Stan Choe

As stocks plunge, should you overhaul your financial plan?

NEW YORK (AP) — Stocks are spiraling lower again, bonds are losing money and everything suddenly feels very shaky. Time to overhaul your financial plan, right? Financial advisers hope your answer is an emphatic “no.” Ideally, you already set up your plan with the understanding that something as common as a 10 percent tumble in stocks would occur again and again. But at the very least, the recent turmoil offers a good marker to reassess where things are, and where you want to be. Conditions have certainly changed from the smooth run of past years, when stock funds were returning double digits with few hiccups. In the last month alone, S&P 500 index funds have dropped close to 10 percent. Bond funds are supposed to be the safe part of a portfolio, but even many of them have lost ground this year. Investors are ringing the phones much more than usual at Inspired Financial, a financial-planning and investment-management firm in Huntington Beach, California. But the voices from clients aren’t in a panic, said Evelyn Zohlen, the company’s founder and the incoming president of the Financial Planning Association. “They’re pragmatic,” Zohlen said of the callers. “They’re asking if there’s anything unusual about this drop and whether they should be doing anything different.” Some things that she and other financial advisers suggest to keep in mind: This is what stocks do The stock market has offered the best long-term returns historically, but they’ve come at a price. Stocks can drop suddenly, sometimes for inexplicable reasons. Drops of 10 percent are common enough, even when the market is largely on the upswing, that Wall Street has a term for them: “corrections.” Since the summer of 2015, the S&P 500 has had three such declines, and the index is narrowly close to a fourth. The S&P 500 is down 9.9 percent since setting its record last month. That latest trigger for market turbulence was a news report on Oct. 29 that President Donald Trump may intensify the U.S. trade war with China by announcing tariffs on all its remaining imports. It sent the stock market in reverse, and the S&P 500 flipped from a gain of as much as 1.8 percent in the morning to a loss of 0.7 percent by the end of the day. The report is the latest addition to the pile of worries weighing on stocks in recent weeks, including higher interest rates and the threat of a coming slowdown in corporate profit growth. An investment mix to match your saving goals If you’re saving money for a retirement that’s 10, 20 or 30 years away, financial advisers ask that you ignore the market turmoil and remember that you’re in it for the long term. Selling stocks now would only lock in the losses. Drops like this make the stomach churn, but stocks have eventually come back from every one of their past declines to set more records. A $10,000 investment made 20 years ago in what is now the largest stock fund has turned into roughly $40,000. That span includes two of the biggest implosions for the stock market: the 2000 dot-com bubble bursting and the 2008 financial crisis. But if you’re saving to pay your kid’s tuition in the next couple years, or even to pay next month’s credit-card bill, the money should be in something far more stable than stocks. Bonds generally have steadier returns than stocks, though many have had losses this year as a result of rising interest rates. Savings accounts or bank CDs are even safer for money that will be needed in the very short term. Control what you can No one can predict for sure where stocks and bonds will go next, let alone dictate it. So try to keep costs down. It’s one of the few actions people can control on their own. Funds with low fees tend to have some of the best success rates because higher-cost funds have to perform that much better just to match their performance. Thankfully, the investment industry is in the midst of a fierce pricing war to lure customers. Fund companies have been slashing fees on mutual funds and exchange-traded funds, and Fidelity recently introduced mutual funds that have zero management expenses, for example. Some help for savers The upside of rising interest rates is that savers are finally able to earn more, if just a bit. One-year CDs offered online are paying rates that are above the rate of inflation, which was 2.3 percent last month. Some money market and savings accounts available online also are getting closer to the rate of inflation, and they allow more freedom to take out money than CDs. Borrowers beware The downside of rising rates is that debt is getting more expensive. Credit-card rates are rising, for example. Higher mortgage rates, meanwhile, are weighing on home prices, which raises worries for people who had been banking on selling their homes to pay for their retirements. Another area where Zohlen has seen some clients feel pressure is through their home equity lines of credit. “They had been basking for years in incredibly low HELOC rates and have been chipping away interest-only because they were only paying 3.5 or 3.75 percent interest,” she said. “All of a sudden, we’re looking at 5.5 or 6 percent, and we’re starting to see some pain.”

For many young investors, the stock market’s only gone up

NEW YORK (AP) — Meet the generation of investors who haven’t known a bear market. The U.S. stock market has been on the upswing for nine and a half years, during which a cohort of younger investors has never dealt with a 20 percent drop in the S&P 500 — the classic definition of a bear market. Such a decline has historically happened on average every four or five years. That’s nice for these 20- and 30-somethings, and their retirement accounts, but it raises the question: What will they do when the next downturn inevitably arrives? How they respond will be crucial because this generation bears a heavier responsibility for paying for their own retirement, as pensions go extinct and Social Security’s finances weaken. Few analysts are predicting an imminent downturn for the S&P 500, which hit a record high on Aug. 20, but they’re much less confident about 2019 or beyond due to rising interest rates and other market challenges. The fear is that inexperienced investors will panic at their first taste of a bear market and sell their stocks, which would lock in their losses. For young investors with decades to go before retirement, conventional wisdom says the best bet is to ride through and wait for a recovery. The average bear market brings a loss of nearly 40 percent for the S&P 500, but it typically lasts less than two years, according to S&P Dow Jones Indices. Many experts say today’s young investors are generally taking the right approach. For instance, many are invested in the stock market through specialized kinds of mutual funds in their 401(k) accounts called target-date retirement funds, which may keep them from making rash moves. Some younger investors also say the experience of their parents in the wrenching financial crisis of 2008-2009, when the S&P 500 lost more than half its value, has prepared them for the next downturn. They know the stock market more than made up all those losses, eventually. They’re investors like Marcus Harris, a 34-year-old physician in the Houston area who started investing about five years ago. “It’s going to sound terrible, but I’m actually looking forward to the next downturn,” he said of the opportunity to buy stocks at a lower price. “I know it’s an overbought position right now, and I’m just sitting on my hands saying, ‘I can’t wait.’ Hopefully it will go to half the price, and I can gobble up a lot of it.” He’s somewhat of an anomaly among his peers in that he owns stocks at all. Only four in 10 households led by someone under 35 owned stocks in 2016, according to the most recent data from the Federal Reserve. Stubbornly low wages and high debt are keeping many younger workers out of the stock market. Still, the ownership rate among younger households, at 41 percent, has been on the upswing and is much higher than the 23 percent rate in 1989. Since then, the only time young investors were much more likely to own stocks was around the dot-com bubble. “All the ones I know, they do want to get involved,” said Kimelah Taylor, a 36-year-old accounting adviser in Houston who began investing with a financial adviser about four and a half years ago. “There is that delay in when they get involved because they’re paying off student loans and other things.” Some younger investors may also be in the market without even realizing it. More employers are automatically enrolling their workers into 401(k) accounts, and many of those have a target-date retirement fund as the default investment. These funds automatically change over time and create a portfolio that’s appropriate for an investor’s age. When the target retirement year is decades away, they’re virtually entirely in stocks. As retirement approaches, they shed some stocks for bonds and other safer investments. Young people are much more likely to have their entire 401(k) in target-date funds than older savers, and the hope is that when the next downturn hits, young investors will continue to leave the investment decisions in their hands. “Inertia in this case is working for them,” said Jeanne Thompson, senior vice president at Fidelity Investments. “In many cases, that inertia will help when there is a market downturn, and they’ll probably leave their assets and stay the course.” In some ways, they’re more fortunate than older generations, who didn’t have target-date funds to take care of the decisions and often gave into the urge to sell stocks during a downturn. “The main reason young people are not running away from stocks is they aren’t figuring it out for themselves,” said Jean Young, senior research associate for the Vanguard Center for Investor Research. And even though younger investors haven’t faced a full-blown bear market yet, they have had a few mini-tests, with two drops of 10 percent since early 2016. Through them, younger investors made more calls than usual to T. Rowe Price, but they usually stopped short of selling their stocks, said Roger Young, senior financial planner at T. Rowe Price. If anything, market dips have only emboldened some, said Charles Adi, financial adviser at Blueprint 360 in Houston. During a tumble earlier this year, for example, he was balancing calls from older clients looking for reassurance with younger clients hungry to buy more shares of stock. “In 2008, it was unexpected,” Adi said. “Now, a downturn is expected. They’re ready for it. They’re waiting for it.” Still, there is the threat of overconfidence. Maybe young investors’ nerves won’t remain as steady as they expect. “They think they’re good fighters,” said Danny Alexander, a financial coach at Stangier Wealth Management in Portland, Oregon, which recently hosted an event for clients called “Gearing up for the next crash.” “But until they’ve been in a fight and punched in the mouth, they don’t know how they’ll respond.” Editor’s note: This story has been updated to reflect that the S&P 500 hit a record level on Aug. 20.

