It was all going so well...
August 13, 2006 4:22 PM Subscribe
I'm confused - I want to plan for my retirement and have got as far as applications for a 401k and a Roth IRA; but then it all goes hideously wrong....
I am reasonably financially illiterate so I'd been reading jdroth's Get Rich Slowly and Ramit Sethi's I Will Teach You To Be Rich and ran off to open a 401k and a Roth IRA.
Stage 3 of the 401k application process is Choose Investments, at which point I have pick from 16 choices: all 16 mean absolutely nothing to me.
When I apply for a Vanguard Roth IRA and hit Learn More About Vanguard Mutual Funds, I'm told that I can "Choose from among more than 100 low-cost pure no-load Vanguard® mutual funds". I rather suspect that these 100+ mutual funds will also mean absolutely nothing to me (although I do understand the value of no-load).
So how do I learn about these things and make educated decisions? It's clear that I have absolutely no idea what's going on, but I want to get these things started now and I don't really have the time to take a degree in investment banking - how do you guys do it?
I am reasonably financially illiterate so I'd been reading jdroth's Get Rich Slowly and Ramit Sethi's I Will Teach You To Be Rich and ran off to open a 401k and a Roth IRA.
Stage 3 of the 401k application process is Choose Investments, at which point I have pick from 16 choices: all 16 mean absolutely nothing to me.
When I apply for a Vanguard Roth IRA and hit Learn More About Vanguard Mutual Funds, I'm told that I can "Choose from among more than 100 low-cost pure no-load Vanguard® mutual funds". I rather suspect that these 100+ mutual funds will also mean absolutely nothing to me (although I do understand the value of no-load).
So how do I learn about these things and make educated decisions? It's clear that I have absolutely no idea what's going on, but I want to get these things started now and I don't really have the time to take a degree in investment banking - how do you guys do it?
The Vanguard 500 (VFINX) would be a pretty good choice for your IRA. It's based on the idea that 75% of mutual funds underperform the S&P 500 when their load is factored in, so why not just create a no-load fund that tracked the S&P 500?
posted by justkevin at 4:37 PM on August 13, 2006 [1 favorite]
posted by justkevin at 4:37 PM on August 13, 2006 [1 favorite]
I'm interested in reading the answers this thread provides, but I suspect a great deal of your questions would be answered by talking with a financial advisor. Though how you find one I'm not exactly sure (except for picking blindly from a phone book or having a friend in the business).
If you belong to a credit union or know of one near you, I would start there. I plan on applying at the one nearest me. Applying online leaves a lot of questions open for me, though I do like ING Direct.
Where are you applying online? Good luck!
posted by freudianslipper at 4:39 PM on August 13, 2006
If you belong to a credit union or know of one near you, I would start there. I plan on applying at the one nearest me. Applying online leaves a lot of questions open for me, though I do like ING Direct.
Where are you applying online? Good luck!
posted by freudianslipper at 4:39 PM on August 13, 2006
If it's a 401k you will be limited to only a few choices of investments; your employer will give you a list. For the Roth IRA you can do what you want. Vanguard is a good choice for opening these accounts because they have very low costs. You should call them at 877-662-7447 and tell them your quandry. They will have some sort of answer for you. Or go to the Vanguard site; the site is simple and helpful. Honestly, an hour's reading there will set you straight.
If you're really at a loss on what to do, then maybe you should go one step at a time. Start by opening the account at Vanguard, funding it, and selecting the Prime Money Market Fund as your investment. The 3% return is paltry but it's about the lowest risk investment you can make and it's a safe and easy way to get started. Let it sit there for a few months. You can change your mind later when you have more time to research the investment options.
posted by Nelson at 4:42 PM on August 13, 2006
If you're really at a loss on what to do, then maybe you should go one step at a time. Start by opening the account at Vanguard, funding it, and selecting the Prime Money Market Fund as your investment. The 3% return is paltry but it's about the lowest risk investment you can make and it's a safe and easy way to get started. Let it sit there for a few months. You can change your mind later when you have more time to research the investment options.
posted by Nelson at 4:42 PM on August 13, 2006
This is where having some sort of investment manager is golden. There's a fairly standard survey to assess the level of risk you can handle and a few other factors, and the investment dude uses this to put together a portfolio. And then can explain this to you in a conversation tailored to your age and amount of investment.
posted by desuetude at 4:52 PM on August 13, 2006
posted by desuetude at 4:52 PM on August 13, 2006
It is confusing. But you'll be able to make different choices later, so even if your choices are imperfect, they're probably still pretty good. Most employer-sponsored funds offer a mix of risk levels, and types of funds, all of which are reputable. You're doing the most important step, which is getting started. You may want to choose an index fund, which is fairly safe, and will do as well, or poorly, as the stock market. You can move your investments to a different fund when you feel better informed.
