Reuters Money

Zap zombie funds within your portfolio

Do you have zombie index funds within your portfolio?

Instead of eating up your brains, they devour your nest egg with high expenses and walking dead performance. They may be lurking within your 401(k)-type plan or individual retirement account.

I like index funds because they generally can track nearly any kind of asset class. As such, they are the white bread of investing and should cost about the same from fund to fund. The cheaper the better. Why pay Nieman-Marcus prices for the same thing you can get at Costco or Sam’s Club for less?

You can vanquish these funds without overtly violent acts, but first you have to identify them. Unfortunately, mandated fee disclosure is still pending, so you have to take the initiative.

So how do you identify a zombie fund? First you need a reliable benchmark for comparison purposes. The easiest way is to look at the index that the fund is supposed to be tracking. A good proxy for the U.S. bond market, for example, is the Barclays Capital Aggregate Bond Index. It’s a basket of listed bonds. If a fund tracks the index return within 0.20 percentage points or less, then that’s pretty good and not expensive.

A low-cost bond index fund would look like the Fidelity Spartan Intermediate Term Bond Index investor class fund, with a 0.20 percent expense ratio. You’d need at least $10,000 to get into this fund, though.

You want to pay a manager more to get less return on bonds? The ING US Bond Index portfolio charges a hefty 0.95 percent annually, meaning it will lag the index by nearly a full percentage point every year.

What the Occupy Wall Street crowd should be saying

Are the thousands who have taken to the streets in the “Occupy Wall Street” (OWS) protests a bunch of anarchistic slackers or do they have a point?

If they’re protesting their personal financial situations or prospects for the American Dream, they have plenty to howl about, but the “99 percent” crowds could use some message management.

When I recently visited the Chicago OWS spin-off  in front of the Federal Reserve Bank, they were decrying everything from predator drones to corporations in general.  There were fewer than 100 people there, although their theme was similar to the New York demonstrations.

Instead of yelling at people ensconced behind financial district edifices, though, protesters could be making some more constructive demands. I’d like to humbly offer a few suggestions:

• Demand that big banks give ordinary citizens the same rates they receive from the Federal Reserve on loans. Borrowers can’t re-negotiate their college loans the way a big corporation or bank can, because they have access to interest rates that are nearly zero. Moreover, students can’t consolidate high-rate private loans with lower-rate federal borrowing, so the plums of high finance are out of their reach. Those who graduated from college may be staring down decades of paying off debt — an average of nearly $23,000 per student; those with professional degrees are wincing at six-figure burdens.
• Demand that Congress permit regular folks to discharge student debt in bankruptcy. It’s somewhat of a consolation that graduates can get lower payments based on sparse income or employment if they have federal loans, but they still have to repay those loans. If they file for bankruptcy, they can’t discharge those debts, which are like albatrosses. Not so with the megabanks, who not only received a multi-trillion-dollar bailout, but got the U.S. Treasury and Federal Reserve to buy their bad debt and toxic securities. There’s a solid reason why the delinquency rate for student loans is almost as high as credit cards.
• Demand that Congress pass a stimulus plan to create infrastructure, education, research and clean energy jobs instead of investing in two wars that three-quarters of the American electorate thinks are senseless. If the job market were robust, none of these protesters would have to worry. Like previous generations, they could work, pay off their debts and buy things like appliances, furniture and homes. They could afford to have children and provide them decent educations. That was the American Dream. The younger generation is not getting the job opportunities their parents or grandparents had. They are faced with average 15 percent unemployment. It’s much higher for minorities. Even if they can get a job, wages are depressed due to the recession and many are underemployed, working several jobs or are part-timers.
• Instead of targeting financial districts, focus on specific congressmen and senators blocking financial/bankruptcy reform and job creation.

Unless more people get in the face of politicians, one thing is certain: it will be continue to be a raw deal for the middle class. Now is the time for the protesters to take their demonstrations out of financial districts and into the offices of their elected representatives. All of this reminds me of when Ralph Waldo Emerson visited Henry David Thoreau in jail, who was imprisoned for not paying a poll tax. Emerson asked his friend why he was there. “Why are you not here?” Thoreau replied. Maybe we’re not quite on the streets today in spirit, but most of us were there some time ago in personal financial solidarity — whether we choose to admit it or not.