Best time to be an investor? Yes. Best time to invest? Meh.

NEW YORK (AP) — This may be the best time in history to be an investor. Never has it been so cheap to put money into the market, and it’s about to get even cheaper following Vanguard’s recent decision to end online commissions for most ETFs. Financial advice is easier to get, particularly for people with smaller account sizes. And advances in technology mean investors can keep tabs on their accounts simply by pulling their phones from their pockets. That increasing ease plus the strengthening job market are helping to coax more Americans into the stock market. Slightly more than half of all U.S. families own stocks in some way, the highest rate since 2007, when the Great Recession was beginning. And stocks, with their long history of providing better long-term returns than bonds and other investments, are one of the most powerful tools to help people’s savings grow. The only downside in all of this is that it didn’t happen sooner. Because while it may be a good time to be an investor, it’s not necessarily the best time to be investing. After a long run of more than nine years of gains for stocks, more voices along Wall Street are saying the good times could end in the next few years. If they’re right, it will be up to investors not to turn all these newfound advantages and trading tools into implements of destruction. Even though it’s easier —and less expensive — than ever to trade, sometimes the best thing to do when markets are falling is nothing. Barry Bannister, head of institutional equity strategy at Stifel, says the bull run that began for the S&P 500 in March 2009 may end by the first quarter of 2020. Predicted cause of death: continued interest-rate increases by the Federal Reserve. The Fed has already raised rates seven times since 2015 off their record lows, and it says two more increases may be coming this year. Higher rates have historically put the brakes on stocks and other risky investments, and Bannister says the Fed’s pace means the federal funds rate may cross a key threshold next year. With profit margins already high, Bannister says the next decade will likely have weaker returns for stocks than the previous one. “I think we’re looking at a rotating and trading market for 10 years,” Bannister said. “So the ability to move fast and be flexible is probably at a premium.” That’s good for investors who are able to take advantage of their new trading tools. Funds that cover everything from foreign bonds to low-volatility stocks to global technology companies have all been getting cheaper to own. Improved websites and lower commissions also make ETFs easier to trade. So anyone with the foresight to move from losers to winners can do so quickly and cheaply. But it’s also important to remember that many investors, for all their confidence, have a long history of selling and buying at inopportune times. When stocks are soaring, everyone’s happy to pile into the market on the expectation that more gains are to come. The biggest year for flows into stock mutual funds was in 2000, for example, according to the Investment Company Institute. That’s when the stock market hit its peak and the dot-com bubble burst. When stocks are falling, meanwhile, antsy investors sell their holdings. That may help avoid losses, but it creates a tough decision: when to get back into the market? Many investors who dumped stocks during the Great Recession missed out on the big gains that followed. That’s why investors, as a group, have largely fallen short of the returns of the funds they invest in. Consider Fidelity’s Contrafund, one of the largest mutual funds by assets. It returned 10.9 percent annually over the 10 years through June 30. But not all of its investors stayed committed to the fund through that stretch. After accounting for dollars coming in and out of the fund, Morningstar says the average investor got an 8.8 percent annual return from the fund. So, the best approach may be to take advantage of all these opportunities in a moment of calm, before markets are falling sharply, to ensure that your portfolio is set up in a way that will leave you comfortable regardless of the market’s direction. If you can’t stomach the idea of the stocks in your portfolio dropping 10 percent, consider shifting more money into bonds and other less volatile investments. Then, take comfort in knowing that this golden era of investing means you can act quickly during the next downturn, but you don’t have to.