posted by theora55 at 5:02 PM on August 13, 2006
posted by theora55 at 5:02 PM on August 13, 2006
Unfortunately, although many of the strategies suggested above are good in the abstract or for certain people, they are also full of pitfalls if you don't know what you're doing and for whom it's a good choice. Burton Malkiel's book A Random Walk Down Wall Street is the classic intro to investment decisionmaking. It's very helpful, addressing the exact questions you're dealing with. One of the best things he teaches is that "active" investment -- following the daily vagaries of the market, and actively buying/selling in attempts to beat it -- is a demonstrably futile and unnecessary drain on your capital. He teaches instead how to buy wisely for your current age and goals, then let that investment grow with minimal intervention other than annual re-balancing.
posted by nakedcodemonkey at 5:13 PM on August 13, 2006 [1 favorite]
posted by nakedcodemonkey at 5:13 PM on August 13, 2006 [1 favorite]
How old are you? If you're fairly young (say, under 30) you should be going for growth stock funds and other higher-risk investments. The reason being, your timeframe is quite long. For example, suppose you invest $10,000 each year in a mutual fund. Let's say that the fund has a really terrible year the first year and loses half its value. Your $10,000 investment is now worth $5,000! Catastrophe, right? Not really. Because you're going to put another $10,000 in the second year and this $10,000 will buy twice as many shares as your first year's contribution bought. When the fund's value rebounds (and it will, if your horizon's 30-40 years), you will make a lot more money on that half-price batch of shares than you did on the first year's. This is called cost averaging, and it's the closest thing to a free lunch there is. It means that, if you can withstand the risk that you might temporarily lose a good chunk of money, you are better off investing in a fund whose year-to-year return deviates widely from its long-term average than in a more conservative fund.
Cost averaging also means that if you are investing equal amounts in various funds (e.g. the large company, small company, and international funds suggested by echo0720), then you are automatically buying more of the fund that's undervalued at the moment (and thus more likely to increase in the future) and less of the ones that are overvalued (and thus more likely to decrease).
You can enhance this latter effect by periodically rebalancing your portfolio. Rebalancing just means that you make the balances proportional to your contribution. For example, if you're putting 33% into each of the three funds, over the course of a year, one fund may do better than the other and you may end up with, say, 40% in one and 30% in the other two. So, rebalancing will sell some shares in the one with the 40% balance, and buy more shares in the other two, such that of the balance 33% is in each fund again. This is simple buy low, sell high. A fund that is overperforming is more likely to be overvalued and thus underperform in the future, and the underperforming funds are underperforming and thus likely to overperform in the future. So you're taking profits on the fund that's been doing well and putting the proceeds into funds that are more likely to fare well in the future. Most brokers offer an automatic rebalancing feature, so you don't even have to think about it.
Once you understand this, you will see that fluctuations in the value of your holdings are not merely inevitable, they are actually good for your wealth if you manage them properly.
Now, on to how I actually picked what's in my 401(k): I looked for the lowest-fee funds offered by John Hancock (nothing more than 1%) then out of those I chose about half a dozen funds with various targets. Most of it (40%) is in a S&P 500 index fund. I put 10% or so into a bond fund, 10% into a REIT fund, 10% into an energy fund, 20% into an international fund, and the last 10% I think went into an "aggressive growth" (mostly small caps) fund. Overall my portfolio is fairly aggressive, probably a bit more than it really should be considering I'm 37, but I got a late start.
For my Roth I'm investing in individual stocks, but have been doing poorly with that. Basically I feel lucky not to have actually lost any money. I have some big winners but also some big losers. However, next year I'll buy some more of the big losers (assuming they're still big losers then) and hopefully do better with them over time -- cost averaging again.
posted by kindall at 5:30 PM on August 13, 2006 [1 favorite]
Cost averaging also means that if you are investing equal amounts in various funds (e.g. the large company, small company, and international funds suggested by echo0720), then you are automatically buying more of the fund that's undervalued at the moment (and thus more likely to increase in the future) and less of the ones that are overvalued (and thus more likely to decrease).
You can enhance this latter effect by periodically rebalancing your portfolio. Rebalancing just means that you make the balances proportional to your contribution. For example, if you're putting 33% into each of the three funds, over the course of a year, one fund may do better than the other and you may end up with, say, 40% in one and 30% in the other two. So, rebalancing will sell some shares in the one with the 40% balance, and buy more shares in the other two, such that of the balance 33% is in each fund again. This is simple buy low, sell high. A fund that is overperforming is more likely to be overvalued and thus underperform in the future, and the underperforming funds are underperforming and thus likely to overperform in the future. So you're taking profits on the fund that's been doing well and putting the proceeds into funds that are more likely to fare well in the future. Most brokers offer an automatic rebalancing feature, so you don't even have to think about it.