Stock bargains: 5 tips to protect against falling knives

For bargain-hunters, identifying stocks in this struggling market might seem like an easy layup. Some prominent companies are languishing in the 99-cent bin, trading at seemingly laughable price-earnings ratios.

Consider Hewlett-Packard, on offer for a current P/E of 5.7. Then there’s BP at 5.9, Capital One at 5.8, Gannett (GCI) at 4.95 and Hartford Financial at five.

In normal times, it would be a no-brainer to load up your shopping cart. But these are hardly normal times, and there can be very good reasons why companies might be trading at such low valuations. As any Bear Stearns or AIG shareholder can tell you, it’s a tricky proposition to – as the investing saying goes – “catch a falling knife”.

That’s what has investors like Michael Gleason paralyzed. Gleason, an American TV producer who lives in London, would like to put more money to work – but the panicked gyrations of the markets don’t give him any confidence. “I’ve gone on hold lately, because volatility has gotten a bit worrying,” says Gleason, 57. “Maybe it’s better to stay out then to get out.”

And there’s the dilemma of every deep-value investor: How to decide when to take that risk, and make potentially the best pick of your investing lifetime instead of the worst. Sometimes it’s a very fine line. Could embattled Societe Generale bounce back smartly, for instance, or could it go down in flames like Lehman Brothers?

“Three years ago investors started catching falling knives, and got badly bloodied,” recalls Hank Smith, chief investment officer of equities at Radnor, Pennsylvania-based Haverford Investments, which has $6.5 billion under management. “Even though they were doing all the things they were supposed to be doing, like buying on dips. But there are a few ways to avoid the falling knife, both on a macro and a stock-by-stock basis.”

The trick is to separate those stocks that are merely beaten up, from those that may be down for the count. A few key criteria to keep in mind:

Utility stocks that can plug you into yields instead of losses

After trailing the market in 2009 and 2010, utilities have emerged as its leading sector, and a number of analysts believe they are on track to maintain that position for at least the rest of 2011.

The Standard & Poor’s 500 Index fell 3 percent in the first eight months of the year, while utility shares  rose 7.3 percent. In August, the index fell nearly 6 percent, while utilities went up 1.7 percent.

Investors have been drawn to stocks of electric, gas and water utilities for a number of reasons. Dividend yields north of 4 percent look tempting when 10-year Treasury securities yield less than 2.5 percent. The stocks are less volatile than the rest of the market, and their stable earnings and other defensive characteristics stand out in a weak economic environment. The extension of the favorable 15 percent tax rate on dividends through 2012 also adds to their appeal, at least for now.

Fans include Robert W. Baird & Co. utility analyst David Parker, who noted in a recent report that, “If boring is good, and it likely is with growing global economic uncertainties, then the utility sector should not disappoint,” in the second half of 2011. Citing their resilience in a weak economic environment, Standard & Poor’s changed its portfolio allocation recommendation on utilities from “market weight” to “over weight” in late August.

But the appeal could evaporate quickly if the stock market gets bullish again and plodding stability starts looking drab again. That happened in 2009 and 2010, when utility stocks rose 21 percent over the two years, compared to a 51 percent leap for the S&P 500 Index. Rising interest rates, which would prompt income-seeking investors to abandon stocks for higher-yielding bonds, could also end the party fairly quickly.

“In a strong bullish environment, utility stocks won’t do as well as cyclical or growth stocks,” warns Tim Winter, a utility analyst with Gabelli & Co.

Beat high-frequency trading machines by not playing their game

The days of you trying to make a buck actively trading in the stock market are over.

Individuals don’t stand a chance anymore because they are largely competing against rational machines often guided by herd-like irrational forces. The robots can rule in the blink of an eye.

I’m not spouting lines from an Isaac Asimov novel, but citing reality. The machines and people who program and profit from them have won — for now.