Despite age and doubters, bull market looks to keep running

NEW YORK (AP) — Wall Street is forecasting another year of gains for stocks in 2018, even as worries rise that the end may be nearing for one of the market’s greatest runs in history. The Standard &Poor’s 500 index has nearly quadrupled since the dark days of early 2009, and this bull run of eight-plus years is well into senior-citizen status. Only the rally of 1990 to 2000 lasted longer. But analysts see several reasons this bull market isn’t ready for retirement. Chief among them: Economies around the world are growing in sync. The global gains, along with the lower tax rates that Congress just approved, should help companies pile their profits even higher. That should provide more life for the market, analysts say, because stock prices tend to follow the path of corporate profits more than anything else over the long term. Plus, interest rates are expected to remain relatively low, which can raise investor appetite for stocks. The expected gains aren’t as strong as in the past few years, however. For one thing, stocks are expensive. There are also concerns that a growing economy could eventually spark inflation. Another gain for stocks in 2018 would be the latest step into record territory for a market that’s been maligned and doubted since it emerged from the rubble of the global financial crisis. Investors have been hesitant to fully embrace stocks after watching the market lose more than half its value from late 2007 into early 2009. “No one seems complacent” about the market’s performance, said Rob Lovelace, vice chairman of the Capital Group, whose American Funds family of mutual funds invests $1.5 trillion. “Everyone seems scared as heck. We’re continuing with the pattern of this being one of the most untrusted, unloved bull markets.” Most of the predictions indicate investors shouldn’t expect returns to be as big or as smooth as they have been. “The sky is not falling, but our market outlook has dimmed,” economists and strategists at mutual-fund giant Vanguard wrote in a recent report. Over the last five years, investors have enjoyed an annualized return of more than 15 percent from S&P 500 index funds. In the coming decade, Vanguard expects annualized returns for global stocks to be closer to the 4.5 percent to 6.5 percent range, with U.S. stocks likely returning less than their foreign counterparts. For 2018, strategists at Goldman Sachs say the S&P 500 may end the year at 2,850. That would be up roughly 6 percent from its close Wednesday. Strategists at Morgan Stanley have a base target of 2,750, which would be less than a 3 percent gain. A big reason for the relatively modest forecasts is how expensive stocks have become. The market has been rising faster than corporate profits, which makes it less attractive than in years past. The S&P 500 is close to its most expensive level since the dot-com bubble was fizzling out, according to one measure popularized by Nobel prize-winning economist Robert Shiller that looks at stock prices versus corporate profits in the last decade. That’s why many investors are increasingly turning their attention abroad for stocks. Investors have poured $227 billion into foreign stock funds over the last year, six times more than they put into U.S. stock funds, according to Morningstar. Europe is earlier in its economic expansion, which could mean it has further to run. Foreign stocks, although not cheap by historical standards, are also cheaper than their U.S. counterparts. Of course, a year ago, many voices along Wall Street were warning investors to ratchet back their expectations for 2017. Instead, they got a nearly perfect year. The S&P 500 has returned about 20 percent and, perhaps more remarkably, the gains have come with virtually no headaches. Only four times this year have investors had to stomach a drop of at least 1 percent in the S&P 500. That’s way down from 22 in 2016, and it’s the fewest such days in a year since 1995. The market has had yearslong periods of calm before, so 2018 could be serene as well. But market watchers do anticipate volatility to rise a bit from its ultralow level in 2017, in part because investors’ climbing expectations for economic strength and other indicators leaves more room for disappointment. Another worry is that an old foe for markets may return. Inflation has been low for years, and many economists expect it to stay subdued. But the healthy job market is leading to some small gains for workers’ wages. If the pickup accelerates, it could drive inflation higher across the economy. “Inflation is the one risk worth highlighting to investors, mostly because we haven’t had any for so long,” said Brian Nick, chief investment strategist at Nuveen. “Central banks haven’t had to deal with higher-than-expected inflation, investors haven’t had to deal with it and companies haven’t had to make choices about keeping wages down or raising prices.” If inflation does rise, the Federal Reserve and other central banks could be forced to become more aggressive about raising rates. That, in turn, could slow the global economy and knock down stocks. What may end up being the biggest threat this year is simply that many investors are worried that this nirvana of constantly rising stocks, high prices relative to profits and perfectly calm markets is unsustainable. It’s been nearly two years since the last time the S&P 500 had a drop of 10 percent, something market watchers call a “correction.” “Everyone thinks we’re in the ninth inning,” said Capital Group’s Lovelace. “But with synchronized economic growth and the strength of many of these companies we’re seeing, I can come up with more reasons for why this is the fifth or sixth inning.”

Profits and stocks: When better than expected is barely good enough

NEW YORK (AP) — Here’s how much hope and expectation has been built into the stock market: Big companies are healthy and making fatter profits than Wall Street expected, yet it’s barely enough to keep the market from falling. Consider Home Depot, which gave an earnings report on Aug. 15 that was seemingly fantastic. The retailer made more in profit from May through July than any other quarter in its history, and its 14 percent rise in earnings per share was stronger than analysts expected. Home Depot at the same time raised its profit forecast for this year and reported higher revenue than Wall Street forecast, all of which should be kibble for investors ravenously looking for growth. Even still, Home Depot’s stock slid 2.7 percent after the report. That reaction hasn’t been too far off the norm recently, as companies have lined up to report how much they earned during the spring. Companies in the Standard &Poor’s 500 index are on pace to report one of their strongest quarters in years. Earnings per share were likely up more than 10 percent from a year earlier, better than the 7 percent that analysts had penciled in when the quarter ended, according to FactSet. Despite those gains, S&P 500 index funds are nearly exactly where they were before the heart of earnings reporting season began in mid-July. “Equity markets have greeted positive earnings reports largely with indifference,” strategists at BlackRock wrote in a recent report. “Investor sentiment shows more signs of fatigue than euphoria, even as stock markets have repeatedly reached new heights this year.” Usually, when a company reports better earnings than analysts expected, it sends the stock higher, at least for a day. Since 2006, such companies have typically done 1.14 percentage points better than the S&P 500 the day following its release, according to Goldman Sachs. But through mid-August of this reporting season, the performance edge has been virtually nil at 0.03 percentage points. That’s the lowest level in at least a decade. When a company has reported better-than-expected earnings but fallen short of forecasts for revenue, its stock has tended to do worse than the rest of the S&P 500, according to BlackRock. And when a company has missed on both measures? Much worse. At first blush, such a reaction may be surprising. Stock prices can move up and down for many reasons in the short term: whatever the president is tweeting about, what central banks in far-flung corners of the world are doing or the latest change some hedge fund has made to its trading algorithm. But over the long term, stock prices tend to track closely with corporate profits. When companies are making more money, investors are willing to pay more for each of their shares. This time may be different because stock prices had already climbed so much in anticipation of higher profits ahead. Even when profits were falling early last year, the S&P 500 index was still holding steady or rising. One of the main ways analysts use to measure whether stocks are expensive is to compare their price to corporate profits. The S&P 500 is now trading at 20.7 times how much its companies have earned over the last 12 months, according to FactSet. That’s more expensive than its median price-earnings ratio of 15.6 over the last decade. Now that strong profit growth has returned, it may be mere validation for the gains S&P 500 index funds have already made. And if corporate profits continue to rise faster than stock prices, they’ll look less expensive. With the Federal Reserve raising interest rates, many analysts expect the market’s price-earnings ratio to creep lower from its lofty heights. At the least, many are telling investors to expect the stock market to rise no faster than corporate earnings. The good news is that Wall Street is expecting profit growth to continue in the second half of this year, though maybe at a slower rate. Some of the biggest profit gains this year have been coming from companies that do lots of business overseas. That’s because, despite Washington’s push for America-first policies, companies are seeing some of the strongest growth in markets like Europe, Asia and elsewhere. In part, it’s because those market are finally accelerating out of the doldrums they’ve been stuck in for years. The sinking value of the dollar is also helping, because it makes each euro or Mexican peso of sales worth more in dollars than before. When Ecolab, a company that gets nearly half its revenue from abroad, reported its quarterly results on Aug. 1, it told analysts that global economies in general look “OK to good” and that it’s anticipating a very solid 2017. The company, which provides water, hygiene and other services, reported both earnings and revenue that topped analysts’ expectations for the quarter. Its stock fell 0.2 percent that day.

