Choosing an index fund?

In My Humble Opinion
41

This doesn’t relate directly to the OP but might interest some lurkers.

True diversification means being invested in all asset classes, not just diversifying among choices within one such as stocks or bonds. And while there are ETF and funds that do give you exposure to things like int’l markets and real estate, there doesn’t seem to be anything that covers the whole gamut including commodities, currencies, natural resources, etc.

So I checked the screener at my broker’s site for alternative funds and found some that looked interesting - probably risky, but interesting.

T. Rowe Price Global Real Estate Fund TRGRX - invests in real estate anywhere in the world with at least 40% outside the US - 4 stars (Morningstar)

Diamond Hill Long Short Fund Class A DIAMX - goes long stocks the manager thinks are undervalued and shorts ones he feels are overvalued - 4 stars

PIMCO CommodityRealReturn Strategy Fund Class D PCRDX - commodity linked derivatives - 4 stars

edit: how to diversify using 3 vanguard funds

42

So… I should wait?

No, actually. First of all, I have an entire $10K I want to invest immediately, since I already have a Roth with an entirely different company. Secondly, as I said above, the IRA chooser on the Vanguard site says I should be putting my money into a Traditional IRA, because I’m not certain that my retirement income and tax burden on such will be the same or go up when I retire, so I’m not even sure a Roth is what I’m supposed to create.

Was I supposed to be looking at those? Because I wasn’t even considering those.

I think in the majority of the possibilities you cite, I’d have bigger problems than my retirement portfolio. :stuck_out_tongue:

Still, the bonds point is kind of well-taken. I’m starting to wonder a little about the previous posters’ anti-bond (for lack of a better term) advice. Hrm.

This is all very confusing for me (which is, of course, why I started this thread).

43

I love this stuff.

Okay so firstly, let’s address one major point about where to put your money. If you have no workplace retirement savings plan (401k, 457b, various etc plans) and you can invest say $5,500 per year (this is certainly true for this year where you have $10k) then that full $5,500 can be claimed as a deduction against your income come tax filing time. This is available to you whether you itemize or not, and basically means your tax burden is being lowered by your $5,500 IRA investment.

That’s basically more money in the “here and now”, and Vanguard is correct–if you think there is a realistic chance that when you retire your income will be lower than it is today then you are probably better off taking a tax deduction against your currently higher tax rate than you are avoiding the lower tax rate in retirement.

But there are a two reasons most people would still advise a Roth:

[ul]
[li]Many people believe over time all U.S. tax rates will increase, so that even if your income is lower in retirement your tax rate will still be higher. Or at least equal to what it is now.[/li][li]Roth earnings can’t be withdrawn early without paying the 10% penalty tax, however Roth contributions can be withdrawn at any time for any reasons from a Roth IRA. This makes it a much easier to use “savings account of last resort” if you need to dip into retirement savings. Traditional IRAs and 401ks typically you cannot withdraw your contributions without paying a 10% penalty tax in addition to being taxed on the withdrawal as though it were regular income.[/li][li]The most minor of issues, but if you do get a 401k or similar plan through work, and you earn more than $59,000/year, and you still want to contribute to your IRA it may not be fully tax deductible any longer. If you have a Roth IRA it’s irrelevant because your contributions are being made with post-tax dollars and wouldn’t have been tax deductible in the first place.[/li][/ul]

Here’s what I would do with my $10k using a Vanguard account:

$3,000 into Vanguard 500 Index Fund Investor Shares (VFINX)

$3,000 into Vanguard Small-Cap Value Index Fund (VISVX)

$3,000 into Vanguard FTSE All-World ex-US Index Fund Investor Shares (VFWIX)

If you are having trouble finding these funds with lower than $10,000 minimums on Vanguard be aware of this, depending on your settings on Vanguards site when you first click on a fund it will default to the “Admiral Shares” view. Admiral Shares are basically shares in the same underlying mutual fund that are offered at a lower expense ratio because your holdings are larger than $10,000 (typically.) But from any fund page on Vanguard, right below the big fund title in red you should see a link that says, “Also available as Investor Class shares.” If you click that link it will take you to the Investor Class.

The above allocation of $9,000 is not ideal to me personally, but I think it is the best you can do only opening three funds. What it does for you:

  1. Gets you into an S&P 500 Index Fund. Which is basically a diversified large cap company investment focused on the U.S.

  2. Gets you into a Small-Cap Index Fund. Why? Historically small cap stocks have given a return that is premium to that of the S&P, but with greater risk. So a small cap investment makes sense for someone with a 20 year investing horizon who is risk tolerant. It positions you for better returns.

  3. Gets you into international equities, the FTSE All-World Fund is an international index that’ll expose you to most of the major companies around the world traded on international exchanges. It’s nice because they invest in traditional international markets like Canada/Europe/Pacific but also hit some developing markets.

Note I have no bond investments. In truth if you want exposure to the bond market I’d do something like next year or whenever you have $3,000 again buy into the Wellesley Income Fund, which exposes you to bonds but also still is heavily into equities, and while the Wellesley Fund is actively managed it has extremely low expense ratio for an actively managed fund and a sterling track record.