I knew it was over for human traders when I heard that high-frequency trading firms were hooking up their data lines directly to exchange computers to gain an extra hundredth of a second in execution time.

High-speed programs are designed to move millions of shares in a fraction of a second to take advantage of small movements in securities prices. These algorithms are ideal Wall Street workers. They don’t need health insurance and you don’t have to pay them bonuses to help finance their Lamborghinis or homes in the Hamptons.

There’s no way to beat the machines, unless of course, you have a faster machine, better programs or the ability to predict the future. Your odds are better in Vegas, which never had great odds for a palooka pulling a one-armed bandit.

Who are you trading against when you take on the machines? Any entity from a boutique investment firm with a handful of “quants” — math majors who flocked to Wall Street for the big bucks — to a mega-bank or hedge fund. Some 60 percent of the volume of the New York Stock Exchange is attributed to high-speed trading, maybe more.

How much stock should older investors hold?

Jim Dundee’s business is doing well — he’s an optician and owns his own retail optical store near Tampa, Florida. But Dundee started to get nervous about the economy and stock market a couple months ago.

“Even though business has been great here, you could just tell by listening to customers. We serve a pretty savvy clientele, and they were all saying something was brewing and that stocks would take a hit.”

Dundee, who is 57, decided to reduce the exposure to stocks in his retirement portfolio. Working with his broker at Raymond James, he cut equities from 70 percent to 50 percent, with another 35 percent in cash; the remainder is in bonds and gold. He hopes to be “semi-retired” by 62 by scaling back time spent on his business. “I’m asking myself, how little risk can I get away with?”

Dundee is hardly alone. The percentage of U.S. households willing to take “above-average or substantial risk” to meet their financial goals has plunged among all groups according to to survey data from the Investment Company Institute (see chart, below). The decline has been sharp across all age groups, but is especially dramatic among older baby boomers.

And the market’s recent volatility has put new focus on a key question older investors have been asking themselves since the 2008 crash: what is the correct retirement portfolio equity exposure for investors close to retirement, or who already are retired?

Ask the experts, and you’ll get answers that are all over the map. The Putnam Institute recently surveyed target date funds and found that retirement date equity allocations ranged from 65 percent to just 35 percent. And Putnam’s own experts concluded that retirees should have no more than 25 percent of their money in stocks.

Meanwhile, T. Rowe Price advises retirees at age 65 to keep 55 percent of their money in equities, 35 percent in bonds and 10 percent in cash.

Tempted to bail on stocks? Learn this lesson from 2008 data

Past performance is no guarantee of future results, as the saying goes. But a new Fidelity Investments analysis of what’s happened to retirement investors’ portfolios since the 2008-2009 market crash is worth considering if you’re tempted to pull money off the table during the market’s current volatility.

The big message: Investors who held on tight through the harrowing 2008-2009 crash have been richly rewarded since then.

Fidelity looked at the performance of 7.1 million 401(k) accounts, comparing returns for investors who made changes to their portfolios during the 2008-2009 market crash up through June 30th this year — a point when the market was on an upswing preceding the steep drops and volatility that began in late July.

The key findings:

• Participants who changed their equity allocations to zero percent between Oct. 1, 2008, and Mar. 31, 2009 and stayed out of stocks through June 30th this year saw an average increase in account balance of only 2 percent.
• Participants who exited stocks but then returned to some level of equity allocation after that market decline saw average account balance increases of 25 percent.
• Investors who stuck it out with a continuous asset allocation strategy that included stocks had an average account balance increase of 50 percent.

Fidelity also looked at participants who stopped contributing to their 401(k)s during the 2008-2009 crash; they experienced an average increase in their account balances of 26 percent through the end of the second quarter, compared with 64 percent for those who kept making regular contributions.

Only a very small percentage of Fidelity’s 401(k) investors withdrew entirely from the market. Less than one percent of account holders (0.8 percent) bailed on all their equity investments during the 2008-2009 crash and stayed out entirely, according to Beth McHugh, vice president of market insights at Fidelity. And among investors who had been actively contributing before the crash, only 1.4 percent stopped doing so as a result of the downturn.

