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

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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 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

MONEY exchange-traded funds

Why Index Funds Are Like Cheap TVs at Walmart

"Why are you window shopping?" Sale inside sign on store window
jaminwell—Getty Images

You can get a great deal on exchange-traded funds tracking large stock indexes. But watch out for the extra spending that can pile up.

Every industry has its loss leaders, and the investment world is no different. The theory is that you will go to the store for the $12 turkey and stick around to buy dressing, cranberries, juice, pies and two kinds of potatoes.

In the investment world, the role of the cheap turkey is played by broad stock index exchange traded funds. While investment firms say they make money on even low-fee funds, their profit margins on these products have been narrowing.

There’s been a bidding war among issuers of exchange traded funds that mimic large stock indexes like the Standard & Poor’s 500 or the Wilshire 5000 stock index. Companies including Blackrock, Vanguard, and Charles Schwab have been competing to offer investors the lowest cost shares possible on these products. Right now, Schwab — which will begin offering pre-mixed portfolios of ultra-low-cost ETFs early in 2015 — is winning.

Their theory? You’ll come in the door for the index ETF and stay for the more expensive funds, the alternative investments, the retirement advice.

“We believe we will keep that client for a long time,” said John Sturiale, senior vice president of product management for Charles Schwab Investment Management.

Investors, of course, are free to come in and buy the cheap TV and nothing more. Here are some points to consider if you want to squeeze the most out of low-cost exchange traded funds.

A few points don’t matter, but a lot of points do.

“Over the long term, cost is one of the biggest determinants of portfolio performance,” said Michael Rawson, a Morningstar analyst.

If you have a TD Ameritrade brokerage account, you can buy the Vanguard Total Stock Market Index Fund ETF for no cost beyond annual expenses of 0.05% of your assets in the fund. At Schwab, you can buy the Schwab U.S. Broad Market ETF for an annual expense of 0.04%. That 0.01 percentage point difference is negligible.

But compare that low-cost index fund with an actively managed fund carrying 1.3% in expenses. Invest $50,000 at the long-term stock market average return of 10% and you’ll end up with $859,477 after 30 years of having that 0.05% deducted annually. Pay 1.3% a year in expenses instead (not unusual for a high-profile actively managed mutual fund) and you’ll end up with $589,203. You’ll have given up $270,274 in fees, according to calculations performed at Buyupside.com.

Don’t pay for advice you don’t need.

The latest trend in investment advice is to charge clients roughly 1% of all of their assets to come up with a broad and diversified portfolio — with index funds at their core. Why not just buy your own core of index funds and exchange traded funds directly, and then get advice on the trickier parts of your portfolio? Or pay an adviser a onetime fee to develop a mostly index portfolio that you can buy on your own?

You won’t give up performance.

High-priced actively managed large stock funds as a group do not typically beat their indexes over time. Even those star managers who do outperform almost never do so year after year after year.

Build a broad portfolio.

Not every category of investment lends itself to low-cost indexing. You may do better with a seasoned stock picker if you’re taking aim at small-growth stocks, for example. But you can make the core of your plan a diversified and cheap portfolio of ETFs at any of the aforementioned companies, and save your fees for those extras that will really add value — the gravy, if you will.

MONEY

Schwab’s Pitch to Millennials: Talk to (Robot) Chuck

Charles Schwab Corp. courts young investors with low-cost online financial advice.

Charles Schwab Corp. became an icon of the 1980s and ’90s bull market by helping individual investors make cheap stock trades.

Schwab made a smart bet that people were willing to research and pick stocks without the advice of a broker, if only they were given the technology (first just the telephone, and later online) to do it for themselves. But the new generation of investors is already comfortable with technology—what they’re increasingly wary of is picking stocks.

Enter the so-called “robo-advisers,” investment firms that rely on computer algorithms to help investors pick a slate of mutual or exchange-traded funds, typically for a lower cost than traditional advisers. Companies like Betterment and Wealthfront have gained thousands of clients and millions in start-up money, hoping that they might become, essentially, the Schwab of the millennial generation.

Not surprisingly, the actual Charles Schwab wants a piece of the action too.

On Monday the San Francisco discount brokerage unveiled its plan for a product called “Schwab Intelligent Porfolios,” which will launch in the first quarter of 2015.

Schwab isn’t the only investment incumbent to try to jump on this trend. Vanguard has been running a pilot version of a program that takes a similar approach. Fidelity recently announced a venture with Betterment, one of the new upstart firms.