What’s next for bond investors?

NEW YORK (AP) — Everywhere bond-fund investors look, reasons to fear seem to be lurking. After decades of dropping interest rates led to strong and steady returns for bond funds, conditions seem to be massing in the opposite direction. The Federal Reserve raised short-term rates last month, the third time it’s done so since December. It’s also planning to pare the vast trove of bonds it built up to keep rates low following the financial crisis. Even words from way across the Atlantic are rattling the U.S. bond market. The European Central Bank said a couple weeks ago that it could trim stimulus efforts if that region’s economy keeps strengthening. That could send European rates higher, luring money back into European bonds and out of Treasurys. Anticipating such a shift, investors pushed Treasury prices lower over the past two weeks, helping to send the yield on the 10-year T-note up to 2.35 percent from 2.13 percent. Rick Rieder, chief investment officer of global fixed income at BlackRock, which manages $1.6 trillion in bonds, says the bond market is indeed going through a change. But he cautions investors not to get carried away. Demand for bonds has remained strong this year, and $170 billion flowed into bond funds through the first five months of this year, nearly double last year’s pace at the same point, according to the Investment Company Institute. That deep hunger for income, a result of an aging population looking to retire, should help keep the upturn for rates moderate, Rieder says. Answers have been edited for length and clarity. Q: Many voices are calling this a big inflection point for the bond market. How momentous is this right now? A: I would agree that things are changing, but I don’t think they’re momentous. Rates are going to move moderately higher. There’s a demand for income in the world driven by demographics that’s generationally historic, and whenever rates back up, you see this tremendous buying come in (which in turn lessens the upward pressure on rates). The only thing that’s different than historically is the interest-rate sensitivity of the market is higher. Small moves in rates can lead to decent-sized moves in price. Q: So many factors seem to be pushing the U.S. bond market, not just the Fed raising rates. A: Long-end interest rates are influenced more by the European Central Bank and the Bank of Japan than the Fed, ironically. When Europe takes some of the pressure off interest rates, it’s so dramatically large, it allows the long end of our interest rates to move out. Q: What about the Fed paring back its $4.5 trillion in bond investments? Will that have a bigger effect on the market than any rate increases? A: They’re starting very, very slowly. The reduction of the balance sheet, this year, is a smaller influence than a rate move. They’re talking about $10 billion a month, which relative to the size of fixed-income markets is tiny. But in the next two years, the pace is increasing at the same time that the federal borrowing level is changing. Supply and demand (for Treasurys) come much more in balance, which means rates can move higher. Q: How much higher? A: We think 2.50 percent to 2.75 percent for the 10-year Treasury this year. You can move to 3.25 percent next year. Q: Inflation has also remained low for a long time now, and it sounds like you think it can stay that way for a while, which would moderate rising rates. A: One of the reasons why this is an inflection point but not momentous is we’re witnessing something that’s truly historic. First, what drove the volatility in inflation over the last 25 to 30 years was energy and oil. We’re witnessing a greater equilibrium in oil, and OPEC doesn’t drive the price any more. There are so many other players. Second is housing prices. You go back 20 or 30 years, and the Baby Boomers were driving the environment for housing prices, and you don’t see that now. Third, technology is pressing down on inflation like nobody’s ever seen before. You saw it in the last (Consumer Price Index) report. From apparel to transportation, i.e. the Uber effect, you’re creating this unbelievable pressure on potential inflation. Inflation will go higher, but we’re going to be in this range of in and around 2 percent inflation. Q: So what can investors expect from their bond funds? Certainly not the big returns they got from earlier years. How likely are losses? A: You can still generate good fixed-income returns, but you have to do it differently than historically. In the BlackRock Strategic Income Opportunities fund, you can still do a positive 4 to 5 to 6 percent return, but you have to capture some of these emerging markets to create more balance, rather than hope the 10- or 30-year Treasury will hold at these levels.

Funds in the first quarter: Foreign markets were first

NEW YORK (AP) — Anyone with an American-only 401(k) account missed out in the first quarter. Funds that own stocks from Latin America, Asia and other foreign markets were some of the best performers during the first three months of the year. Hundreds had returns that were more than double those of the most popular U.S. stock funds, which were no slouches themselves. The largest U.S. stock fund had one of its best quarterly performances in years. It was all part of a strong start to the year for funds in general. Not only did stock funds of all types power higher, so did bond funds. Just over 93 percent of all the funds tracked by Morningstar had positive returns in the first quarter, as of March 29. Fortunately, more investors seem to have taken advantage. Money poured into stock funds in the final months of 2016, mostly focused on the U.S. market due to excitement that a Republican-led Washington would usher in business-friendly policies. Here’s a look at the trends that helped shape the quarter for mutual funds and exchange-traded funds. All of the return figures are through March 29. Foreign led the way For years, foreign stock funds did nothing but frustrate. Every peek higher would inevitably give way to another tumble, and the largest foreign-stock fund returned less than 1 percent annualized for the decade through 2016. What made the ride even more frustrating was that U.S. stocks nearly doubled over the same time, after including dividends. Even with the mediocre performance, many investors continued to buy foreign stocks, looking for ways to diversify their portfolios. Yes, U.S. stocks had been on top for a long time, but they likely couldn’t stay that way forever. And foreign stocks were looking cheaper than their U.S. counterparts by several measures, following the split in performance. That patience was rewarded in the first quarter, and Vanguard’s Total International Stock Index fund returned 9.2 percent for its best quarter in nearly four years. Returns were even bigger for the types of funds that have been the most frustrating recently: those that invest in emerging markets. The dollar’s falling value in the first quarter helped, because it meant returns denominated in South Korean won or Mexican pesos were worth more in dollars. The MSCI Emerging Markets index returned 8.8 percent in their local currencies, but 13 percent in dollar terms. Still strong in the US Foreign stock funds may have overshadowed their U.S. counterparts, but both delivered in the first quarter. The largest U.S. stock fund returned 5.6 percent, for example. That’s the second-best performance in the last three years for Vanguard’s Total Stock Market Index fund. The job market continues to improve, and optimism has been surging for shoppers and businesses. Corporate earnings, meanwhile, are on the rebound, which has helped push stock prices higher. In the background have been hopes for help from Washington, such as cuts in taxes and looser regulations for businesses. Funds that own larger stocks generally had better returns during the quarter than smaller-stock funds. Managers who focus on stocks with the fastest sales and earnings growth were also particularly strong. Transamerica’s Capital Growth fund returned 16.3 percent, for example, one of the top performances for U.S. stock funds in the quarter. Three of its five biggest investments jumped more than 20 percent during the quarter: Facebook, Illumina and Tesla. Bond funds chug along Many investors were bracing for losses from their bond funds as the calendar flipped into 2017. That’s what happened at the end of last year, after all. The average intermediate-term bond fund, which forms the core of many portfolios, lost 2.5 percent in the fourth quarter as interest rates jumped. When rates rise, prices for existing bonds fall because their interest payments are less attractive than those of newly issued bonds. And rates rose sharply late last year on expectations that the Republican sweep of the White House and Congress would lead to faster economic growth and inflation. The Federal Reserve is also back to raising interest rates, after keeping them at a record low for seven years following the 2008 financial crisis. But even after the Fed raised rates at its most recent meeting a couple weeks ago, rates actually sank. The Fed has stressed that it plans on moving gradually and modestly, perhaps even more so than many investors had been expecting. If it follows that script, bond fund managers say losses may not be inevitable. The average intermediate-term bond fund returned 1.1 percent during the first quarter. While that’s off from earlier years, when 2-percent quarterly returns would sometimes occur, it’s also far from the big losses that some investors were anticipating.