Once you understand this, you will see that fluctuations in the value of your holdings are not merely inevitable, they are actually good for your wealth if you manage them properly.
Now, on to how I actually picked what's in my 401(k): I looked for the lowest-fee funds offered by John Hancock (nothing more than 1%) then out of those I chose about half a dozen funds with various targets. Most of it (40%) is in a S&P 500 index fund. I put 10% or so into a bond fund, 10% into a REIT fund, 10% into an energy fund, 20% into an international fund, and the last 10% I think went into an "aggressive growth" (mostly small caps) fund. Overall my portfolio is fairly aggressive, probably a bit more than it really should be considering I'm 37, but I got a late start.
For my Roth I'm investing in individual stocks, but have been doing poorly with that. Basically I feel lucky not to have actually lost any money. I have some big winners but also some big losers. However, next year I'll buy some more of the big losers (assuming they're still big losers then) and hopefully do better with them over time -- cost averaging again.
posted by kindall at 5:30 PM on August 13, 2006 [1 favorite]
...how to buy wisely for your current age and goals, then let that investment grow with minimal intervention other than annual re-balancing.
This is a really good point, and if you have access to Fidelity funds, they make it easy by offering a series that is based on your projected retirement date (Fidelity Freedom Funds) - so if you think you'll work until 2030, you'd buy the Fidelity 2040 which is pretty risky now, but over the years as you get closer to your retirement age, they will reallocate assets to make it less and less risky (so...right now, it's probably all equity, whereas 30 years from now it will be mostly bonds). I'm sure there are other families of funds that offer similar options that make planning a bit easier.
posted by echo0720 at 5:34 PM on August 13, 2006
This is a really good point, and if you have access to Fidelity funds, they make it easy by offering a series that is based on your projected retirement date (Fidelity Freedom Funds) - so if you think you'll work until 2030, you'd buy the Fidelity 2040 which is pretty risky now, but over the years as you get closer to your retirement age, they will reallocate assets to make it less and less risky (so...right now, it's probably all equity, whereas 30 years from now it will be mostly bonds). I'm sure there are other families of funds that offer similar options that make planning a bit easier.
posted by echo0720 at 5:34 PM on August 13, 2006
Exactly what kindall said -- especially the part about how it all depends on your age. If you are young and plan to be making consistent contributions over the course of your career, you should be using the long-term horizon to your advantage: higher risk means higher return if you have time to wait out the lumps (and if you're young, you do). So, look for things marked "growth", "international", and "mid-cap" or "small-cap."
If you're older and intend to retire on your IRA funds soon-ish, then you are more risk averse because your horizon is shorter and you can't afford lots of big downward swings. Look for things marked "large cap" and "fixed income" or even just "income" (as opposed to a "growth"). Money market and certain bond funds tend to be the most conservative for these purposes.
There is a bewildering variety between these two poles, but you'd probably be fine to set up your own balance by selecting some from each category if you're in between, with a larger portion of your portfolio towards the end that better describes you.
posted by rkent at 5:40 PM on August 13, 2006
If you're older and intend to retire on your IRA funds soon-ish, then you are more risk averse because your horizon is shorter and you can't afford lots of big downward swings. Look for things marked "large cap" and "fixed income" or even just "income" (as opposed to a "growth"). Money market and certain bond funds tend to be the most conservative for these purposes.
There is a bewildering variety between these two poles, but you'd probably be fine to set up your own balance by selecting some from each category if you're in between, with a larger portion of your portfolio towards the end that better describes you.
posted by rkent at 5:40 PM on August 13, 2006
If you just want to make a simple, solid investment and get on with your life, you could put your IRA into one of the Vanguard Target Retirement Funds. You choose the fund in the family according to the year of your expected retirement, for example 2045 or 2030. This single fund will provide you with a diversified portfolio of domestic stocks, international stocks and bonds. Just plug it in and forget it. This investment will probably beat 80% of the rest of investors that are flailing about chasing winners and speculating in stocks. (As echo0720 said, Fidelity has similar funds.) These target retirement or lifecycle funds are a really great innovation for investing and I believe that most investors would be much better off if it were their only investment. They are gradually making their way in to the more enlightened 401(k) plans.
If you can find something similar in your 401(k), you would be fortunate. It should have a name like target retirement or lifecycle. If not, then the next best option would be if your 401(k) has index funds. Then you could select something simple like one-third total U.S. stock market, one-third international stock market and one-third total bond market.
