Index fund advice, please.

June 15, 2008 5:54 PM

Should I put my savings into an index fund? If so, how?

I have about $25,000 in savings, and I don't know all that much about investing. I'm looking to invest the money over a pretty long period of time (20 years or possibly even longer). I should also mention that I'm pretty young.

One thing I have heard time and again is that index funds are usually a pretty good bet (and that they almost invariably beat mutual funds) for anyone who doesn't want to invest actively because (a.) they're about as diversified as it gets (b.) the fees are lower since they aren't actively managed.

Here's what I'm wondering:
(i.) I've heard there are different types of index funds. Where can I learn about which type to pick?
(ii.) Once I've picked one, how do I go about putting my money into it?
(iii.) Are there any reasons why investing mostly in an index fund might be a bad idea?

posted by JamesJD to work & money (20 answers total)

1) There are many different types of index funds, all following different indexes. You probably want a broad US large-cap index (such as S&P 500 or Russell 1000) or a total-market index (Russell 5000), an international index, and possibly a small amount of a real-estate index, a commodity index, and a bond index. Or, there are other funds that automatically invest in underlying indexes based on how long you have until retirement (lots of stocks early on, moving more toward bonds as your retirement approaches).

2) You open a brokerage account and start buying shares of a mutual fund or an exchange-traded fund. ETFs are basically mutual funds that are bought and sold on the stock market like a stock. They are nice because there is no minimum to get into them, as there is with some mutual funds. You have to pay a fee to buy or sell them (just like a stock), but since you have $25,000 you can get a Wells Fargo WellsTrade account, which gives you 100 free trades a year. Whether you go with a standard mutual fund or an ETF, though, you want to look at the ones offered by Vanguard, as they usually have the lowest fees.

You might want to look into a Roth IRA. You can only put in $5000 a year, so it would take you five years to get all your money in, but once it's in, you will never pay taxes on what you earn.

You also want to contribute regularly so you can take advantage of cost-averaging. Basically, by buying constant dollar amounts of indexes (monthly, quarterly, or even annually), you buy more shares when the market's down, which benefits you greatly when it comes back.

3) No, index investing is a great idea. Most actively-managed funds fail to beat the index. You should read "A Random Walk Down Wall Street."
posted by kindall at 6:12 PM on June 15, 2008

Putting $ in index funds is a good idea. It's simple... open a discount brokerage account, buy the fund, you're done.

HOWEVER the question is which index fund. If you were to put all your $ in a US equities index right now you'd stand a pretty good chance of being wiped out semi-completely if/when the dollar collapses and GD2 (the second great depression) ensues. Not saying it's gonna happen, but many people privately think it may. It's not a great time to be in US equities.

The smart thing to do is to occasionally switch between index funds.

IMO the simplest way to do this is to check Decision Moose each week. The Moose is actually a fund manager giving his private opinion of which index is the best to be in. Right now he's recommending either a T-Bill index fund (if you're risk averse) or a Latin America index (if you're greedy). Personally I'd go with the T-Bills. If you're really down on the Yankee dollar (I am), go with a Canadian T-Bill index.
posted by unSane at 6:47 PM on June 15, 2008 [2 favorites]

If you were to put all your $ in a US equities index right now you'd stand a pretty good chance of being wiped out semi-completely if/when the dollar collapses and GD2 (the second great depression) ensues.

You also stand a good chance of losing your money if a meteor the size of Texas wipes out the Northern Hemisphere or if a giant lizard wipes out New York City.

Your best bet is almost certainly something like an S&P index fund unless you feel like putting in a lot of time learning about investments. Don't listen to people advising you to invest in Latin America as a safer bet than the US market. That's a bold assertion.
posted by Justinian at 7:09 PM on June 15, 2008

Vanguards pages for their index funds have good descriptions, including information about the funds investment strategy, who should invest, etc.
posted by PueExMachina at 7:25 PM on June 15, 2008 [1 favorite]

If you want to fire and forget for the next 20 years, an S&P index is (probably) safer than a Latin American fund. If you're willing to change funds once every three months or so, there are vastly better places to have your money. I don't think most Americans have the slightest conception of how much trouble their economy is really in.
posted by unSane at 7:27 PM on June 15, 2008

And I don't think most people prophesizing doom know much about economics, but there you are.