The most contrarian move in investing: Trusting a stock picker

NEW YORK (AP) — It’s perhaps the most contrarian move in investing today: Trust a stock picker. Investors have been dumping funds run by managers who try to beat the market, and they’re pouring money instead into those that track the Standard & Poor’s 500 or other indexes. Last month alone, $44 billion left actively managed stock funds, and nearly $41 billion went into comparable index funds. To understand why, have a look at the mutual fund scorecard. Index funds have generally done better than actively managed ones over the last one, five and 10 years. Among mutual funds that invest in a mix of large-cap stocks, just 15 percent of actively managed funds managed to beat index funds over the decade through June 2016, according to Morningstar. It’s not just stock pickers catering to mom-and-pop investors who are struggling. Hedge funds, which invest for the uber-wealthy and big institutions, have also been lagging behind index funds. Through July, they were on pace for a third straight year of lower returns than either an S&P 500 index fund or an investment that tracks a Barclays bond index, according to industry researcher HFR Inc. But what if you can’t stand the idea of being just average? Some investors are confident they can pick the active manager who will beat the market. Other, more skittish investors would like the comfort of having a manager who can limit losses when market indexes are tumbling. That’s why some actively managed funds are still pulling in money. American Funds, which is the second-largest fund family by assets, is unabashedly in favor of active management. It attracted a net $5 billion in investment in the first seven months of this year, though the pace has cooled recently. Even the biggest index-fund provider, Vanguard, has actively managed funds of its own, and they’ve been drawing dollars too. Two important factors can help determine whether an actively managed fund will beat the market. Number one is fees. Lower-cost actively managed funds have a better track record of success than expensive ones. It’s for the simple reason that a high-fee fund needs to perform that much better to match the returns of a low-cost fund. Index funds have some of the lowest fees available. After splitting large-cap blend funds into four categories based on their fees, Morningstar found that 19 percent of the cheapest funds beat index funds over the last decade. That may not sound like much, but it’s way better than the 8 percent success rate for the highest-cost funds. The trend carries through across different categories of mutual funds and is most pronounced at funds that invest in stocks from China, India and other developing economies. Stock pickers say these markets are particularly suited for them because they can avoid the large, state-owned companies that make up big chunks of those indexes. Another consideration is to look for active funds where managers invest alongside their own shareholders. It’s a concept called “eating your own cooking,” and managers have to disclose in filings with the Securities and Exchange Commission data about how much they’ve invested in their own funds, if they do so at all. American Funds says that stock funds with both low expenses and high manager ownership have much better track records than other actively managed funds. After looking at rolling one-year returns over the two decades through 2015, it said this select group within large-cap U.S. stock funds had average returns of 10.1 percent, a shade higher than the S&P 500’s 9.8 percent. They also beat the index 55 percent of the time. For their part, stock pickers acknowledge they’ve had a rough few years in comparison to index funds. But they say they’re anticipating better conditions ahead. In recent years, stocks have often moved up and down in unison, making it harder to pick winners and losers. That herding effect reduces the rewards for a stock picker looking to pick which, say, individual oil company looks best in the industry. Stock pickers lay the blame for this, in part, on the massive amounts of stimulus coming from the Federal Reserve and other central banks. The Fed’s next move now, though, is likely to raise rates, not lower them. If that helps break the market’s recent herd mentality, active managers say conditions may finally tilt more in their favor.  

Market fear can mean profit, but know the risks

NEW YORK (AP) — For some investments, the sound of crashing stock prices and panic in the market is actually the sweetest melody. These investments tie themselves to the VIX index, a measure that traders call the stock market’s “fear gauge,” and they’ve been in higher demand as markets have become bumpier. Investors poured more than $2 billion into volatility funds during the first half of the year, triple the amount they did 12 months earlier, according to Morningstar. But before joining the tide, it’s important to know that these kinds of funds aren’t for everyone, and they’re certainly not leave-it-alone, long-term holdings. “Unfortunately, most of those are not well suited to retail traders,” says Randy Frederick, managing director of trading and derivatives at Charles Schwab. “I see a lot of people wasting their money buying volatility-related products to try to catch that next big spike in volatility.” Frederick says many investors enter these kinds of funds with the wrong expectations, and the wrong idea about how to use them. For one, don’t expect a VIX fund to move just like the VIX. And don’t expect to be rewarded for buying one and patiently holding it. The VIX is called the “fear index” because it shows how much traders are worrying about big swings hitting the S&P 500 in the next month. It does that by looking at how much traders are paying for options on the S&P 500, which they use to shield themselves if they’re anticipating more volatility. The VIX tends to surge when stocks drop sharply, something that’s been occurring more frequently due to the weak global economy and a long list of other concerns. The S&P 500 has dropped 2 percent in a day nine times over the last 12 months. It had just two such days in the 12 months before that. On June 24, for example, the VIX spiked nearly 50 percent after stocks tumbled on the United Kingdom’s vote to leave the European Union. So, wouldn’t it be great to own something that rises with the VIX, if not to profit from schadenfreude then to help offset losses in the stock portion of a portfolio? But volatility funds don’t track the VIX, which is not an investable index. Instead, they’re often investing in the VIX futures market, where traders bet on where the VIX will be in coming months. That means volatility funds often don’t move as much as the VIX itself. The ProShares VIX Short-Term Futures exchange-traded fund, for example, rose on June 24, but by only about half as much as the VIX. To get closer to the VIX’s performance, some funds use leverage to boost their returns. ProShares’ Ultra VIX Short-Term Futures ETF, for example, tries to give double the daily change of its underlying index, and it jumped 44 percent on June 24. It’s these kinds of short-term pops that investors should be looking for. Investors in the fund, which trades under the symbol UVXY, are holding it for a week or less, on average, says Joanne Hill, head of institutional investment strategy at ProShares. They aren’t planning to hold UVXY for the long term: The fund is down 99.999 percent over the last five years. “When people decide to use these, they’re not looking at this five-year chart of how they’ve performed,” Hill says. “They’re looking at the fact that last August, when the VIX moved up 135 percent, UVXY moved up” 159 percent. One reason for the poor long-term performance is the way prices work in the VIX futures market. Contracts for far-off months are generally more expensive than for close-in months. And the fund is regularly selling close-in contracts and replacing them with farther-off contracts. Hill says dollars tend to pour into funds like UVXY when the market is calm, an indication that traders are trying to buy low in anticipation of an uptick in volatility. She says selling is highest when volatility does strike. “The appeal of getting volatility exposure is the same reason we buy insurance for our house,” Hill says. Volatility funds piqued the curiosity of Brian Jacobsen, who is chief portfolio strategist at Wells Fargo Funds Management, a couple of years ago. He bought one of the more complex ones he could find, “just to see what it was like.” “I rode it for about a week, and I threw in the towel because it was doing nothing like what I was expecting,” he says. Does he remember which fund it was? “I don’t,” he says. “I try to block it out.”  

