Back to Basics

For some time I’ve been posting about specific topics like CDs, I Bonds, Reward Checking accounts, Vanguard Target Retirement and LifeStrategy funds, etc. I’ve decided that it’s time to review the basics. If you want to read another perspective on the basics of investing, a good resource is the Bogleheads Investment Philosophy. Watch the video version of it if you learn better by watching and listening to someone speak. For fun, I am  writing this without referring to those resources. Let’s see how many points we agree on (feel free to check). Here we go …

Retirement Investing Priorities

You’re ready to start investing for retirement, but should you invest using your employer sponsored retirement plan (401(k), 403(b), etc.), an IRA, or something else? In general, these are the retirement investing priorities I would follow:

1. 401(k) or 403(b) to get the maximum employer match
2. Pay down high-interest debt
3. IRA (traditional or Roth) up to annual limit
4. 401(k) or 403(b) up to annual limit
5. Taxable account

Following is a discussion of the rationale for these priorities.

Vanguard Target Retirement Funds Minimum Investment Now $1,000

Vanguard recently lowered the minimum investment for its Target Retirement Funds from $3,000 to $1,000. I discussed these funds in my blog post A Single Fund Solution. The lower minimum investment makes these funds an even better way to get started investing. Now instead of having to save $3,000 to start investing in a single, well-diversified, low-cost index fund, you can get started with only $1,000.

Pick Your Poison (You Can’t Avoid Risk)

No matter how you choose to save and invest, you are taking some type of risk. This is obvious if you are investing in stocks (including stock mutual funds), but it may be less obvious if you are simply keeping all of your money in a savings account. Stocks are clearly risky, since values can fluctuate dramatically. What you may need to think a bit more about is that if you keep all of your money in a savings account, you are taking the very real risk that after taxes and inflation, your savings will lose purchasing power over the years. One of the most important steps in developing an investment plan is to think clearly about risk, and decide what types of risks and how much of each type of risk it is appropriate for you to take.

Financial Illiteracy, Procrastination and Inertia

"... it is difficult to make wise decisions about retirement savings and investment. The mistakes people make about their retirement savings have been attributed to financial illiteracy and to a number of psychological biases: misperceptions of risks; procrastination; inadequate self-discipline; inertia; and overconfidence, which leads most active investors to the illogical conclusion that each can outsmart the others." This quote is from The Squam Lake Report: Fixing the Financial System, a new book based on the work of 15 of the world’s leading financial economists. I’ve highlighted in bold the points I want to focus on in this blog post.

A Single Fund Solution

If you can’t find the time, interest or energy to learn much about investing and to manage your investments, perhaps you would be interested in investing in a single mutual fund that will provide broad diversification, and will be appropriate to invest in for the rest of your life. Types of funds that are intended to meet these goals are known as target-date, target-retirement, or life-cycle funds.

In general, target-date funds gradually lower risk by reducing the allocation to stocks each year. This is consistent with the widely recommended approach of taking more risk when you’re young, and decreasing risk as you get older. As with most other mutual funds, my favorite provider of this type of fund is Vanguard, and they are in the process of making some changes to these funds that make them even more attractive from my perspective. I’ll use Vanguard’s Target Retirement funds to illustrate how target-date funds work, and why they may be an appropriate investment for people who want a low-maintenance, prudent approach to investing.

Costs Matter

A seemingly small difference in mutual fund costs can make a huge difference in how your investment grows over many years. A 1% or 1.5% expense ratio may not sound like a lot, but compared to the 0.2% or less you will pay for a low-cost index fund, your investment returns are most likely to be severely diminished by the higher costs over an investing lifetime of 50 years or more.

Equity Index Fund Basics

In this post I’ll cover a number of concepts related to mutual funds, using the Vanguard Total Stock Market Index fund to illustrate. I use this fund because it’s an excellent fund that everyone should consider including in their portfolio. You can learn a lot about this fund at the Vanguard web site. In the remainder of this post, I’ll refer to the Vanguard Total Stock Market Index fund by its ticker symbol, VTSMX.

Your Retirement Goal

Setting goals and targets is part of the investment process. Retirement is a goal for most people. How do you determine your target for your retirement savings? This isn’t something that can be fully answered in a short blog post, but it’s something that most people probably should think more about. Here are some guidelines that may help.

Winning The Loser’s Game

Winning The Loser’s Game, by Charles D. Ellis, is one of the books on my recommended reading list. It’s not the first book I’d recommend for a novice investor, but it’s definitely worth a read if you’re serious about learning about investing. I don’t own it, but recently checked it out of the library to re-read, and thought I’d share a few key points from the book.

