the management, sell the stock. In the case of an index fund, the rule has to be, if you don’t like the management, fix the management, because you can’t sell the stock. So I look at indexing as the great hope of governance.

Q: You’re concerned that the financial sector is too big. Why?
A; The job of finance is to provide capital to companies. We do it to the tune of $250 billion a year in IPOs and secondary offerings. What else do we do? We encourage investors to trade about $32 trillion a year. So the way I calculate it, 99% of what we do in this industry is people trading with one another, with a gain only to the middleman. It’s a waste of resources.

Q: What keeps you at this? Why are you sitting here talking to me instead of, I don’t know, looking at paintings in Venice?A: It’s a little bit that you carve out, probably inadvertently, the kind of person you are. And people expect you to be that kind of a person. Those kinds of expectations—Adam Smith called them “the invisible spectator”—shape what you do. And I guess I am just the type that likes to keep moving. I can’t imagine starting a day not knowing what I’m going to do.

Read next: Vanguard’s Founder Explains What Your Investment Adviser Should Do

MONEY financial advice

Vanguard’s Founder Explains What Your Investment Adviser Should Do

Jack Bogle, founder of the mutual fund giant, shares what makes an investment adviser worth paying for.

The life of a financial adviser can be very tricky. Many of them believe that leaving a client’s investments alone is the best option, but when, year after year, clients come in asking what the best course of action is for their money, what do you tell them? Jack Bogle, who 40 years ago founded the mutual fund giant Vanguard (it now has about $3 trillion of assets under management), explains exactly what a financial adviser should do and what a financial adviser should say.

Read next: Jack Bogle Explains How the Index Fund Won With Investors

MONEY mutual funds

Can You Beat the Vanguard 500 Index Fund?

John C. Bogle, founder of Vanguard and president of its Bogle Financial Markets Research Center, in his office at Vanguard’s headquarters in Malvern, Pennsylvania, Jan. 25, 2012.
Jessica Kourkounis—The New York Times/Redux Pictures John C. Bogle, founder of Vanguard and president of its Bogle Financial Markets Research Center, in his office at Vanguard’s headquarters in Malvern, Pennsylvania, Jan. 25, 2012.

It's the epitome of the low-cost mutual fund.

One of the simplest ways to invest, and get close to market-level returns, is with low-cost index funds. Of these kinds of funds, the Vanguard 500 Index Fund, which tracks the S&P 500, is one of the best-known and one of the largest, trailing only the Vanguard Total Stock Market Index Fund in total assets.

In short, lots of people have decided, since they can’t beat the market, they might as well be the market. Is that the right move for you? Furthermore, are there funds that follow other indices that offer better long-term potential? In short, there are other index funds — as well as individual stocks — that may be better-returning alternatives, but there’s still a lot to like about the Vanguard 500 Index Fund.

Let’s take a closer look at the fund itself (and the three share classes), as well as those alternatives.

Returns depend on which shares you own
Vanguard has long been the stalwart in low-cost index investing, since it was first started by Jack Bogle in the 1970s, and the Vanguard 500 Index Fund was the first of its kind. And while it remains one of the lowest-cost funds, it’s important to understand that there are actually three share classes within the fund, and depending on which shares you own, your returns will differ slightly:

Screen Shot 2015-07-23 at 2.07.07 PM

On the surface it looks like the ETF is a no-brainer, right? The best answer is, “it depends” because it varies by how much you’ll be able to invest up front, if the share class is even available to you (Admiral class shares aren’t typically available in most brokerage accounts), and how often you plan to reinvest new money, due to the impact of trading fees, especially for the ETF (which is traded on a stock exchange).

Here’s a look at how the expense ratio — which is the annual cost Vanguard charges to run the fund — alone has affected returns:

Screen Shot 2015-07-23 at 2.05.10 PM

Since just after launching the ETF shares, you can see that the difference in the expense ratio has affected total returns, while the ETF shares have also been affected by the more volatile nature of its trading on a stock index. Over a longer period of time, this would likely normalize, since it has the same intrinsic value as the other share types.

Which share class is best?
It’s largely a product of how much you have to invest, where you are investing it — i.e. 401(k) through your employer, a personal account with a discount broker, or directly with Vanguard — and how much/how often you will invest new money.

For example, a fund balance of below $10,000 in either mutual fund share class will cost a $20 per year service fee, while there’s no such fee for ETF shares. But you’ll be subject your broker’s commission rate if you buy ETF shares. As to the mutual fund shares, your broker may or may not even offer them for sale, limiting your options. The Admiral shares, as an example, are typically only available either directly through Vanguard, or through a Vanguard-managed relationship with your employer.

If you’re planning to invest less than $10,000, that $20 annual fee makes the “effective” expense ratio much higher, so if you’re not going to be able to get above that threshold, the ETF might be cheaper, unless you’re planning to invest new money regularly. If you are, then trading commissions would end up costing a lot more than $20 per year. In short, if you have the $3,000 minimum to invest and plan to add more on a regular basis, the investor shares are probably the best bet. If you will start with less, or buy new shares only occasionally, the ETF shares would be cheapest as long as your trading fees don’t break $20 per year.

Basically, figure out which share class will result in the least cost in fees and expenses based on how much you’ll invest, and invest in that class.

Make it part of a diverse portfolio
Even though the Vanguard 500 Index Fund is already diversified with exposure to the 500 largest U.S. public companies, you will improve your chances of the best long-term returns by not putting all of your eggs in this one basket of stocks.

