Help me choose an index fund and a financial institution.

So, after reading all the helpful threads about the importance of Roth IRAs and and the benefits of investing in your retirement as early as possible, I am ready to take the plunge. I have about $2k to put away now, and I should easily be able to put away another $2k before next April to max out my Roth IRA contribution for this year.

The last step is selecting my financial institution and the particular index fund I’m going to invest in. From comparing rates and user reviews, I have heard good things about Vanguard, Sharebuilder, and Fidelity. However, I’m kind of a novice to investing, so I am not sure that I am absolutely fully aware of all the fine print and miscellaneous fees that will reduce my return. I would really like to hear people’s personal experiences with these three companies (suggestions for other companies gladly welcomed, of course), and what has worked out best.

As far as index funds — I am starting out young, so I’m strongly considering something more aggressive than the standard S&P 500, DJIA, NASDAQ, etc. Would something like Emerging Market Value / Emerging Small Cap be appropriate? Would it be totally foolish of me to invest only in the higher-risk indices, ignoring the safer but lower-return conservative index funds?

You are right to assume more risk by emphasizing value stocks and small stocks. You should also diversify geographically. But don’t overdo it — an 80% (or even 100%) total-market stock portfolio is probably risky enough, that you don’t need to hold only high-risk stock indices.

Take a look at this article on model portfolios on William Bernstein’s asset allocation site.

I have no experience with US mutual funds, but from everything I’ve read, Vanguard is a very good choice.

posted by blue grama at 8:45 PM on September 4, 2006

Pontius, I went thru the same process not too long ago myself. Here’s what you do:

1) Stick with name brands, especially as a beginner. Vanguard, Schwab, Fidelity, Ameritrade, you get the idea. Schwab and Fidelity will hold your hand more tightly; with Ameritrade you’re on your own but atleast its a major brand. Stick with major brands whatever you do, as a beginner.

2) Before you put your money anywhere, get an account with right away. They rate mutual funds, you’ll be able to search thru their funds database on exactly the criteria you want (aggressive, not aggressive, international exposure, all down to any level of detail you want: you want an aggressive fund with 30 percent intl exposure and 30 percent tech exposure? you can search precisely for that in their database; and its a snap). Also morningstar will give you GOBS of information about funds and about sensible investing — they rate funds, fund managers, fund families; they provide unbiased advice on how to go about investing with mutual funds; they write up long and interesting articles describing all these things. You cant live without it if you are a beginner and want some great unbiased information covering the entire spectrum of US mutual fund investing. (They also cover stocks, by the way).

3) Once you decide on a particular fund that is aggressive enough for your taste, and have an idea of the risks etc, then jump into it — go to their website, open an account, send them your check. Its all very easy and they make it very easy these days.

4) set up a regular automatic investment scheme with them (they will show you how) and put in regular investments automatically from you bank account.

5) Sit back and watch it grow; once you have over 10 or 20 thousand you can think about splitting it up between multiple funds if you want to.

One caveat for a beginner — Once you’ve selected a fund and fund family you’re comfortable with, DONT trade excessively or switch fund families on a whim — ALL funds go up and down with the market; so long as morningstar and other news sources show that there is nothing fundamentally wrong with the fund family, the fund, or its manager, you’re better off sticking with it; past performance may not be a guarantee of future success — but its the best indicator of it in this business.

Correction: Before you put your money anywhere, get an account with www.morningstar.com right away.

-oops.

posted by jak68 at 8:58 PM on September 4, 2006

Vanguard is well-marketed but Dimensional have the strongest theoretical underpinnings.

posted by zaebiz at 9:05 PM on September 4, 2006

I just went through this exercise for my 401k rollover (into a traditional IRA). My breakdown is as follows (this is not advice, just a personal ancedote):

S&P 500 index: 12.5%

US Small cap growth index: 18.75%

US Small cap value index: 18.75%

Emerging markets index: 25%

Developed markets large cap index (excluding US): 25%

I went through Vanguard on three of these, but I would’ve used them for all 5 funds if not for some particular details having to do with some other investments I have.

I’m 25 and wanted to stack my tax-deferred retirement account with riskier equity positions. I have other investments outside of the retirement account, but I think I’d still build my retirement account in the same fashion if I didn’t.