James: this it the problem you're going to encounter asking for advice like this. You have no way of evaluating the advice you are getting because you don't know anything about investing. Is unSane correct that we're all doomed economically? Am I correct that there have been people predicting the end of the financial world as we know it for the last 30 years and we haven't seen it yet? Is PueExMachina correct that Vanguard is good way to go? (He is, by the way). The simple fact is that you don't have the background to evaluate the answers.

So I'm going to have to retract the idea of an index fund and advise you to talk to a financial adviser. You're young and you have $25,000 dollars to invest. That's a very good place to start, but you need someone with a responsibility to give you good advice. Otherwise you're likely to listen to the wrong person and end up doing something you might not really understand.

Failing that, Vanguard really is a good company for plopping your money in a couple funds and forgetting about them and things like "Decision Moose" are not places that a naive inexperienced investor should be using.
posted by Justinian at 7:34 PM on June 15, 2008

Yes. Buy index funds. A couple things:

1) Pick a couple index funds from the Money 70 list of mutual funds. A key element of an index fund is the expense ratio. That is the percent of your money used to maintain the fund. Index funds have low ratios, think .1%-.2%, no more. Also, buy no-load funds, so that you don't pay any fees upfront. Otherwise, the funds for a particular index are quite similar.

2) Ignore the post about the US economy tanking (take a look at this good 10 rules of investing article at MarketWatch for a long view). But do diversify your index investments. Perhaps 40% in the S&P 500, 20% in a mid-size company index (like VIMSX), 20% in a small-size company index, and 20% in foreign indexes. A sample allocation for a 20 year-old is here.

3) You can open an account at Charles Schwab, etrade, Fidelity, or Vanguard. All should be able to have no-fee accounts for you with no-fee index funds available. You should consider tax-advantaged accounts like a Roth IRA, if you are saving for retirement.


In short, kindall's advice is quite good. unSane's does not represent the standard conservative thinking on the subject of investing (sorry unSane), which has proven that, in general, trying to time the market is, in the long term, much less effective then investing in market indexes and holding them. Over the last thirty years, for example, the S&P 500 index fund from Vanguard has averaged 11% a year.
posted by blahblahblah at 7:39 PM on June 15, 2008 [1 favorite]

For the long haul, look no further than China. A China index fund will give you the most bang for your buck in the long run.
posted by Zambrano at 7:46 PM on June 15, 2008

After seeing all the conflicting advice here, I am going to agree with Justinian. Talk to a financial advisor first.

I know that Justinian, kindall, and myself are giving you the conventional, and smart, advice on this subject (put most of your money in US index funds, allocate a smaller amount to riskier foreign funds), but you have no way to know which of the many posters here are correct, and you shouldn't take it on faith.

Go to your local Vanguard, Fidelity, or Schwab brokerage and start asking questions. Read Smartmoney or some other mainstream investor site. Don't trust us sketchy people on the internet.
posted by blahblahblah at 7:51 PM on June 15, 2008

Limited Menu: Choose Only 3". Reprinted from the Wall Street Journal. Very good short piece.
posted by alms at 7:56 PM on June 15, 2008

I don't want to get into a pissing match with Justinian. I just happen to think that 'index fund' doesn't have to mean the S&P 500 and that if you're willing to do some minimal research you may find more interesting places to put your money, especially if you're young. For ETFs, I like what iShares is doing. I think you are on the right track.
posted by unSane at 8:06 PM on June 15, 2008

Well, if you believe Warren Buffet (which many people do), an actively managed hedge fund with fees can't beat a no load index fund (like the S&P 500). This was on Boing Boing just the other day.
posted by stovenator at 8:38 PM on June 15, 2008

I have most of my money in index funds but in different ones: S&P500, small cap, foreign and a little bit in bonds. Seems to be working out OK.

I also have a very small amount of money for individual investments but this is because I am trying to learn more about investing. I stick to companies that work in fields that I know, for the most part which also seems to be working out OK.
posted by fshgrl at 8:57 PM on June 15, 2008

You might want to consider a Roth account for the initial 25K as you've already paid taxes on it once, I'm assuming. Why pay taxes twice?

UnSane: "The smart thing to do is to occasionally switch between index funds." Wouldn't this create a tremendous tax bill when you switch between funds if the account is not tax-deferred?
posted by webhund at 9:43 PM on June 15, 2008

For ETFs, I like what iShares is doing.

