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How to invest with Vanguard
July 21, 2014 10:27 PM   Subscribe

What are your specific investment recommendations for someone who's 25 years old, self-employed (contractor), has $130k in savings and no debt?

I've just started a Roth IRA and put it in the 2040 Target Retirement Fund, but my friend recommends the 2050 one. My other friend, however, thinks the 90% stocks and 10% bonds is too risky. Then I call a financial adviser, and he says he would be aggressive with the Roth IRA and put it in the S&P 500. With the $130K, however, he says he'd be much more conservative but wouldn't give specific recommendations during the free phone consultation. I am considering whether or not to become his client. He charges $1k a year for 10-12 sessions or $500 for 3 to 4 sessions.

So, if this was you and your money, where would you put the Roth IRA and where would you put the $130K? I may need this money in the future for a wedding and a house, but I shouldn't need all of it, and I would be saving up more money in the meantime.

I hear about "tax-advantaged vehicles" for the $130K, but I don't know what those are. Also, is it worth it to start an individual 401K or SEP IRA? I'm concerned about not saving enough for retirement with just the Roth IRA.

I would like a more hands off approach, as I don't know much about investing, as much as I've tried to learn about it. That's what drove me to consult a financial adviser.
posted by Forty-eight to Work & Money (14 answers total) 22 users marked this as a favorite
At 25, I would put it all in stocks (via S&P 500 index fund). You have decades ahead of you to ride out any upturns or downturns in the market. You do have to be emotionally prepared to deal with drops -- remember, you're not so much worried about your net worth in 5 years; it's your net worth in 40 years that matters.

You should hold out some portion of the money as a cash emergency fund -- I think the typical advice is enough to cover around 6 months of expenses.
posted by Blue Jello Elf at 10:39 PM on July 21 [3 favorites]

If it were me, I'd also probably put 100% in stocks, although I might choose the even more diversified total market index instead of S&P 500 index. For some further diversification you could consider putting a small percentage in REIT index and total bond index. I wouldn't pay the advisor $1,000. Almost a total waste of money. In my opinion, all you need to know is invest early, invest regularly (preferably with automatic contributions from your bank account), don't try to outguess or time the market, and invest only in low cost highly diversified index funds (or possibly ETFs). If you do all those things, you'll be investing in a much smarter way than many, many other people.
posted by Dansaman at 10:53 PM on July 21 [1 favorite]

Start here, with this entry on the Bogleheads wiki.

Yes, you should set up something like a SEP IRA or individual 401k, as you want to take maximum advantage of tax-deferred savings vehicles.

Bogleheads frequently recommends a Three Fund Portfolio (domestic equity, international equity, bonds), but you will be fine using the target date funds. Rule of thumb is your age in bonds, but this is a rule of thumb, not something written in stone. With the stock market doing so well, lots of people think 90/10 or 100/0 is a perfectly great allocation, but when times change, so will people's advice on this. "Age in bonds" or "age minus ten in bonds" is a time tested rule of thumb. But it's up to you to figure out what allocation will allow you to sleep at night so you don't freak out when the market drops by 10, 20, 30 or even 40%.

Whatever you will need for a wedding and a house you should consider not investing and just keeping in a savings account. Also, don't put that money into your tax-deferred accounts, as you don't want to withdraw it (you can withdraw Roth contributions tax and penalty free, but you really want them to stay in there and grow--time is your friend).
posted by MoonOrb at 11:00 PM on July 21 [2 favorites]

I would start by setting up a Roth IRA and buy solid stocks that pay a dividend (that you won't have to pay income tax on). I think that's a really smart, conservative move. Otherwise, the market's really high right now. Don't start trading. If you can afford to set some money aside, you're in a great position. Keep your focus on maintaining or increasing your earning potential.
posted by phaedon at 11:58 PM on July 21 [1 favorite]

Before anything, read Scott Adams' Financial Advice. Whatever your opinion of Adams, he covers the important financial bases as cogently as anyone. Note especially the 6 months of emergency funds.

You want to be a hands off investor, so you should consider "lazy portfolios." More from Bogleheads. The idea is this: buy just a couple of low-fee index funds (or etfs) that cover basically the whole stock & bond market, at specific allocations. At your age you really could do all stocks, or do the age-10 thing in bonds so 85% stock / 15% bonds for now. Once a year you invest more money and reallocate to match your percentages, so when you're 35 you'd be at 75% stocks / 25% bonds, etc. The rest of the year, you studiously avoid all financial news, because the absolute worst thing you can do is to try to time the market or react to something on CNBC.

The key is to keep your fees as low as possible. Vanguard index funds are like .015% fees, while most actively managed funds are in the 1-1.5% range. That really adds up over the long haul.

Finally, the Individual 401K is definitely worth it. You can put in money ($17,500 this year) AND your business can put in an additional contribution as well. Talk to an accountant about that.
posted by rouftop at 1:06 AM on July 22

And if you want to keep a portion of the 130K available for future big expenses - a house down payment or a wedding - there really isn't any trick right now to make it earn much interest AND be safe AND be liquid at any time. If you think you'll have a little lead time for such purchases (expensive weddings, at least, take a year or so of advance planning), you could go for some short-term bonds & get a couple of percent. Avoid any deals that sound too good to be true.
posted by mr vino at 4:07 AM on July 22

I second MoonOrb's recommendation to look at the Bogleheads wiki.

Because a lot of this money will probably be in a taxable account (as opposed to a tax-advantaged account like a Roth IRA/401(k)) you'll want to keep tax efficiency in mind.

Figure out what you want your asset allocation to be, and then divide it into your accounts based on tax efficiency.

