Discuss IRAs with me, por favor.

In My Humble Opinion
1

Well, I’ve finally saved up enough to start investing in an IRA and I’ve already decided on a Roth IRA. The two companies that I’m looking at are Vanguard and Fidelity (both my father and my uncle have recommended both, as has my boss).

After going through Vanguard’s little investment quiz, it’s narrowed its recommendations down to three options:

  1. 500 Index Fund Inv
  2. Total Stock Mkt Idx Inv
  3. Growth and Income Inv.

Now, a few requests:

  1. If you have any recommendations between the two companies, I’d like to hear them.

  2. If you have any recommendations regarding specific funds, specifically the three mentioned.

  3. What do the numbers they give after it mean? This is the most important one. They give figures for yield, then one year, five year, ten year average annual total returns. But they dont necessarily make sense to me. For instance, the 500 Index has a yield of 1.51% B, but returns of 34.94%, -1.26%, and 11.61%.

So should I give more weight to the yield or the past performance? In short, what’s going on?

2

Working backwards:

  1. Yield refers to dividends paid by the fund, as a percentage of its total value. Return is the change in value of the fund – for the past year, the fund (like the market in general) has increased in share price significantly; over the last five years, the stock market has seen some drastic declines, and most funds actually lost value. Neither yield nor return is guaranteed by past performance, although most companies that pay dividends try not to change them too much. Performance is, of course, the major determinant of your IRA’s value.

  2. Index funds are an excellent place to start an IRA; they have low management costs (they should, anyway), and they’re decently diversified with an emphasis on large successful companies, which makes them a low-to-medium risk. Growth funds are higher risk, and usually invest in smaller, more volatile stocks, but they are therefore capabe of much greater increases as well. A “growth and income” fund usually has a spread of high and medium risk investments.

  3. Sorry, they’re about the same to me.

3

Take a look at this page for some more information. For your case, I can’t suggest trying to choose a fund based on any of those values, as they like to say “past performance is no guarantee of future results”, and that’s damn true.

The first two funds you listed are index funds. An index fund basically tries to keep its assets matched with whatever index it is following. As nametag mentioned, their management costs are lower because you don’t have a fund manager out there researching stocks and trying to beat the market. That’s the one thing I would make sure to look at, the expenses and fees each fund charges, those are guaranteed charges, you should know what they are.

Since I don’t think these guys can reliably beat the market, I generally lean towards index funds so I don’t have extra expenses, and don’t have to worry about how my fund manager is doing. A quick peek at the S&P 500 / DJIA, etc. and I’m happy.

4

What’s a typical rate/fee? About how much would be too much (I know it depends on the service and what I’m comfortable with, but about how much should I be expecting?)

5

I kind of feel like I left you hanging there on choosing a fund. I would choose more on the type of risk I wanted to have rather than on what fund performed well in the last year or 5 or 10. The Vanguard 500 is going to be full of big company stocks, safe, but with lower expected returns. The total stock market fund will have a wider variety of companies, bit riskier, but better average returns (in theory). A small cap fund will have many small companies, risky investments, but better returns, and you’re still protected by diversification. Couple the type of risk you’re looking to take on with the expenses each one has and you can pick the one you want.

6

I just checked out the Vanguard docs and the V500 has an expense ratio of 0.18% which is extremely low, others can go well over 1% of your holdings per year.

7

I have index funds as core holdings in my 401(k) and in my long-term non-tax deferred funds. The general wisdom is that the stock market, on average, grows by about 10% per year. (Note that this is on average- in any given year, as we’ve seen recently, the market can go way up and way down.) Now, over the long haul, about 80% of managed mutual funds do not beat the stock market. So if your investment horizon is long term, which it probably is for a starter IRA, an Index Fund is a good core holding. You can diversify with some higher risk stuff down the line, but setting yourself up with a good index fund that (to paraphrase Ron Popeil) you can set and forget is probably as good an idea as any.

8

This is great, thanks you guys.

OK, so the basic wisdom right now is leaning towards Index funds, at least at first.

And from what I’m getting so far is that the 500 is going to be a little bit riskier than the Total Stock Market index, since it has less diversity? Or did I make that mistake.

And the expense ratio. Does that mean that they’ll take .18% of my investment earnings, in addition to the $10 fee? Or is does it mean something else?

9

That means they take 0.18% of the total value of your holdings each year. For a $10,000 investment, that’s $18/year. A 0.46% expense ratio (like the Growth and Income fund) would be $46/yr, adjusted for your earnings.

On the Vanguard website, go here there are some tools including “compare costs” that will show this to you.

With respect to risk, I’m going to step a bit out on a limb and say the V500 is less risky than the total market (but I’d say they’re pretty close). Yes, it has less diversification, but it’s plenty diversified and the underlying companies are safer investments.

Risk can be divided into two parts (damned if I can remember the technical names though) There’s risk that can be diversified away, and risk that is inherent in the security itself. Inherent risk is ok because you generally earn more returns on risky investments than safe investments. Stocks are more inherently risky than treasury bonds, thus have higher expected returns (people wouldn’t buy them without higher expected returns)

The diversifiable risk is bad because you don’t earn anything for putting all your eggs in one basket, you just put your money at risk. But, once you’re diversified enough, adding more diversification doesn’t really help reduce that risk.

The large companies will have less inherent risk because of their size and maturity, they’re just not going to grow or shrink as much (percentage wise) as small companies will. Small companies will be more volatile, so you can earn and lose more, but you should get better returns in the long run, because if you didn’t people would gravitate to the safer large companies.

The total market fund will have more small stocks, more inherent risk (and return, one hopes) One of the things they told us in school was that if you take on risk, make sure you get paid for it!

10

I have a trading account with Fidelity for my IRA. It allows me to buy/sell stocks, bonds, mutual funds, and some other more obscure things if I choose to. I have found this method of setting up an IRA to be MUCH more flexible. You can also buy/sell mutual funds offered by companies other than Fidelity. All of this allows me to keep my IRA under one company, and it allows me the flexibility to change my investments, simply, online.

11

I would probably also go with ETFs instead of mutual funds. Mutual funds have too many fees involved.

Right now, my personal preference for a long-term IRA would be IOO

http://www.etfconnect.com/select/fundpages/etf_funds.asp?MFID=19078

or DGT

http://www.etfconnect.com/select/fundpages/etf_funds.asp?MFID=31693

All about ETFs:

http://www.etfconnect.com/

12

One of my 401k accounts is with Vanguard; my daughter’s ed IRA (or whatever they are called these days) is with Fidelty. I have been extremely pleased with both firms, and I believe that neither has been tainted by scandal. Their service fees are reasonable too. So far, you’re doing great.

Consider balancing your Roth with a good mix of low-risk balanced funds, bonds, hotter small caps (smaller firms that are growing rapidly hopefully) and others. My Vanguard plan has a REIT (real estate investment trust) fund that I have been pleased with–I am betting that the property in these kind of funds keep increasing in value significantly over time.

It seems like you are getting good advice in this thread.