With $2k to invest now, you’ll probably run into some limitations due to minimum investment sizes. On the Vanguard funds, my minimum initial investment was $1k in a retirement account (their website says $3k though). You might have to limit your investment choices now and then begin to diversify with later investments.

posted by mullacc at 9:10 PM on September 4, 2006

If you’re concerned about minimum initial investments or want to do dollar cost averaging, the minimum on T. Rowe Price plans is $50 if you setup an automatic investing plan. If, hypothetically, I had just graduated from college and now had a horribly underpaid job in D.C. that’s how I’d invest.

posted by jed at 9:28 PM on September 4, 2006

If you are buying a particular Index fund, you want to choose your fund vendor by who’s going to provide you with the fund at the lowest overall cost. (This is not always true for managed mutual funds, but is always true for ones that mirror an index — index funds)

Yes, really. Index funds buy shares to match particular indexes (for instance, the S&P 500). Because all S&P 500 funds hold essentially exactly the same ratio of shares of the same companies, the difference in return-on-investment from fund to fund is strictly a matter of how much your fund manager is charging to buy and sell those shares, print the quarterly reports, and pay for hookers, rock stars, and blow .

Last year, a group of Harvard and U.Penn Wharton MBA students were given the the task of allocating $10,000 among S&P 500 index funds. Only 5% of these, supposedly savvy business-types, allocated the funds correctly (i.e. for the highest returns — all $10k into the fund with the lowest overall cost). See the paper detailing this experiment and its unexpected results here .

Despite their corporate owner, the Motley Fool is a generally excellent beginners resource for individual investors. They have great information on choosing a mutual fund .

For a $2000 investment in an IRA, your best bet may be to get an account with a discount broker like E*Trade or Ameritrade, and buy one or more ETFs. (See also: Fool’s guide to ETFs. and the dynamic list of all ETFs on Yahoo!)

Full disclosure: I used to work for E*Trade, and I’ve passed the Series 7 exam (which sounds more impressive than it is). I can’t offer you actual investment advice — this post is just a suggestion that you educate yourself.

I like the Vanguard Funds because of their very low fees and the fact that the company is owned by its clients. All of their funds have a minimum investment of $3000 except for the STAR Fund, which has a minimum of $1000. The STAR Fund is a very good diversified fund that holds other stock and bond funds, giving you exposure to domestic and international stocks and bonds.

You could leave your initial investment parked in the Vanguard STAR fund until your account is above the $3000 minimum. Then you can transfer into any of the other Vanguard funds.

For someone starting out, I recommend the Target Retirement funds. Each of the Target Retirement funds is what is called a fund of funds. It consists of other underlying Vanguard index funds to form a balanced portfolio. So you don’t have to buy a bunch of funds to get diversification. By owning one fund, you get a complete portfolio of index funds without the hassle.

The Target Retirement funds are named for the approximate year of your retirement, ranging from 2005 to 2050, in five-year increments. The 2005 end of the spectrum is very conservative, consisting of 75% bonds and 25% stocks to the more aggressive 2050 which is 10% bonds and 90% stocks. The stock portion consists of a domestic stock index fund, a European stock index fund, a Pacific stock index fund and an emerging markets index fund. Unlike most companies, Vanguard does not charge extra fees for managing a fund of funds. You just pay the same fees as if you owned each of the underlying funds individually.

I’m no expert (by a long shot!). But I have read a fair number of the popular investing books/sites/blogs, and they all share a common theme: somewhere, usually as an afterthought, they mention that over time (i.e. over the extended, decades-long time horizon of a typical IRA), no institutional stock-picker has ever beaten the S&P 500 average by more than a few tenths of a percent. (I don’t have the energy to go do the research on my own right now, so if there is a superfund out there, please feel free to make this comment moot.) Even the Motley Fools — who pushed AOL stock til the bitter end, if I remember correctly — mention this in a kind of funny chapter in one of their books, where they cringingly admit that you could, you know, just put all your money on the S&P and not buy any more investing books or watch Bloomberg or read the stock tables or spend $ on commissions anymore. But where’s the fun in that?

posted by turducken at 11:35 PM on September 4, 2006

Turducken: actually, the Fool doesn’t really hide the fact that s&p index will beat 99.5% of investors in the long term. At least they didn’t the last time I read their site a couple years ago, before they bugged you for registration every two pages. I remember the general message was yeah, you could spend hours upon hours trying to beat the market, or you could just get the vanguard 500 and come out ahead in the end anyways.

posted by rsanheim at 12:36 AM on September 5, 2006

After asking this question and receiving, in addition to the above answers, a glowing email from a former Fidelity employee, I moved all my IRAs over to Fidelity.