Is it time to jump back into stocks?

Should I stay or should I go?

This compelling theme, referring to stock investing and not the great Clash song, is like a little gnat buzzing in one’s ear.

The answer depends on how well you can predict the future, your gut check for risk and history. I know that’s a weaselly response, so let me explain.

I could easily make a case for buying stocks now. There are some bargains out there and thousands of companies are profitable.

If I was a gloomy Gus or just patently realistic about Euro Zone debt travails, the moribund U.S. housing market or slack economy, I would wait. How long? Until it’s safe, whatever that means. Let’s explore both points of view.

My re-entry is largely predicated on two options: 1) gradual purchases of stocks, ETFs or mutual funds over time (also known as “dollar-cost averaging”) or 2) a lump-sum, all-in buy into stocks.

On this difficult subject, I’m guided by some excellent research by Craig Israelsen, who teaches finance at Brigham Young University and designed the versatile “7Twelve Portfolio“.

Beaten down by market turmoil? The case for hedged mutual funds

The following is a guest post by Juliette Fairley. A frequent contributor to USA Today, Investor’s Business Daily, Bloomberg Wealth Manager and The New York Times, she is also the author of three personal finance and investing books. The opinions expressed are her own.

With the markets so volatile, financial advisers are screaming “diversify” from the rooftops. One small corner of the market that might attract attention in down times: hedged mutual funds.

Before the latest downturn, the hedged equity mutual fund category, which is comprised of only about 100 funds, was up 1.72 percent year-to-date. That’s less than the average equity mutual fund, of which there are about 10,000, which up 4.97 percent.

But in the tumult since the debt deal, the ratio turned to a 5.69 percent loss for hedged funds compared to a 7.83 percent loss for non-hedged funds, according to data from Lipper, a Thomson Reuters company, through Aug. 10, 2011.

That kind of split is why the hedged equity mutual fund remains a small specialty instrument in the toolbox of many financial advisers. Advisers like hedged mutual funds because they keep clients’ portfolios afloat in a down market, despite lower returns over the long-term.

“Hedged mutual funds act as a diversifier and can both reduce losses or make money. They are designed to return a small amount in any market. In balance, they are good by adding choice and selection to the client’s menu,” says John Longo, a registered investment adviser in Morristown, New Jersey.

Another advantage to hedged funds: lower fees. Traditional hedge funds, such as Paulson & Co. or Avenue Capital, charge two percent of the top 20 percent of any profit.

4 ways to hedge the market without playing whack-a-mole

Is the recent market upheaval the growling of a new, prolonged bear market or a tempest in a teapot?

It’s too soon to tell and most of us will guess wrong anyway. As Washington and global traders sort out the impact of the U.S. “Tea Party debt downgrade,” you should employ the best hedging strategies possible.

Of course, if you already have a comprehensive financial plan with an investment policy statement in place — and it’s working for you — you’re probably fine. While the ongoing market angst is troubling, you’re still on course.

The only thing that’s guaranteed is that Euro Zone debt woes, the threat of a double-dip recession and ongoing U.S. budget battles will create more short-term volatility than a tropical storm.

Here are some ways of avoiding the market turmoil:

Build a can’t-stomach-stocks portfolio There’s no shame in protecting your principal, particularly if you’re in or near retirement. The last decade was bad enough, and you shouldn’t have to suffer any more losses. If you can’t afford to lose anything, you shouldn’t be in stocks anyway. One way of dynamically measuring risks and avoiding market downturns is through tactical asset allocation.

The site MyPlanIQ provides some ways of customizing your portfolio to the kind of risk you can stomach. One simple, ultra-safe model they suggest combines just two income funds: The PIMCO Total Return fund and the Vanguard Short-Term Bond fund . About 67 percent of the plan is allocated to the PIMCO fund and 33 percent to Vanguard. While this portfolio doesn’t completely offset interest-rate risk, it’s a good place to be if stocks are tanking and there’s negligible inflation.