I like iShares too. I have a bit of their Emerging Markets fund (EEM) and Latin America fund (ILF). ILF has doubled in about two years, and EEM has doubled in about three. I have small positions in a number of other ETFs that I add to on occasion. (A couple that particularly tickle my fancy are the FocusShares SINdex, PUF, and Claymore Spinoffs and Mergers, CSD, both technically index ETFs although it stretches the definition quite a bit.)

Even if you're mainly an index investor, it can be fun and sometimes quite profitable to have a little bit in a specialized ETF like that. These can be a good way to play momentum sometimes, or to build a position in a sector that's been beaten down. (I personally am buying a little VFH each quarter since eventually, the financial sector will hit bottom and start coming back.)
posted by kindall at 11:29 PM on June 15, 2008 [1 favorite]

James in response to your three questions, the best thing you can do is learn about the markets yourself.

Even if you were to retain a financial adviser, they can and sometimes do make mistakes. The only person you can really trust with your money is yourself.

In my profile I maintain a set of links to financial news and other resources, as well as plan that will help you become a Student of The Markets.

Even if you were lucky enough to retain the most talented financial adviser in the business, there is absolutely NO DOWNSIDE to being able to ask intelligent questions of this professional. In fact you'll get a lot more out of this professional relationship as you'll be learning - and earning - at the same time.

If you've got any questions don't hesitate to email.

PS - these comments of yours "(a.) they're about as diversified as it gets (b.) the fees are lower since they aren't actively managed." tell me you've already got a good grasp on the issues.
posted by Mutant at 12:55 AM on June 16, 2008 [1 favorite]

Don't start choosing funds until you've done the following:

Set aside 6-12 months of living expenses in the highest-yielding money-market fund you can find. Investing in stock index funds is for your long-term money only. Having a financial cushion that you can access immediately will give you the freedom to take more risks in your life, and one day if you get sick or laid off in a bad economy, it might save your ass.

Meet with a tax advisor and figure out the best way to max out the money you put in a tax-deferred retirement account. The differences between index funds and portfolio allocation strategies are far less important than the hit you take from taxes. The money you pay for a competent tax advisor will pay itself back many times over.

Read and understand the following books:
The Intelligent Asset Allocator
10 Steps to a Perfect Retirement Portfolio
All About Index Funds

I second the advice to spend some serious time on Morningstar, but pay more attention to a fund's alpha, beta, and fees than to Morningstar's ratings. The books will help you understand this more.

If you do meet with a financial advisor, ask them straight up how they get paid. Financial advisors will naturally recommend things to you that increase their personal sales commissions.

Consider the customer service you want. I live overseas, and for me Fidelity's customer service is superlative. I can write checks and transfer money between funds and my bank account easily. Vanguard often has better funds, especially for small-caps and foreign stocks, but my experience is that their telephone support is much worse than Fidelity's.
posted by fuzz at 2:57 AM on June 16, 2008

I will make this simple for you. You can research all you want, but the summation of that research will come down to this:

Keep at least a month's worth of expenses in a high-yield savings account. You will get much better rates online than at your bank. Two good ones are Ing Direct and Emigrant Direct.

Pay off any credit card debt.

Put the rest in the Vanguard Target Retirement 2050 Fund (if you are under 25) or the Vanguard Target Retirement 2045 Fund if you are 26-30.

That's it. You can take care of everything online in a couple hours.
posted by designbot at 7:53 AM on June 16, 2008

Don't start choosing funds until you've done the following:

Set aside 6-12 months of living expenses in the highest-yielding money-market fund you can find. Investing in stock index funds is for your long-term money only.

This is spectacularly good advice (although I'd do more like 3 months at your age). I can't tell you how many times I took months off work to travel or follow my own pursuits and consequently went completely broke in my 20s. Had a lot of fun doing it but it would have been nice to have that cushion for the unexpected car-repair or dental bill I hadn't budgeted for.
posted by fshgrl at 6:56 PM on June 16, 2008

Nthing Vanguard and their Target Retirement funds. They are a mix of US and international stock market index funds and bond market index funds, automatically adjusted for growth vs. safety as you age.
posted by Jacqueline at 7:11 PM on June 16, 2008