A Conservative Approach to Investing

Not everyone agrees that you should invest in stocks to meet critical financial goals. It’s probably a good idea to at least consider this viewpoint, and familiarize yourself with a conservative alternative investment strategy. In the end, you must decide for yourself how much risk is appropriate for you, and make your investment decisions accordingly.

Risk Tolerance

Before I get into details of the portfolios presented in the previous post, it will be useful to discuss risk tolerance, since it's so fundamental to making investment decisions.

In his book, The Only Guide to a Winning Investment Strategy You'll Ever Need, Larry Swedroe breaks down risk tolerance into three components:

1. The willingness to take risk
2. The ability to take risk
3. The need to take risk

Asset Allocation: Part 1

Asset allocation is one of the most important investment topics to understand.  At the top level, asset allocation is how you split your money between cash, bonds and stocks, each of which is a separate asset class.  There are other asset classes, like real estate and gold, but when you're getting started, you mainly need to focus on cash, bonds and stocks.  There are also further subdivisions of stocks and bonds into additional asset classes, but I'll save that for Part 2.

(Note that by "stocks and bonds" I really mean low cost stock index mutual funds and bond mutual funds, but I'll continue to simply refer to them as stocks and bonds.)

College Graduate, First Job -- How to get started saving and investing?

You've graduated, started working, and understand the importance of saving and investing for your future.  What are the very first steps to take?

Your Cash Stash

Before even thinking about investing, you should have some cash stashed safely away for unexpected expenses and expenses planned for the next 1-2 years.  Common advice is to have 3-6 months of living expenses in cash for emergency reserves, but the actual amount depends on many variables; e.g., job/income stability, other sources of funds, likelihood of various unexpected events occuring, planned expenses, etc.  Once you've given it some thought, and decided on how much you want to allocate to your cash reserves, you have to decide where to keep the cash.

The Importance of Starting Young

A friend recently told me that his daughter, in her mid-20s, wasn't thinking much about saving or investing now, but thought this was something to start thinking about in 5 years or so.  This brought to mind the many illustrations I've seen about the importance of starting to save and invest as early in life as possible.  Starting just a few years earlier can have a dramatic impact on how much money one ends up with when they retire.

Investment Account Basics

In my Facebook note version of this article, someone asked the following questions with regard to the investments I've been discussing:

1. Can you pull your money out at any time?
2. If so, do you have to pull out all of your money or can you pull out certain amounts still? I'm guessing as long at the minimum investment is still there you can pull out some money...am I right?
3. Do people invest in these funds for more of a long-term investment vs short-term?

For the answers, read on ...

What is a low cost index fund?

I started writing these articles as Facebook notes, so am copying those to here.  In a comment to my first investing note (on facebook), someone asked what a low cost index fund is.

An index fund is a mutual fund that attempts to track an index. So, first we have to define mutual fund and index.  Then I'll get into the cost aspects.

Please read on if interested ...

Low Cost Index Funds are the Way to Go for Most People

This blog is intended mainly for family and friends who want (or need) to learn more about investing. If people outside of that circle find it interesting or useful, then great.

To get things rolling, I'll mention that I'm a big fan of using low cost index funds as the core of an investment strategy. Academic research has shown that low costs are the best predictor of long term performance, and that it's highly unlikely that you'll be able to "beat the market". Therefore, the winning long term strategy is simply to own the market at the lowest cost. Note that by "the market", I don't mean just stocks (stock funds), but also bonds (bond funds).

Vanguard has the broadest selection of low cost index funds, but Fidelity and Schwab offer a few stock index funds with comparable or even lower costs.

Especially for someone just getting started with a small amount of money, Schwab is good, since their minimum investment for their index funds is only $100 (Vanguard's minimum is $3000), and their fees (expense ratios) are competitive. My 15 year old daughter Alyssa has been investing much of her allowance in a couple of the Schwab funds (Total Stock Market Index and International Index). Schwab has also just come out with some ETFs (Exchange Traded Funds) that you can buy and sell with no commission in your Schwab account.

For those with more money, and who want to use one vendor, I recommend Vanguard, since they have a better selection of lower cost bond funds than either Fidelity or Schwab (or any other financial institution I know of), as well as a broader selection of low cost stock index funds (value, small, small value, REIT, etc.). This allows you to assemble a more diversified, low cost portfolio.