(Disclaimer: I do not take responsibility for any money lost in investments based on the information presented below. My intent is to share my personal experience, and hopefully, inspire you to make an informed investment decision on what works best for you.)
Wow! That was plenty of information to take in from the previous post. Now that you have a basic idea on passive investing, the next step is figuring out which funds to invest.
In your employer’s 401(k) program or your own personal investment portfolio, there are a myriad of funds to choose from. Here is a list of funds you may have seen:
Money market fund: a type of fund similar to a savings account to store money for the short term; the downside to a money market fund is that the rate of return is very low. Investing part of your portfolio in this type of fund helps minimize risk.
Bond fund: a type of fund that invests in bonds for a guaranteed rate of return; investing in a bond fund minimizes risk in your portfolio.
Stock fund: a type of fund that invests in stocks without a guarantee of return; since stocks have a higher risk compared to bond and money market funds, the return is significantly higher. Although there is no guarantee, history has shown that over extended periods of time (10+ years), stocks have a much higher rate of return than any other fund.
At first, the list of funds can be overwhelming because the prospectuses listed are presented in an esoteric way. Stuff like investment returns over the past year, 5 years, and 10 years. Expense ratios and other nonsense fees, such as 12b-1 and front-load fees. The financial industry capitalizes on the general public’s limited knowledge on investing that many mutual funds charge 12-b and front-load fees when we do not have to.
It is recommended that we allocate most of our portfolio to stocks, especially those people who plan on being alive for at least 30 more years. The recommended allocation is 80% stocks and 20% bonds.
Depending on your employer’s 401(k) program or your own personal investment portfolio, you will have various choices to choose from.
I will focus on stocks, since that investment vehicle is where a great deal of our wealth will be generated over the years. I will discuss about funds available through Vanguard, which is what I use.
Two years ago, I signed up to join a Multi-Level Marketing Financial Services company with the hopes of earning more money on the side. I became licensed to sell insurance, but I did not pursue that side job any further, because the only way I would make money is to recruit people and sell customers insurance and mutual funds I did not wholeheartedly agree with. In addition, I needed to study for the Series 6 and 63 exams in order to actually sell mutual funds. During the numerous seminars I attended, I learned that when we deposit our money in the bank, our banks actually lend that money to other customers with an interest rate of about over 12%. The interest rates of our money saved at those banks vary, depending on the type of account, ranging from a paltry 0.01% in a savings account to a mediocre 1% in a CD account. Guess where the other 11% of that profit earned from interest goes to? You guessed it. The banks!
On a personal note, I keep about 1.5 times of my monthly expenses in my checking and savings accounts. The rest goes to investments. Many financial blogs and advisors recommend keeping at least 3 times the amount of your monthly expenses (or three months worth of expenses) in checking and savings accounts. I want my money to be working for me, not working for my banks, which is why I do not keep as much money in my savings and checking accounts. I am okay with the additional risk, especially when it comes to market swings, because time is on my side.
The primary reason why I invest in Vanguard is because the expense ratios of their funds are much lower compared to other investment companies, and do not have additional fees. The expense ratio is the cost incurred to the shareholder (that’s you!) every year to keep the fund. For example, in a fund with an expense ratio of 0.19% where you invest $10,000, you will be charged $19 each year. Almost every fund you invest in has an expense ratio.
Vanguard’s funds on average have an expense ratio less than 0.30%, whereas other investment companies have expense ratios over 1%. The expense ratio percentages and other fees may not seem like much, but over time, the costs will add up due to the power of compound interest.
There are many stock funds to choose from. Here’s a list of stock funds from Vanguard just to name a few:
S&P 500 Index (VFINX): this index funds invests in the top 500 publicly traded companies of America listed by Standard & Poor.
Total Stock Market Index (VTSMX or VTSAX): this index fund invests in all of the publicly traded US companies in the stock market; I personally invest in VTSAX because that fund provides greater diversification compared to VFINX.
Small-Cap Index Fund (NAESX): this index funds invests in stocks that have a small-market capitalization. Market capitalization is the value of all of a company’s shares. A small-market capitalization ranges between $300 million and $2 billion. You may invest in a small-cap index fund if you would like a higher risk in your portfolio in exchange for potential higher returns.
International Stock Market Index (VGTSX): this index fund invests in companies outside of the US.
REIT (VGSLX): known as Real Estate Investment Trust, this fund invests in companies that earn their revenue through real estate; this fund pays out big dividends each quarter, but these dividends are taxed according to your income tax bracket. If you choose to invest in this fund, place this fund in your Roth IRA.
In addition to the various stock market funds, you may have heard of Target Retirement Funds. A Target Retirement Fund is essentially a “fund of funds”, meaning that a certain percentage of your money is invested in a stock fund and bond fund. If deciding which particular funds to invest in isn’t your cup of tea, these funds are a good option. Every year, these funds slowly start allocating more money into bond funds, doing the calculations and rebalancing for you.
The downside to Target Retirement Funds is that you will be taxed according to your tax bracket since the funds technically “sell” and “buy” funds during the rebalancing, unless you invest in these funds in a tax-advantaged account, such as a 401(k) or Roth IRA. I previously invested in a Target Retirement Fund within my Roth IRA — the fund I invested in is VTIVX (Target Retirement Fund 2045). The 2045, in this case, indicates the “intended year of retirement”. I ended up moving my funds from VTIVX to VTSAX, since I prefer the extra risk.
When investing in Vanguard or any investment management company, there is an initial price you have to pay in order to invest in a fund. For the various stock funds I mentioned (VFINX, VTSMX, VGTSX, VGSLX, NAESX), you will need $3,000 to initially invest. For VTSAX (it is the equivalent of VTSMX), you will need $10,000 to initially invest. The difference between VTSMX and VTSAX are the expense ratios, where the latter has a much lower expense ratio compared to the former. For the Target Retirement Funds, you will need $1,000 to initially invest. When you would like to invest more money in those funds at a later time, you need at least $100 per transaction.
If investing in your company’s 401(k) program, you do not need to pay an initial price to invest in a particular fund.
To sum up what was discussed in Part Two of Noy Sauce’s Investing Series:
- There are plenty of funds to choose from.
- It is recommended to invest 80% stocks and 20% bonds in your portfolio.
- Invest in a fund with a low expense ratio and without additional fees, if possible.
- If deciding which fund to invest does not interest you, and you would like to “set it and forget it”, invest in a Target Retirement Fund within your 401(k) or Roth IRA.
- Depending on where you invest your money, there may be an initial investment fee you have to meet in order to invest in a particular fund.