Mutual fund costs at lowest in decades

NEW YORK (AP) — It hasn’t been this cheap to invest in mutual funds for decades, possibly ever. Expenses dropped again last year for both stock and bond funds, and they’re at their lowest levels since at least 1996, as a percentage of their total assets, according to the Investment Company Institute. That’s how far back the trade group’s records go, and funds have been getting steadily cheaper to own since then. “It’s a bit like Olympic records,” says Sean Collins, senior director of industry and financial analysis at the group. “Every four years, for whatever reason, records seem to fall. And you think: At some point, this has got to stop, right? And so far, we haven’t seen it.” It’s heartening because low expenses mean investors are keeping more of their savings. And researchers have found that, in investing, unlike elsewhere in life, you get what you don’t pay for. Lower-cost funds tend to perform better than higher-cost rivals. That’s because higher-cost funds have to perform that much better to deliver the same after-cost returns, which is what investors care about and see in their quarterly statements. Even though minimizing costs is such a key part of investing, investors don’t always notice them. No bill comes due each year. Instead, fund companies directly take out how much they need for managers’ salaries, record-keeping costs and other operating expenses from the fund’s assets. To see how much a fund is taking out, check what the industry calls its expense ratio. This figure calculates what percentage of the fund’s assets is going to cover annual costs, and funds regularly give updates on theirs on their websites. Stock funds had an average expense ratio of 0.68 percent last year, down from 0.70 percent a year before and 1.04 percent in 1996. That means a person with $1,000 invested had $6.80 taken out to cover fees last year, versus $7 in 2014 and $10.40 two decades ago. That may not sound like much, but the savings get proportionally bigger as nest eggs grow. For workers with an average-sized 401(k), which Fidelity Investments recently pegged at $87,900, they could be paying $316 less in expenses each year than they would have in 1996. Plus, long-term investors will see the value of those savings grow through compound interest. A fund’s expense ratio doesn’t include the cover charge that some funds require to enter, something the industry calls a “load” payment. The ICI’s numbers also don’t include expenses for exchange-traded funds, which are becoming ever more popular in part because their fees are often lower than those of traditional mutual funds. The ICI’s numbers give greater weight to the largest funds, so a big reason for the drop in expenses has been the extraordinary growth for index funds in recent years. Money has been pouring into these funds, which are some of the cheapest to own because they don’t hire teams of analysts to pick stocks. Instead of trying to beat the Standard & Poor’s 500 or another index, these funds automatically buy stocks in the index in an effort to match it. Stock index funds had an average expense ratio of 0.11 percent last year, versus 0.84 percent for their actively managed rivals. Investors plugged nearly $413 billion into index mutual funds and ETFs last year, according to Morningstar. They pulled nearly $207 billion out of actively managed funds over the same time. Even when investors are opting for funds run by stock pickers, they’re overwhelmingly focusing on the lowest-cost ones. Last year, 57 percent of all the money invested in actively managed stock funds was held in the cheapest 10 percent of them. Keeping expenses low is even more important with bond funds than stock funds, because returns are lower and expenses can quickly erode them. Bond-fund expense ratios fell to an average of 0.54 percent last year from 0.57 percent a year before and 0.84 percent in 1996. One big reason is many investors pulled money from beleaguered high-yield bond funds last year, which tend to have higher-than-average expenses. These funds invest in “junk bonds” that offer higher yields but are issued by companies considered at greater risk of defaulting. The outlier in the downward trend for expenses lies in what the industry calls “alternative funds.” These funds, described sometimes as “hedge funds for the masses,” use more complicated trading strategies than traditional funds. Some sell stocks short, for example, which are investments that profit when a stock falls. Marketers of these funds argue the higher fees required by the more complex trading is worth it for investors looking for steady returns despite the market’s direction. Many of these funds are also relatively new, and when funds have low assets, they’re not able to spread their costs over as many dollars, which pushes up expense ratios. That math shows why the last time expense ratios rose broadly for stock mutual funds was in 2009, when the Great Recession drained funds of much of their assets. That’s why it may not be until the next recession that trend of falling fees across mutual funds turns. In the meantime, keep pocketing those savings.