I’m thoroughly satisfied. I like their online user interface and I feel like they’re doing what they ought to be to take care of me. For your information, you have enough money kicking around to open a no-fee IRA with Fidelity. (They have a $2500 minimum balance per fund, but it’s waived if you use regular defined contributions.) Also it’s fun to poke around and see all the different things people invest their money in, even if you don’t plan to follow suit.

I have some money in their Spartan 500 fund, too, which is an S&P index. The management fee is 0.08%, the expense ratio is 0.10%, and the turnover fluctuates between 6 and 7%. These are the key numbers in evaluating the booze, coke and hookers rate.

For comparison, most of their sector funds lose about 1% in fees and they all seem to meet a target of about 125% turnover. (Turnover rate is how much of the fund is bought and sold on a yearly basis — it’s also called ‘churn’ because the commissions on these buy and sell actions are butter that the brokerage skims off.)

I would echo the comments above that risk really doesn’t equal return. S&P 500 outperforms a lot of higher-risk, higher-volatility investments on a pretty regular basis.

For someone starting out, I recommend the Target Retirement funds. Each of the Target Retirement funds is what is called a fund of funds. It consists of other underlying Vanguard index funds to form a balanced portfolio. So you don’t have to buy a bunch of funds to get diversification. By owning one fund, you get a complete portfolio of index funds without the hassle.

Has anyone tried these? I’m in Vanguard’s Index 500 now, and considering switching to Target Retirement to automate reallocation as I approach decrepitude. But it seemed the Target Retirement funds haven’t been around long enough to establish a track record. Opinions?

Excellent advice, as always — the hive mind comes through again. Thanks, all!

My suggestions:

Vanguard Target Retirement 20xx (your anticipated year of retirement — the simplest, closest thing to invest and forget, although you should never actually do that, of course — not rated by Morningstar)

-OR-

Vanguard STAR (fund of funds; Morningstar gives it 4 out of 5 stars and notes This mutual fund delivers extraordinary diversification in one fetching package.)

-OR-

Vanguard Total Stock Market Index (4 stars) now, and add their Total International Stock Market Index (4 stars) and Total Bond Market Index (4 stars) funds later as you can.

Don’t mix and match these approaches, however. The Target Retirement especially and STAR funds are designed to give you broad exposure to various markets. If you start adding other funds, you throw off your portfolio mix. An expert might have the knowledge, nerve and assets to overweight in areas where he/she expects growth, but I don’t feel that way and it appears you don’t either.

I believe these all have a $3000 minimum.

Fidelity and T. Rowe Price have similar offerings, if you prefer them.

posted by pmurray63 at 10:06 AM on September 5, 2006

Jane Bryant Quinn has an excellent book for financial newbies called Smart and Simple Financial Strategies for Busy People. I can’t recommend it highly enough.

posted by philad at 11:04 AM on September 5, 2006

Also — in case you didnt know — there is a small difference between buying funds via a trading account at a brokerage house (as with fidelity, schwab, ameritrade etc), VS. buying the fund directly from the fund family’s website (vanguard, etc).

With a trading account, you will have a lot of freedom later on to switch between any of the mutual funds that they offer.

On the other hand if you buy directly from the fund family, you’re stuck with exchanging shares or moving money around only within the funds offered by that fund family.

So in general I’d recommend going with a regular trading account at schwab/fidelity/ameritrade/etc, any place that offers a large number and a wide selection of funds (over 2000, atleast). That will give you lots of variety.

Going directly with a fund family, on the other hand, is probably simpler — no choices = simpler and easier. Also sometimes if there is a particular fund you really want, it might not be offered at your brokerage account; in which case you wont have a choice but go thru the fund family directly.

I’ve had good experiences with Schwab, fidelity, and Ameritrade; keep in mind tho in general Schwab/fidelity may charge fees/more fees than ameritrade, especially in the beginning when your net worth is low (they tend to eliminate fees as your money grows). Once I got comfortable with trading, I moved all my money to ameritrade for the lower fees. But in the beginning the hand-holding and brilliant phone service that both Schwab and Fidelity offered (as well as the countless brick-and-mortar stores they have around the country) was really a big help in making me feel comfortable with the process.

posted by jak68 at 4:28 PM on September 5, 2006

You’re paying for the privilege of buying funds that way. There’s no seperate line item or anything, but those mutual funds are paying marketing fees to the brokerage. and that money’s gotta come from somewhere.

posted by pmurray63 at 8:47 PM on September 5, 2006

To clarify: you may be paying for those fees if your fund is available that way, even if you didn’t buy them that way.

posted by pmurray63 at 8:49 PM on September 5, 2006