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.

I Bonds: Part 2

I received a couple of questions about Series I Savings Bonds (I Bonds) since my last post. One of the questions was about interest rates, and the other was whether or not I Bonds were only a good deal if bought in May 2011. I’ll address these questions in this post, and also will cover a few additional I Bond topics; e.g., I Bond registration (forms of ownership), more on annual purchase limits, and purchasing I Bonds for a minor child or living trust. As always, if you have questions, please post a comment or email me at KevinOnInvesting@gmail.com.

I Bonds

There’s been quite a buzz lately in investing blogs and forums about I Bonds. The reason? The annualized interest rate for I Bonds purchased from May through October 2011 is 4.6% for the first six months. I’ll explain the details below, but this means that you will get a minimum return of about 2.5% if you buy an I Bond in late May of 2011 and sell it on May 1, 2012. This is a guaranteed, risk-free return that is much higher than any short-term, safe investment or savings vehicle, except perhaps for a reward checking account, and the interest is free of state taxes. The return could be even higher, depending on inflation during the second six months.

Your Retirement Goal: An Update

In my May 2010 blog post, Your Retirement Goal, I provided some suggestions for determining how much you need to save and invest to enjoy a comfortable retirement. One of the conclusions of that post may have been more pessimistic than necessary, because I assumed that the amount saved each year was constant. An alternate assumption is that you will be able to save more each year (as your income increases), hopefully at least enough to match inflation. This assumption reduces the initial savings rate. In this post I show an initial savings rate based on the assumption of increasing savings over the years. I also provide a link to a Google Docs spreadsheet you can copy and use to do your own analysis.

More IRA Tips

After publishing my last blog post about it not being too late to make a 2010 IRA contribution (you have until April 18, 2011), I realized that there is more information that could be useful in making the decision about whether or not to do so. Even if not relevant now, this information may be useful to you in the future.

2010 IRA Contribution: It’s Not Too Late

You have until April 18 to make your IRA contribution for 2010. If you don’t have an IRA yet, now would be a great time to start one. If you can afford at least $1,000, you can open an IRA account at Vanguard and use their STAR fund, which invests in both stocks and bonds. With $3,000, you can choose from most other Vanguard funds. It only takes about 10 minutes to open an IRA account online at Vanguard, and you can have the money electronically transferred from your checking or savings account into your new IRA account. If you can’t afford $1,000, then you can open an IRA at Schwab with as little as $100, and you should be able to do so in a few minutes online; Schwab offers a few good low-cost index mutual funds and ETFs. Don’t hesitate to pick up the phone and call the Vanguard or Schwab representative if you need help.

Two-Year Anniversary of Market Bottom

Today marks the 2-year anniversary of the bear market bottom on March 9, 2009, when the S&P 500 closed at 676.53. Today, March 9, 2011, the S&P 500 closed at 1320.02—an increase of about 95% from the bottom (it’s almost doubled), not including reinvested dividends.

Although the S&P 500 still is about 16% below the closing high of 1565.15 on October 9, 2007, those of us who continued to invest in stock index funds during the darkest days of the bear market have more than recovered our losses. Those who panicked and sold at low levels, and who remained fearful and did not buy back in before the tremendous gains in 2009, have suffered severe losses. Of course things could have turned out differently, and there certainly are more bear markets in our future, but at least for now, those of us who braved the storms can pause and reflect on our good fortune (at least with respect to the stock market over the last 2-3 years).

What Do You Think About Investing in ___________ (fill in the blank)?

I sometimes get asked what I think about investing in a particular type of investment; here are examples:

• Emerging Market Stocks
• REITs (Real Estate Investment Trusts)
• Gold
• Futures or Options
• Trust Deeds
• Annuities

The simple answer is that you should have an investment plan and stick to it, and not jump into a particular type of investment just because you’ve heard something about it from a friend, salesperson, or news article. For most people, a rational investment plan involves investing in low-cost stock and bond index funds, and using FDIC/NCUA insured deposit accounts, such as CDs and high-yield savings and checking accounts, for short-term reserves.

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.

CD Update

Certificate of Deposit (CD) rates have decreased a bit since I first wrote about the Ally Bank 5-year CD and the PenFed 7-year CD. As of today, the Ally Bank 5-year CD APY is 2.40%, and the PenFed 7-year CD APY is 3.25%. The Ally 5-year CD still works well for taxable accounts, but I now prefer the PenFed 5-year CD at 2.75% APY for IRA accounts because of the smaller early withdrawal penalty (explained in more detail later).

PenFed 7-Year CD

I recently initiated the process to do a partial rollover (transfer) from a money market in my Fidelity IRA account to a 7-year IRA CD at Pentagon Federal Credit Union (PenFed). The CD rate is 3.5% through the end of November 2010, and the withdrawal penalty is one year of interest (if you withdraw funds from the CD before one year, you sacrifice all interest, but get all of your principal back). Following is a summary of my experience with PenFed so far, and the reasoning that led me to go for the PenFed CD.

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.

Ally Bank 5 Year CD

With interest rates so low, one of the best deals for fixed-income investing in a taxable account is a 5 year CD from Ally Bank. One advantage of Ally CDs is that the penalty for early withdrawal is only 60 days of interest, as compared to 6 months to 1 year of interest at other banks and credit unions. Currently Ally Bank doesn’t offer CDs for IRA accounts (although they plan to in the near future), so the 5 year CD I’m recommending only makes sense if you have quite a bit of money in a taxable account. Following are some more details about why this CD might make sense for some of you.

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.

Paying Down Debt as an Investment

Paying down debt should always be considered in making investment decisions. For example, paying off high-interest credit card debt is almost always your best investment. Paying down lower-interest debt, especially if the interest is tax deductible, is a harder decision, but it should be considered. Let’s look at some examples to illustrate the tradeoffs.

Your International Stock Allocation

By investing in stocks or stock mutual funds you are investing in businesses. Should you invest only in the businesses of your home country, or is it wise also to invest in businesses in other countries?

Investment Return: Price Change, Dividends, Inflation and Taxes

Investment return consists of price change and dividends (or interest), but you also must consider the impact of inflation and taxes in determining your true return. In this post, I look at the impact of price change, dividends, inflation and taxes on an investment in the Vanguard Small-Cap Value Index fund over the 10 years ending 8/2/2010. In the remainder of this post, I’ll refer to the fund by its ticker symbol, VISVX.

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.

Risks of Investing in Individual Stocks

For the vast majority of individual investors, investing in individual stocks, as opposed to mutual funds or ETFs, is a losing strategy. This assertion is based on financial theory and vast amounts of empirical evidence. Unfortunately, most of my own experience also is consistent with this assertion.

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.