Start with something like a 3-fund portfolio (US stocks, foreign stocks, bonds) and keep your emergency fund separate.

So let's say you have $135K total (including the Roth IRA), let's say you were going to start a solo 401(k) (almost certainly worth it) and let's say you'll keep $25,000 in an emergency fund. That leaves you $110,000 to invest across all accounts.

Here's an example allocation:
US stocks: 60%
Foreign stocks: 30%
Bonds: 10%

So in dollar amounts:
US stocks: $66,000
Foreign stocks: $33,000
Bonds: $11,000

Keep your bonds in your 401(k) (that will almost fill your 401(k) this year) and divide up the foreign and US stock funds between your Roth IRA and a taxable account. Use tax-efficient funds for anything that is not tax-advantaged (The S&P 500 fund is pretty tax efficient; Vanguard's total stock market fund is even more so). The Bogleheads article on tax-efficient fund placement is very good.
posted by matcha action at 5:46 AM on July 22

I hate to say it, but you're getting some pretty bad advice in this thread. Everyone telling you to put your savings into only American stocks is implicitly telling you that they think the American stock market will do better than other countries - and they have no way of knowing that.

Even worse, since you're American you're already exposed to the US economy through your job etc.

If you want stocks, Vanguard has VXUS (the entire world minus the US) and VTI (American stocks with much broader coverage than the S&P 500). You could go with a mix of the two.
posted by ripley_ at 7:36 AM on July 22

Congratulations on having so much to invest at a young age!

I wouldn't take financial advice from random people on Metafilter. The fees your proposed advisor are charging are not unreasonable but may be overkill for your situation. $1k on $130k is basically a 0.7% fee, which is a lot. Also you want to be sure that fee is all he's charging; many advisors also collect commissions or trading fees. Stay away from those advisors, it is very often a crooked business.

Vanguard has good investing advice for you to figure this out on your own: start here. Their serious financial planning services begin with $500k accounts, but the basic reps who answer questions from smaller investors can explain to you the differences in the products Vanguard offers.

If you're 25, the Target 2050 fund is a good default assumption for saving for retirement. Consider whether you're saving all that money for retirement though, or whether you may want to use some of it in the next few years for buying a house, education for potential children, etc.
posted by Nelson at 9:40 AM on July 22 [1 favorite]

Re what ripley_ said about international diversification, it's important to note that most of the companies in these S&P 500 and total market index funds have extensive international operations, and many even have more revenues outside the US than inside the US. Furthermore, some of the companies are not even pure American companies. For example, if you look at the holdings of the total market index, high on the list are such non-US companies as Schlumberger. So you are actually getting very broad international exposure with these indexes, without having to pay the higher fees of an international index fund.
posted by Dansaman at 10:08 AM on July 22 [1 favorite]

Starting a Solo 401k means that you won't have to pay tax on all the gains made by your investments, which at your income level is almost certainly worth it (30% increase in gains!). Vanguard, Fidelity, etc should all offer this - eg Fidelity offers no fees and a bunch of phone support to set it up.
posted by the agents of KAOS at 1:16 PM on July 22

So you are actually getting very broad international exposure with these indexes, without having to pay the higher fees of an international index fund.

You get some international exposure and your portfolio is still heavily skewed toward the US. The cost difference is also very small.

Vanguard's VXUS (ex-US) fund has an expense ratio of 0.14%. VTI (total US market) charges 0.05%. On the OP's $130k, that works out to about $75 extra each year ($130k*0.0009*0.65). If you ask me that's a pittance for properly diversifying your exposure by country.

(I'm assuming 65% VXUS, weighting by the countries' market caps)
posted by ripley_ at 7:38 PM on July 22

Re international exposure, from what I've read, for the S&P 500 companies, something like 40-50% of revenues and earnings come from foreign sales, so that's a very high percentage of exposure to foreign markets. I don't think whether the companies doing business in those markets are American, European, or other is particularly relevant. What might be more relevant is exchange rate fluctuations, and if you are buying indexes with foreign companies, you might be getting some benefit of hedging against currency fluctuations.

Past performance doesn't predict future performance, but I think there are reasons to like American companies. If you compare the past 10 years, S&P is up 82% vs. FTSE 57%. If 20 years, it's 328% vs. 109%. If 30 years, 1,094% vs. 538%. FTSE is just one example of a foreign stock index, but the point is, these are huge differences in returns over various long term periods of time that you wouldn't expect to see if European companies were as profitable as American companies.
posted by Dansaman at 10:26 PM on July 22

I agree that you can afford to put all of it in stocks -- you're too far away from retirement to waste potential on bonds. A good place to start is theVanguard S&P fund (VFIAX). It has a $10k minimum, which you can easily swing with your savings, and a 0.05% expense ratio. If you'd like to diversify, look into the international, REIT, or total stock market funds mentioned above.

REITs are not tax efficient, so you'd want to put them in the Roth IRA. The S&P can go in either.

I personally think gold (available as an ETF) is a good long-term position, and a hedge against market swings. It's been pretty stable the past few months after dropping steeply, so this may be the right time to buy. However, that's totally controversial, and not a very popular opinion. Certainly take it with a pinch of salt and don't put too much of your portfolio into it.

If you believe in Warren Buffet, consider buying some baby Berk shares. They've outperformed S&P by a wide margin in the long run (source).

Oh, and logistically speaking, stick to one investment provider (which seems to be your plan anyway). I have accounts in Vanguard, Fidelity, and Sharebuilder, and it's a mess, especially come tax season. I find Vanguard the best of the lot. Their brokerage fees are high, and they have a bit more paperwork than I like, but if you're not planning to trade individual stocks, it shouldn't matter.
posted by redlines at 10:36 PM on July 23

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