Making smart investment choices

Most investors, both institutional and individual, will find that the best way to own common stock is through an index fund that charges minimal fees. Those following this path are sure to beat the net results (after fees and expenses) delivered by the great majority of investment choices. 1

Warren E. Buffet, 1996 Annual report of Berkshire Hathaway Corporation

I’m ready to save. Now what do I do?

Anyone who has ever set up a 401(k) account has asked these important and challenging questions.

• Should I buy funds made up of stocks, bonds, or a money-market or all three?
• What’s the right choice for me?
• How many funds do I really need?

And that’s just for starters!

Yes, investing can seem intimidating. But we’re convinced that if you make diversified and cost-efficient choices, you can find it easy, and even fun, to save for tomorrow.

If you haven’t done so already, may we suggest that you read the companion guide titled Five Rules for Creating a Sound Investment Strategy. It contains useful information on how to allocate your savings among the various asset classes.

The guide you’re reading now will provide you with some important background information and explain how to choose the right types of investments and create a portfolio mix designed to help you meet your savings goals.

An important word about risk: It’s important to remember that investing in stocks involves risk. Markets may or may not act in the future the way they have in the past. However, we believe that by following sound principles and applying them consistently over time, you can get on track to meet your goals and achieve financial peace of mind.

6 rules for making smart investment choices

Rule 1 select index-based funds for maximum diversification

ShareBuilder 401k advocates using index-based investments for your long-term savings plans. Why? Because index-based funds tend to be well-diversified and have low expense ratios, so your money can work harder over time. We believe this so strongly that our entire ShareBuilder 401k offering is comprised of a particular kind of index-based funds called Exchange Traded Funds (ETFs).

Index-based funds hold a portfolio of securities or bonds that work to mirror those comprising a market index (like the Dow Jones Industrial Average or the S&P 500). The goal of these funds is to match the performance of the index it tracks, less the costs needed to run the fund (the expense ratio).

Investments that track the major indexes are by their nature diversified, which means you’re not putting all your eggs in one basket.

Rule 2 costs really do matter

Index-based funds also offer the great advantage of cost efficiency. The following example illustrates why costs matter so much and why knowing the expense ratios of your investment selections is so critical.

Consider these results: From 1980-2005, the S&P index-based mutual funds averaged 12.3% net return (12.5% gross return less 0.2% expense ratio). The average mutual fund provided a net return of 10.0% during the same period. In other words, investors gained a 2.3% advantage by owning the index-based funds.

Compare how this adds up over time for a single $1,000 investment made in 1980:

Net return of $1,000 (1980-2005) 2