Beyond growth and value: Investors are tired of choosing

NEW YORK (AP) — Coke or Pepsi? Biggie or Tupac? Growth or value? For decades, investors chose their stock mutual funds from one of two distinct camps. On one side were growth funds, which bought only the most dynamic stocks with the fastest-rising revenues and profits. On the other were value funds, which hunted the bargain bin for stocks with cheap prices relative to their earnings. Today, just like more people are choosing neither Coke nor Pepsi, investors are pulling out of both growth and value stock funds. Instead, they’re pouring cash into broad index funds and other options that don’t pigeonhole themselves into one of the two investing philosophies. The moves are the result of several trends that are reshaping the investment industry. Chief among them: People are looking for ever-simpler ways to invest, and they’re opting for index funds that track the broad market. So, instead of holding a small-cap growth fund plus a large-cap value fund plus a mid-cap growth fund, more investors are holding just one fund that tracks the entire stock market. The numbers bear out the change in preference. Investors pulled a net $36.2 billion from U.S. growth stock mutual funds and exchange-traded funds in the 12 months through January, according to Morningstar. Another $42.6 billion left U.S. value stock funds. At the same time, $12.5 billion went the opposite direction, into “blend” funds, which own a mix of both growth and value stocks. The trend isn’t as strong with foreign stocks, where investors are still putting money into growth and value stock funds. And even with U.S. stocks, growth and value funds still command big piles of dollars. Together, they control $2.9 trillion, more than the $2.7 trillion that sit in blend funds. But the trend is moving toward U.S. blend funds eventually overtaking their growth and value rivals. One reason for the shift is that investors are tired of picking which philosophy will do best. Or, rather, they got tired of getting it wrong when they tried to pick which would do best. Growth and value stocks tend to take turns at the top, with growth leading for some years before ceding leadership to value. Growth stocks, for example, were in favor during the dot-com boom of the late 1990s. Investors at the time were excited about the “new economy” and were more interested in companies attracting “eyeballs” than in those making profits. After getting burned by the dot-com bust, chastened investors turned back to value stocks. For seven years, the value stocks in the broad Russell 3000 index beat their growth counterparts, from 2000 through 2006. After that, growth stocks regained the lead and had better returns in five of the following seven years. So instead of guessing whether growth stocks will do better than their value counterparts, investors are simply buying broad-market funds that own both groups. Perhaps the biggest reason for the trend is the migration into index funds generally, says Alina Lamy, a senior analyst at Morningstar. After seeing the majority of actively managed stock mutual funds fail to keep up with indexes, investors have been streaming into options that merely try to match the index rather than beat it. Some index funds focus on just growth or value stocks. But the most popular ones cover broad swaths of the market and include both. Vanguard’s Total Stock Market Index fund, for example, has $385.9 billion in assets and tracks the entire U.S. stock market. It’s also more than 10 times as big as Vanguard’s Value Index fund and eight times as big as its Growth Index fund.

Main Street holds up as Wall Street struggles

NEW YORK (AP) — Wall Street is hurting, and Main Street doesn’t care. It’s got burgers and cars to buy. Big losses in stock markets around the world this year have the wingtip-set fretting, but regular consumers across the United States are confident enough to open their wallets and spend more. It’s an about-face from the early years of the economic recovery, which began in 2009, when stocks and big banks were soaring but many on Main Street felt like they were getting left behind. “It’s almost like a stock market is a different animal,” says Earl Stewart, who owns a Toyota dealership in North Palm Beach, Florida, far from the roiling markets in New York, Frankfurt and Shanghai. “We’re not seeing any of the negativity.” The stock market’s malaise hasn’t affected his customers, at least not yet. Sales for the past year have been the best since 2007, and he had record profits in 2015. The divergence underway between Main Street and Wall Street highlights the difference between the U.S. stock market and the economy. The stock market’s worries are centered on things like the strength of foreign economies, such as how much China’s sharp slowdown will hurt exporters and businesses in other countries. Low oil prices are crushing the shares of big energy companies and the big banks that lend to them — but leaving consumers with more money to spend after they fill up their car with cheap gasoline. These forces have dragged the Standard & Poor’s 500 index down 12.5 percent from its peak in May. Foreign stocks have lost double that. Hedge funds, which cater to the wealthiest and biggest investors, are also struggling. They lost money in January and got off to their worst start of a year since 2008, according to Hedge Fund Research. Economists say the split trends between Main Street and Wall Street can continue, but only up to a point. If profits fall sharply enough, for example, it could push CEOs to once again cut swaths of jobs in order to shore up their earnings. If stock prices fall deep enough, the panic in the headlines could traumatize consumers whether or not they have a 401(k), and spending could slow. For now, though, Main Street continues to trend upward. Only 13 percent of the U.S. economy depends on exports, and the rest of it — which is mostly consumer spending — is still growing, albeit slowly. “Down here, as a small business owner, you don’t feel connected to Wall Street at all,” says Jon Sears, a co-owner of four bars and restaurants in Columbia, South Carolina. “When I talk to people in Columbia, I can’t think of a conversation I’ve had about the stock market in the past two or three weeks.” His business depends instead on the nearby University of South Carolina. Revenue growth at his locations has held up this year, at his cheapest bar and his more upscale restaurant that serves local, organic foods. Retailers around the country are seeing something similar. Shoppers bought more autos, clothes and other items last month, even though the S&P 500 in that span had its worst week in more than four years. U.S. retail sales rose 0.2 percent during the month, beating analyst expectations. Consumer sentiment did show a dip in early February. But confidence still remains near its average for last year and well above where it was for every other year of the recent bull market. Among the reasons that Main Street is feeling relatively confident while Wall Street stumbles: • The job market is getting better. Employers continue to add jobs, particularly in the retail and health care industries, and the unemployment rate is at an eight-year low. Job growth did slow last month, but economists say that just balances out the big surge in hiring at the end of last year, and they’re still forecasting more gains. Even more importantly, wages are trending higher. That means workers are feeling more secure in their jobs and in their finances. Just over 3 million workers quit their jobs in December, the highest number in nearly a decade. That’s an optimistic sign because people generally quit when they have a higher-paying job offer in hand. • Bills are getting a bit easier to pay. The plunging prices of gasoline, natural gas, heating oil and other commodities are getting lots of attention, but prices are low across the economy. Prices for meat, poultry, fish and eggs also fell in December from a year earlier. So did prices for clothes and airfares. There is a fear that the economy may get too much of a good thing. If prices fall too sharply, it could lead to a vicious cycle in which customers wait longer to make purchases, which forces businesses to cut jobs. • Home values are rising. “More people care still care about the value of their homes than the value of their stocks,” says Diane Swonk, an independent economist. That’s because for many Americans, their home is their biggest if not only investment. And that investment is doing well, regardless of the stock market’s struggles. Home prices nationwide are nearly back to peak levels from before the Great Recession, and they’re already at a record in San Francisco and several other cities. It may just be Main Street’s time in the sun, says Bob Doll, chief equity strategist at Nuveen Asset Management. He says economic recoveries have long been split into two phases. “The first half of an economic cycle is when markets tend to best, and that’s when Wall Street gains on Main Street,” Doll says. “The second half is when labor gets an increasing share of GDP, and that’s just starting.” Associated Press Auto Writer Tom Krisher contributed from Detroit.