Now this may be complicated, but what you should also do is this. Once you’ve opened either an IRA or Roth IRA account with Vanguard and set up those mutual fund investments, you can create a linked IRA brokerage account. An IRA brokerage account at Vanguard lets you trade basically anything in the world a brokerage can trade in (stocks, funds from other companies, direct bond purchases, CDs, preferred securities etc.) There is typically a $7 commission on your first 25 trades with low-dollar brokerage accounts at Vanguard. As long as you sign up for all electronic delivery options the brokerage account linked to your IRA should not cost you anything in terms of maintenance fees.

Anyway, the neat thing about a linked Vanguard IRA Brokerage Account is you can buy Vanguard ETFs at no-commission. What I’d do is take that final $1,000 and use it to buy something like the Vangaurd REIT ETF (VNQ), that gets you into a holding that reflects a market a little diversified from the equity market. A lot of REIT funds out there are actually mREIT funds, meaning they take out low interest short-term loans to buy higher-interest long term mortgages and make profit on the difference between the interest rates of those two things. That’s fine, but it makes those funds more similar to bond investing, the Vangaurd REIT fund actually holds shares in companies that own and manage physical properties. Think of it as holding a small slice of fund that holds portions of large land lord type companies.

Over time what I would do with your three main funds is try to get it so 60% of your money is in the S&P 500, probably 20% in the Small Cap and 20% in the International fund. Like I said, those three funds being equal in size isn’t an ideal allocation at least for me, but to get started it hurts nothing and it gets you in all three funds. Once you’re in a fund you can make new investments in much smaller amounts and gradually get to the percentages I’m talking about there.

44

It might make sense for you to wait somewhat at this time. What you can do right now is put $5,500 into the S&P 500 Investor Class share and hold the rest of your money somewhere else. It’s only for half a year so we’re not talking a major opportunity cost here and for a relatively small amount I’m not sure it’s worth opening a taxable brokerage and putting it in the market then cashing it out and making it an IRA contribution in 2014.

So you can put $5500 into the S&P 500, then come January of next year you can take money out of the S&P 500 and combine it with your new $4500 for 2014 and use that money to buy the two other funds and the ETF I mentioned. (This assumes your $5500 is still $5500, it could be higher or lower, obviously–we could revisit this with another thread come January.)

I probably wouldn’t, they tend to be overweight with bonds at all points in their allocation plan.

jharvey’s post about bonds was basically incorrect. Right now I would not advise getting into the bond market because interest rates are at historic lows. Or at least they were a bit ago, and they’re still very low now. What that means is there is basically no way they can actually go lower, only higher. When rates go higher, existing bond investments lose value because people value their lower-rate bond holdings less than new-issue higher rate bonds and start selling them at a discount to face value. This effects funds that hold bonds and can lead to what is called a “liquidity trap.” The situation is different if you hold physical bonds instead of bond funds, since you aren’t necessarily affected directly by change in face value (unless you want to sell.) I won’t go into too much detail other than to just say in my opinion bonds aren’t a great place right now.

But bonds have a place, always have and always will. Even Warren Buffet who hates bonds has some money in bonds. Factually, for the bulk of the 20th century the 10-year Treasury Bond returned a little over 5% versus historic inflation rate of 3.22%. Other bonds returned more, high quality corporate bonds and junk bonds for example. Typically those have higher volatility but less so than equities. During the roughly same period the S&P 500 returned around 11%. But there were also times when bonds returned more than the S&P 500. By holding both it means you can smooth out your returns and make your portfolio less volatile. I think for someone 20+ years from retirement and making your investment like this it’s not ideal to buy a bond fund, but I wouldn’t say never think about one. It’s one you can add later as you’ve built your IRA up more.

45

Also, if you don’t like the thought of splitting your investment time up by doing $5500 now and $4500 next year. Note that in January of 2014 (up until April 15, actually) you will be able to make both “current year” and “prior year” contributions to an IRA. So you can contribute, in January 2014 all $10,000 of your money at once and then allocate it how you choose (I liked my recommendation FWIW.) You would classify (there is a simple interface for this when investing into a Vanguard IRA where you classify amounts as either 2013 or 2014 contributions) $5,500 as “prior year” contributions. So that means in 2014 you’re classifying $5,500 as 2013 contributions, and then classify $4,500 as “current year” (2014) contributions. Then you can make your whole investment at once if that’s important to you.

46

Leaper - I think we are having trouble giving you advice for your $10,000 because it is not clear how much you are currently contributing to your Roth. Are you currently putting the full $5,500 into a Roth IRA each year? If not, how much are you contributing to the Roth annually, and do you intend to continue to make this contribution each year? Once we know this information, we can better advise you on what to do with your additional funds.

47

I’m going to be putting the full $5500 into my existing Roth in addition to this extra $10K. I’m able to do this right now because I’ve had a full-time job for over a year. I hope I’ll be converted to full time and continue this job, but I’m not sure.

