Indexed mutual fund vs ETF vs Roth Ira for supplemental retirement savings

Okay so I am having a hard time wrapping my head around the pros and cons of different ways to start setting a bit aside for a retirement investment. I have finally reached the point where I am able to set a bit extra aside and so I want to get a long term indexed market investment set up. I was hoping I could get a bit of advice.

My situation. I’m 32, my wife is a year older than me. We are looking to start small. I am self employed so traditional 401k and whatnot is out of the question, though I do have a small amount set aside in one from before I became self employed.

I want something with minimal fees and some liquidity so a Roth honestly seems like it’s out of the question (I am not looking for anything tax deferred right here. That’s something I have taken care of), but maybe there are advantages I am not seeing. And then I can’t really figure what the difference between an ETF and an indexed fund at Vanguard would be for me on a practical level. If they are both indexed to the S&P what’s the real difference (to me, I am pretty sure I understand how they function differently).

So what do you guys think? If you were going to start putting a bit into an investment fund, what would you choose?

First thing is to maximize your contributions that will receive favorable tax treatment to the extent you can afford to lock that money away and not touch it until retirement. It really is the best bang for the buck for retirement savings. Really. Do this first if you can afford to. Roth IRA. Self-employed 401k. SEP IRA. SIMPLE IRA. Whatever.

Once you have hit your maximums for tax deferral, or if you want to save for a medium to long term goal before retirement, then indexed funds are an easy way to get market performance with minimal management fees. ETF’stend to have lower fees and often take smaller investments than an index mutual fund. You might find index funds geared to track some subset of the market (say a particular international focus) where there is no comparable ETF.

Huh. If I m looking at something tax deferred if there a significant difference between an SEP IRA and a Self employed 401k?

Looks like you can contribute more to a SEP IRA each year. Limit is about $53,000 on what you can put into the account and get tax deferral.

Self-employed 401k limit is lower, $18,000 with additional catch up contributions allowed for those over age 50.

Not a bad idea to talk to an investment adviser to choose which types of tax advantaged accounts would be best for you.
SEP, SIMPLE, 401k, Roth, etc… are all essentially labels that you can place on a retirement account. You can invest in a variety of investments (stocks, ETF’s, mutual finds, bonds, etc…) within that retirement account.

Be sure to think about if you’ll ever need to pull a backdoor IRA maneuver. Some accounts make that more complicated.

If Vanguard is your broker, the practical differences between a Vanguard mutual fund and a Vanguard ETF are going to be minimal. For a new investor, I would recommend the mutual funds, as buying and selling them is quite straightforward and you can issue your buy/sell orders at any time without worry. With ETFs, you really need to issue your orders during trading hours.

At small amounts, the MER (fee) on the mutual funds will be a bit higher than what you would pay on the ETF. However, when you only have a small amount invested, the additional fee is going to be at most a couple of dollars per year – it’s really not worth worrying about. And once you have enough money invested, your mutual fund investments get their fees reduced to something on par with the ETF fee, so this really isn’t anything to ever worry about. IMO, the most important thing is that you invest in something simple enough for you to feel comfortable with what you’re invested in.

What you are forgetting is that with a Self-employed 401(k) (also called Solo 401(k)), you are both the employer and employee and can contribute as each. As an employee you are limited to $18,000 but as the employer you can also contribute 25% of net earnings. There is still the overall $53,000 limit that the SEP-IRA has, but with a Solo 401(k) you are allowed to contribute more at lower incomes.

Note that in both cases the 25% of net earnings actually works out to be 20% when you take into account self-employment taxes, where the employer portion is first deducted from the net earnings.

Example: self-employed earnings of $100k.

SEP-IRA: limit = 20% of net earnings = $20,000.

Solo 401k: limit = $18,000 + 20% of net earnings ($20,000) = $38,000.

See here.

That’s extremely helpful.

Eventually I will talk to an actual investment advisor, I know many, but I want to know what I am talking about when I go talk to them.

This is totally off topic, but it’s my thread:

if I form an s Corp (a real possibility for 2017) does that screw with any of this? At that point I would be an employee, sorta kinda.

Sounds like the mutual fund is really the way to go all other things being equal then. Thanks.

A Roth-type account, assuming you can do so while being self-employed, is actually ideal for you. If your wife is employed for wages, she certainly can contribute to a Roth IRA - her workplace may even have a Roth 401(k) available (mine does).

You’ve got some liquidity regarding the actual amount of money you put in, just not the earnings - e.g. if you put in 10,000 and in a few years it’s grown to 15,000, you can access the 10,000 without penalty or tax impact. Obviously I recommend against doing that except in the direst of need.

And a Roth - or any other retirement account - can typically be used to invest in almost anything - Vanguard et al have hundreds of funds you can direct your money to, and there are even self-directed IRAs you can use to invest in things like real estate or gold or the like.

It has been a while since I looked into it, but can’t you do a Roth IRA and buy index funds within it? That was my plan after listening to some books on the subject. I was just going to go with Vanguard index funds that mirror the top 500. Maybe I misunderstood. I hope to finally start putting money back myself this year for retirement. I too am self-employed, though farther down the road than you are (translation - older).

Yes. “Roth IRA” is simply the tax status of your investment; “index fund” is what the money is invested in. When you open a Roth IRA account or deposit additional money into it, you can choose what fund to invest it in - index fund, non-index fund, bond fund, target date fund, whatever.

Thanks for the confirmation. I hope to do so this year for the first time.

I believe you’re still able to do it for last year as well. The annual contribution limit for a Roth IRA is $5500 and I think you have until April 15 to contribute. If hitting the limit for 2016 could even possibly be an issue and you have the money now, it would probably be best to contribute for 2015, but you have to do so in the next month. I know Vanguard lets you do this; it’s as simple as ticking a radio button when you purchase the mutual fund.

The biggest difference is expense ratio and trading fees. For the S&P 500 you have:

VOO - ETF at 0.05% expense ratio
VFINX - Mutual fund at 0.17%. $3,000 minimum
VFIAX - Mutual fund at 0.05%. $10,000 minimum

It looks like they’re all free to trade if you have a Vanguard brokerage account. So the best option is going to be the ETF.

Unfortunately, the likelihood of me ever hitting a limit is low with our income. I had hoped to do so for last year but had an unexpected $3000 expense that killed that dream. So, hopefully my wife and I can put some money away this year. I don’t want to end up like my parents have nothing for retirement. Trying to make better decisions and to do better even though they set the bar pretty low.

The thing is, if he’s just under the minimum balance with $9999, the mutual fund is going to cost him about $12 per year. If he has less invested, the fee difference will be even less.

Meanwhile, with the ETF he has to trade within NYSE trading hours on business days (9:30EST through 4PM), learn what times of day to avoid trading (don’t trade in the first or last 30 minutes of the trading day, don’t trade international ETFs if the market that they track is closed, etc) and learn to use limit orders.

$12/year is not a lot to spend to make his life significantly simpler.

I used to be a big fan of index funds, but there is one problem. Because there is so much money invested in these funds, the stocks in the indices (whether the Dow Jones, S&P 500, etc) tend to be overvalued (because more money is chasing after them for no reason except they are in the index). Hereis a NY Times article on the situation.

This would not keep me from putting some of my money in an index fund, but I would put some money into an actively managed no load fund.


That article was just the typical fear-mongering perpetuated by active managers who are getting killed by Vanguard. Put your money in total market index funds that invest in basically every stock available on the market and the problem is solved without paying 1+% of your money.