As the rest of the world dumps Chinese stocks, some wade in

NEW YORK (AP) — While the rest of the world scrambles to get out of the crumbling Chinese stock market, a trickle of investors is heading straight into the wreckage. Managers of Chinese stock mutual funds have seen huge drops many times before, and they even find things to like about them. Instead of taking cover, and preserving cash in their portfolios, this time these managers say they are buying stocks of companies set to take advantage of how the Chinese government is reshaping the economy. This most-recent plummet has been even swifter and sharper than past ones, but managers of Chinese stock funds say it’s also brought down share prices enough that they’ve been buying companies that they thought were too expensive just a few months ago. “With a volatile market like China, buy it when the world hates it and sell when no one’s worried,” says Jim Oberweis, who runs the Oberweis China Opportunities fund. “That’s worked pretty well over the last 20 years in China, and now sure seems to me like a period where everyone hates it.” Only time will tell if he and other Chinese stock fund managers are right. They could have made the same argument after each of the Chinese market’s many sell-offs the last five years, and it wouldn’t have netted them much, if anything. The MSCI China index has had seven declines of at least 10 percent over the last five years, including the 19 percent tumble since late October, which itself followed a 34 percent plunge from April into September by just weeks. After all those ups and downs, the MSCI China index has lost 12 percent over the last five years and is close to its lowest level since the summer of 2009. That’s why fund managers say an investment in Chinese stocks will require lots of patience, maybe even a decade. Oberweis’ fund, for example, has lost 15.9 percent over the last year, even though it’s been one of the top performers in its category. But over the past 10 years, it’s returned an annualized 8.9 percent, better than the S&P 500’s 6.1 percent annual return. What’s causing the panic China’s economy grew last year at its slowest pace in a quarter century, and economists expect it to slow even more this year. Part of that is by design. The Chinese government is steering the economy toward consumer spending and away from exports and investments in infrastructure. It hopes that will yield a more sustainable, though slower, rate of growth. The government is also pushing anti-corruption measures and efforts to make the country’s huge state-owned banks and telecom communications companies more efficient. The goal is to try to slow growth without stopping it. The worry is that the government will lose control of the slowdown, and the economy will fall hard. “It’s painful at the moment, and there could be some more pain to come,” says Jasmine Huang, manager of the Columbia Greater China fund. “Eventually it will be good for the economy.” Huang is avoiding companies from what’s known as “Old China” and owns no raw-material producers and few companies in the industrial and energy sectors. But instead of hiding out in cash, she has been investing in “New China.” She has been focusing on e-commerce companies, where she expects revenue to grow even if the overall economy stumbles because more Chinese shoppers are going online. She also sees big growth for health care companies. They make up only about 2 percent of the MSCI China index, and she says they could grow to become the 10 or 20 percent of the market that health care represents in developed markets. Why this decline is different Andrew Mattock, lead manager at the Matthews China fund, understands if investors are feeling gun-shy about Chinese stocks. “For five years now, if you’ve made money, it’s been hard to get, and you’ve lost it quickly in these sell-offs,” he says. But the most recent drops for Chinese stocks have brought them close to their cheapest level since the financial crisis, relative to their earnings. The MSCI China index was recently trading at about 8.5 times its expected earnings per share over the next 12 months. That’s down from a price-earnings ratio of nearly 10 at the start of the year and approaching the 6.8 ratio of 2008. Mattock, like Huang, has steered his fund toward stocks that he sees profiting from China’s shift toward consumer spending. His top holdings at the start of the year included Tencent, which operates the popular WeChat social media service, and JD.com, one of China’s largest e-commerce sites. “This time, I think, is different because there’s actually change going on now,” Mattock says of the economic reforms underway in China. “There are doubts about whether they can do it, but what they’re trying to do is positive.”

With emerging market stock funds, check what’s in the tin

NEW YORK (AP) — When you’re built different, in investing, you act different. That’s why it’s important to check what’s in your emerging-market stock fund — even if it’s an index fund. Emerging-markets index funds track different indexes, which can have very different exposure to different parts of the world. And as Brazil, India and other emerging market economies move in increasingly different directions, actively managed funds are looking more distinct as well. Some managers are avoiding broad swaths of the developing world, and they say their funds have never looked this different from their index-fund rivals. The big differences in composition can lead to big differences in returns. All of the 20 largest emerging-market stock mutual funds are down this year, but by anywhere from 3.9 percent to 21 percent, as of Wednesday. That gap of more than 17 percentage points is much wider than the 7.4 point gap in performance for the biggest funds in the largest category of U.S. stock funds. The changes in portfolio focus are occurring as more dollars head into emerging-market stock mutual funds and exchange-traded funds. More than $5 billion flowed into them in the first 10 months of the year, according to Morningstar, at a time when nearly $73 billion left U.S. large-cap stock funds. If you want to join the tide into emerging-market stock funds, it’s important to ask a few questions: • If it’s an index fund, what index does it follow? It may seem like a boring question, but it can make a difference, as a look at the two largest emerging-market stock ETFs shows. The iShares MSCI Emerging Markets ETF keeps nearly a sixth of its portfolio in South Korean stocks, such as Samsung Electronics and Hyundai Motor. The only country that accounts for a bigger percentage of its portfolio is China. Vanguard’s FTSE Emerging Markets ETF, meanwhile, doesn’t own a single Korean stock. That’s because the two ETFs track different indexes, which disagree on whether South Korea is an emerging market or a developed one. Despite the difference, the two ETFs have performed similarly this year: Both lost 11 to 12 percent, including dividends, as of Wednesday. But the ETFs are set to get even more different. The Vanguard ETF is in the process of adding small-cap emerging-market stocks to its portfolio, which are generally riskier than large-cap stocks but have the potential for bigger gains. The Vanguard fund is also bringing in so-called A-shares of Chinese companies. These shares are listed in Shanghai or Shenzhen, and the Chinese government has only recently begun loosening limits on foreign ownership of them. A-shares have had much sharper jumps up and down than the Hong Kong-listed shares that many emerging-market stock funds focus on. • If the fund is actively managed, what is it flocking to and avoiding? Emerging-market stock indexes tend to be full of state-owned companies in China and commodity producers in Brazil and Russia. These are precisely the stocks that many active managers say they’re most keen to avoid. China’s growth has slowed sharply, as the government tries to shift the economy away from industrial-led gains to one more dependent on consumer spending. That has helped send prices for metals and oil tumbling, which hurts Brazil and Russia. They’re big commodity producers, and both their economies are in the midst of recessions. That’s why Laurence Taylor, portfolio specialist at T. Rowe Price, says adhering to an index is akin to “investing in the history of emerging markets.” He prefers countries that are smaller players in emerging-market stock indexes, but where growth prospects look better, such as Indonesia and the Philippines. He also favors India, which is well represented in emerging-market indexes. Actively managed funds can also steer clear of places where politicians are making things difficult. When Russia, which makes up about 4 percent of emerging-market stock indexes, annexed Crimea in 2014, it led to an international uproar and sanctions that hurt Russian companies badly. Lee Rosenbaum, portfolio manager at the Loomis Sayles Global Equity and Income fund, which can invest anywhere around the world, sold the fund’s investment in the Russian Internet company Mail.ru after the upheaval. Now he says it’s safe to assume it won’t be buying another Russian stock again for a while. • What are the fees? As with investments in all funds, try to keep expenses low, regardless of whether you opt for a fund that tracks an index or is actively managed. Investing in emerging markets can be expensive in general, and the average expense ratio is 1.56 percent for mutual funds in the category. That means $15.60 of every $1,000 invested goes to cover fund manager salaries and other costs. A fund manager with higher costs will need to perform that much better just to match the after-fee returns of lower-cost funds.
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