It’s worth considering also investing in funds, like the iShares Russell 1000 Growth Index ETF ISHARES TRUST RUSSELL 1000 GROWTH ETF CLP IWF -0.18% , adding exposure to more small companies, or the Vanguard Growth ETF VANGUARD INDEX FDS GROWTH VIPERS VUG -0.24% , (also available in mutual fund classes like the 500 Index Fund) which tracks the CRSP Large-Cap Growth Index — a collection of almost 400 more growth-oriented businesses than the S&P 500. Over the past several years, both of these funds have outperformed the 500 Index Fund, and there’s a lot of evidence that exposure to more companies with growth potential, versus just the S&P 500 components, can improve long-term returns.

Furthermore, there’s nothing wrong with investing a portion of your portfolio in index funds like these, while still investing in individual stocks. It will guarantee that you get market-level returns with at least a portion of your portfolio, while also trying to beat the market on your own. It’s hard to beat the market — most investors won’t. But it’s not impossible.

Either way, the Vanguard 500 Index Fund, after 40 years, remains one of the cheapest ways for the average investor to get market-level returns. If you’re looking for a low-cost, simple way to track the market’s returns, you could do worse.

More From Motley Fool:

MONEY financial advice

How Vanguard Founder Jack Bogle Invests His Grandchildren’s Money

Ahead of Father's Day, Bogle also talks about the investment advice he gives—or doesn't give—his children.

Just a few days before Father’s Day 2015, MONEY assistant managing editor Pat Regnier interviewed John C. “Jack” Bogle, the founder and former CEO of Vanguard, the world’s largest mutual fund company. The elder statesman of the mutual fund industry—and a pioneer in index investing—talked about the investing advice he gives his children, one of whom runs a hedge fund, along with how he invests, and doesn’t invest, on behalf of his grandchildren. Look for an in-depth interview with Bogle in an upcoming issue of MONEY.

Read next: Where are Most of the World’s Millionaires?

MONEY retirement savings

Women Are Better Retirement Savers Than Men, but Still Have a Lot Less Money

woman's coin purse and men's billfold
iStock; Getty Images

It's all about the difference in wages.

Income inequality doesn’t end when you quit working. A report out Tuesday finds that women lag far behind men in retirement savings, even though women save at higher rates and take fewer risks with their investments.

According to Vanguard’s How America Saves report, women are more likely than men to be in a 401(k) plan: 73% of women vs. 66% of men. The difference is even larger at higher income levels. Last year, 81% of women earning $50,000 to $75,000 a year participated in their 401(k) vs. 62% of men. Among people earning $75,000 to $100,000, 86% of women put away money in a 401(k) vs. 70% of men.

Women also save at higher rates than men: Women put away 7% to 16% more of their income than men. And women are less likely to engage in risky investment behavior, such as frequent trading.

Despite those good habits, women are significantly behind men in the amount they have put away. Men have average account balances that are 50% higher than women’s. The average account balance for a man last year: $123, 262, compared with $79,572 for women.

“Women are better savers, but the difference in account balances comes down to the difference in wages,” says Jean Young, senior research analyst at the Vanguard Center for Retirement Research and the lead author on the report. “It’s not surprising. Women typically earn less than men do.”

Still, Young says, the Vanguard report revealed a lot of positive trends among retirement savers.

Among the findings:

  • More people are enrolled in 401(k)s. One-third of companies have auto-enrollment programs that automatically put new employees into 401(k)s unless they choose to opt out. That’s up from 5% a decade ago. Among large companies, 60% have auto enrollment. More companies are doing this not just for new hires but about 50% of plans with auto enrollment are also “sweeping” existing employees into plans during open enrollment, with a choice to opt out. Auto-enrollment has been criticized for enrolling people at very conservative deferral rates, typically 3%. That’s changing slowly: 70% of companies that have auto enrollment also automatically increase contributions annually, typically 1% a year. And, while 49% of plans default people to a 3% deferral rate, 39% default to 4% or more vs. 28% in 2010.
  • More retirement savers are leaving it to professionals. Thanks to the rise in target date funds and automatic enrollment (which typically defaults people to target date funds), 45% of people in Vanguard plans have professionally managed accounts vs. 25% in 2009. The number of people in such accounts is expected to surpass 50% this year, and that’s a good thing, says Young. According to Vanguard, people in professional managed accounts have more diversified portfolios than those who make their own investment decisions.“A professional helps you find the appropriate asset allocation, rebalance, and adjust the portfolio to your life stage,” says Young.
  • The bull market continues to deliver. The median total one-year return for people in Vanguard 401(k) plans was 7.2% in 2014. Over the past five years, 401(k) participants returns averaged 9.9% a year.
  • Few people max out. Only 10% of 401(k) participants saved the maximum $17,500 allowed in 2014. But the number rises with higher earners: One-third of people who earn $100,000 or more a year max out.
  • Savers are doing better than you think. Most financial planners recommend putting away 12% to 15% of annual income to save enough for a comfortable retirement. While the average 401(k) deferral rate is just 6.9%, combined with employer contributions, it’s 10.4%, close to that mark.

That doesn’t mean that most people are all set for retirement. Vanguard reports little change in account balances: The average 401(k) balance is $102,682, while the median is $29,603. The typical working household nearing retirement with a 401(k) and an IRA has a median $111,000 combined, which would yield less than $400 a month in retirement, according to a recent report by the Boston College’s Center for Retirement Research. But those who have access to a 401(k) and contribute regularly are in much better shape, regardless of whether you are a man or a woman.

MONEY financial advice

CEO of World’s Largest Mutual Fund 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.

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