48

Thanks. That’s helpful. Starting from the assumption that you will be putting the full $5,500 into a Roth each year (and have already done so for 2013), you can not put any additional money into any IRA, Roth or traditional. So we can eliminate the IRA option for the $10,000 completely. Instead, you can open an investment account with Vanguard or another broker, deposit the entire $10,000, and then invest it based on any of the scenarios suggested in this thread. I personally think that given your small initial investment, for simplicity you might just want to put the entire $10,000 into a Vanguard index fund. You can always transfer some money to other funds as your investment grows.

49

Ah, if you’re already going to hit your $5,500 this year and continually for the foreseeable years then you do not really have a means of getting this $10,000 of found money into your Roth IRA.

A taxable account can have a place in your retirement planning, if you want this money to go towards retirement savings. Obviously taxable accounts are the least ideal mechanism for retirement purposes, but they have some nice utility. Since I was in my 20s I’ve always had a regular brokerage in addition to retirement savings because money in my regular brokerage, while invested with a mind towards the “long term” is super liquid and available anytime I want, so is all the income generated from my income generating holdings.

You can still follow any of the advice you’d like from this thread, and even do this through Vanguard. Just open an account, and select “General Savings”, then select either Individual or Joint as appropriate. Click through and you’ll come to a screen where you just enter the Vanguard fund name you are interested in, and there you go. I probably would not follow my advice on opening a general brokerage account with Vanguard. They don’t charge a maintenance fee if you’ve got a retirement account but they charge like $20/year for general brokerages in non-retirement accounts under a certain dollar value (I think $50,000.) If you want to do general brokerage activities I’d check out Fidelity, Scottrade or one of those as those discount brokerages don’t charge maintenance fees just for having a brokerage account.

50

Oh, geez, I completely forgot that the $5500 was for ALL Roth IRAs. :smack:

I guess the question then becomes whether I’m better off putting that cash into an existing IRA or starting the new one. (I have no idea if the rate of return is/would be better on a new one, frankly; I suppose I should find out, but still.)

If it helps, I have no idea how to trade on my own, and thus have no plans to, but I still want to do SOMETHING with my extra $10K.

51

No actually $5,500 is for ALL IRAs, both Roth and non-Roth. You can put a total of $5,500 per year into IRAs in general, so if you put $3,000 into a Roth, or $1500 in two Roths, you can put $2,500 into a normal IRA or split up among two normal IRAs or whatever. You can have 10 IRAs or 1, and you can’t contribute a penny over $5,500.

The only exceptions are if you’re over a certain age, they let you contribute a little more ($6,000.)

Edit: Just to leave it clear, what we’re saying is you can’t put this $10,000 into any tax-advantaged retirement plan, be it a Roth or a regular IRA, period.

52

Yeah, sorry, that was a mis-type. I think I knew that.

Now I have to figure out what to do with the $10K and the $5500 IRA contribution. :stuck_out_tongue:

53

I don’t think they’ll let you into Admiral - but for $10k (or $3k in an IRA), the fee difference isn’t really going to amount to much. They’ll allow you to convert for free once you hit the minimum.

If you want the tax advantage of whichever flavor of IRA you prefer, you’ll need to keep the initial investment within that limit. If you aren’t in too much of a hurry, you can drop $5,500 into a Roth now, and then put the other $4,500 into it Jan 1, 2014, at which point (assuming the market is up or steady) they should let you convert it to the Admiral fund.

54

Well, it doesn’t apply in this case, but there’s also the SEP IRA. I bring this up because I had been self-employed for several years, thinking $5K (at the time) was the limit for IRAs, not knowing that there was a thing called a SEP IRA that has separate limits.

55

How is your existing Roth IRA currently invested? You should be able to move that money into whatever investment you choose.

As for the $10,000, I would still recommend opening up an investment account and investing it. If at some future time you don’t have enough money to put into your IRA, you can always take some out of your investment account for that purpose. You can put the $10,000 into one or more index funds, as suggested above, and then just leave it there for the next 20 years or more until you’re ready to retire. No need to worry about trading or any of the associated fees.

56

In accounts at another company entirely. I’d have to look again to see what exactly it’s invested in.

57

Vanguard would be happy to help you transfer it to them. Might be convenient to have all accounts at the same location.

58

I haven’t kept up, being busy with clients. But two points:

  1. The over-50 limit for 2013 is $6500 with of IRA contributions.
  2. You CAN put this into IRAs if you have a spouse (which I can’t remember and don’t want to go back to check). $5K into two separate IRAs makes that work.
59

I’m sure they would, though there’s a personal angle involved in this case (my uncle — whom I do trust and am relatively close with — got me into this company and handles at least part of my account). That’s one reason I forgot about the limit.

Oh, and I’m not married, so…

60

If you want to leave your Roth with your uncle, that works. You just need to decide if you want to hang on to your $10,000 to be used for future Roth contributions, or if you want to use it to open your own investment account. If you decide to go the investment account route, it can be extremely simple and require minimum attention. Just create the account at Vanguard (or elsewhere), transfer in the money, purchase one or more index funds, and sit back and relax. I try to check my account value no more than once per month, and I reevaluate my investments only once per year.