All the new web-driven advice services take for granted that many investors—already used to banking online, shopping on Amazon and sharing personal details on Facebook—will be willing to interact with a financial adviser only online or over the phone. In some cases, the services do away with the flesh-and-blood advisers altogether. Instead, a computer model creates a portfolio of stock and bond funds after a customers fill out an online questionnaire about their goals and risk tolerance. Just as with books and music, putting money advice online has been pushing costs down. Working with a traditional financial adviser, you might pay 1% or more assets per years in fees. Advisers like Wealthfront and Betterment charge less than 0.5%.

The new services also tend to be available to a wider group on investors, with minimum portfolios of $25,000 or less. Many traditional advisers look won’t work with clients unless they have at least ten times that amount.

How does Schwab’s planned new service compare the upstarts? The details about Intelligent Portfolios are still a bit thin. Schwab describes the service as offering “technology-driven automated portfolios” but also says “live help from investment professionals” is available. Schwab is being aggressive on cost: It will not levy any asset-based fee at all, and will require as little as $5,000 to invest. Schwab says it will make money when Schwab’s own exchange-traded funds are included as investment recommendations, and from portfolios’ cash holdings which will be in Schwab bank products. Without knowing which ETFs Schwab ends up recommending, it’s difficult to get a sense of the total amount investors will pay. (Some Schwab ETFs are very low-cost, however.)

What is clear is that the new services have changed the game, pushing companies to get the sticker price for basic advice down as low as possible. For example, an older Schwab investment program, it’s ETF “managed portfolio,” allows investors to talk to advisers over the phone and in branches. It charges investors up to 0.9% of their assets a year.

MONEY 529 plans

Why the Best College Savings Plans Are Getting Better

stack of money under 5-2-9 number blocks
Jan Cobb Photography Ltd—Getty Images

Low-cost 529 college savings plans continue to rise to the top in Morningstar's latest ratings.

Competition is creating ever-better investment options for parents who want to save for their kids’ college costs through tax-preferred 529 college savings plans, according to Morningstar’s annual ratings of the 64 largest college savings plans.

In a report released today, the firm gave gold stars to 529 plans featuring funds managed by T. Rowe Price and Vanguard. The Nevada 529 plan, for example, which offers Vanguard’s low-cost index funds, has long been one of Morningstar’s top-rated college savings options. The plan became even more attractive this year when it cut the fees it charges investors from 0.21% of assets to 0.19%, says Morningstar senior analyst Kathryn Spica.

“In general, the industry is improving” its offerings to investors, Spica adds.

You can invest in any state’s 529. In many states, however, you qualify for special tax breaks by investing in your home-state 529 plan. If you don’t, you should shop nationally, paying attention to fees and investment choices.

Morningstar raised Virginia’s inVEST plan, which offers investment options from Vanguard, American Funds and Aberdeen, from bronze to silver ratings, in part because Virginia cut its fees from 0.20% to 0.15% early this year.

Virginia’s CollegeAmerica plan continued as Morningstar’s top-rated option for those who pay a commission to buy a 529 plan through an adviser. American Funds, which manages the plan, announced in June it would waive some fees, such as set-up charges.

But there are exceptions. Morningstar downgraded two plans—South Dakota’s CollegeAccess 529 and Arizona’s Ivy Funds InvestEd 529 Plan—to “negative” because of South Dakota’s high fees and problems with Arizona’s fund managers.

Rhode Island’s two college savings plans moved off the negative list this year after the state started offering a new investment option based on Morningstar’s recommended portfolio of low-cost index funds. Given the potential conflict of interest, Morningstar did not rate the plans in 2014.

Joseph Hurley, founder of Savingforcollege.com, which also rates 529 plans, says he hasn’t analyzed the Morningstar-modeled funds because they are new and don’t have enough of a track record. But, he adds, the Rhode Island direct-sold 529 plan offers several low-cost index fund options.

Here are Morningstar’s top-rated 529 plans for 2014:

State Fund company Investment method Expenses (% of assets) for moderate age-based portfolio (ages 7 to 12) Five-year annualized return for moderate age-based portfolio (ages 7 to 12)
Alaska T. Rowe Price Active 0.88% 11.25%
Maryland T. Rowe Price Active 0.88% 11.42%
Nevada Vanguard Passive 0.19% 8.65%
Utah Vanguard Passive 0.22% 8.01%

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