For education, if you want something simple I would recommend reading "The Lazy Person's Guide to Investing: A Book for Procrastinators, the Financially Challenged, and Everyone Who Worries About Dealing with Their Money" by Paul Farrell. This simple book has some fluff, but quickly covers the basics and provides some simple cookbook portfolios. If you read this one book you would be better off than the majority of investors out there, who are pretty clueless. The idea is to just make your investment and get on with your life and not obsess over it.
If you want something a little more challenging and are the type that likes to tinker with your investments in a search for the "perfect" portfolio, I would recommend "The Four Pillars of Investing" by William Bernstein. This is slightly more mathematically oriented but nothing more complicated than reading a few tables and graphs. If you read this book you would probably be better off than 90% of investors.
posted by JackFlash at 5:43 PM on August 13, 2006
If you can find something similar in your 401(k), you would be fortunate. It should have a name like target retirement or lifecycle. If not, then the next best option would be if your 401(k) has index funds. Then you could select something simple like one-third total U.S. stock market, one-third international stock market and one-third total bond market.
For education, if you want something simple I would recommend reading "The Lazy Person's Guide to Investing: A Book for Procrastinators, the Financially Challenged, and Everyone Who Worries About Dealing with Their Money" by Paul Farrell. This simple book has some fluff, but quickly covers the basics and provides some simple cookbook portfolios. If you read this one book you would be better off than the majority of investors out there, who are pretty clueless. The idea is to just make your investment and get on with your life and not obsess over it.
If you want something a little more challenging and are the type that likes to tinker with your investments in a search for the "perfect" portfolio, I would recommend "The Four Pillars of Investing" by William Bernstein. This is slightly more mathematically oriented but nothing more complicated than reading a few tables and graphs. If you read this book you would probably be better off than 90% of investors.
posted by JackFlash at 5:43 PM on August 13, 2006
Whenever I have to pick a new investment, I always get stuck. I always think it's because there's some information I need to make the best possible decision, but really, it's just money anxiety. I bet you already know everything or nearly everything you need to to make a reasonable choice, one that's lots better than not acting. Aim for that, rather than for the best possible choice. Here are two of the basic things to consider:
1. Before you pick any funds, you need to figure out what percent to devote to stock mutual funds, bond funds, and money-markets. This depends on how long until you retire and whether you can live with fluctuation to take advantage of greater growth. Someone at Vanguard or your 401(k) provider can help you figure these percentages out if you haven't already, but if you're young and you can deal with fluctuation, you're going to want most of your retirement savings in stock mutual funds. As pointed out above, if you don't even want to do this step, a target or lifecycle fund can do it for you. Such funds usually have higher expense ratios than other funds, and certainly higher than index funds. But, if you really don't want to have to think about it at all, and if you're with a firm like Vanguard or Fidelity, they won't be outrageous. Depending what firm your 401(k) uses, the expense ratios may be much higher there, though.
2. Decide whether to go with index funds or actively managed ones. Index funds track the market, and have the lowest expense ratios. Actively managed funds have managers who try to beat the market, or match it with less risk, and they will have higher expense ratios -- slightly higher in the case of many Vanguard and Fidelty funds, and lots higher in the case of some other firms' funds. High expense ratios, like loads and fees, are one of those basic things you want to avoid.
Since you don't have a particular investment philosophy, and since lots of very informed people (like the Random Walk guy referenced above) think it's folly to try to beat the market through active management, I think you might as well go with index funds. They're the cheapest, and they simplify the rest of your decision-making about which funds to pick.
I know I'm leaving some parts of your question unanswered -- your 401(k) may not include both a stock index and a bond index among your choices, and Vanguard may have several of each. Or, you may already know that you want actively managed funds instead. I trust other, more informed posters have/will direct you further (or I can try posting some more if you follow up with additional questions).
posted by daisyace at 7:13 PM on August 13, 2006
1. Before you pick any funds, you need to figure out what percent to devote to stock mutual funds, bond funds, and money-markets. This depends on how long until you retire and whether you can live with fluctuation to take advantage of greater growth. Someone at Vanguard or your 401(k) provider can help you figure these percentages out if you haven't already, but if you're young and you can deal with fluctuation, you're going to want most of your retirement savings in stock mutual funds. As pointed out above, if you don't even want to do this step, a target or lifecycle fund can do it for you. Such funds usually have higher expense ratios than other funds, and certainly higher than index funds. But, if you really don't want to have to think about it at all, and if you're with a firm like Vanguard or Fidelity, they won't be outrageous. Depending what firm your 401(k) uses, the expense ratios may be much higher there, though.
2. Decide whether to go with index funds or actively managed ones. Index funds track the market, and have the lowest expense ratios. Actively managed funds have managers who try to beat the market, or match it with less risk, and they will have higher expense ratios -- slightly higher in the case of many Vanguard and Fidelty funds, and lots higher in the case of some other firms' funds. High expense ratios, like loads and fees, are one of those basic things you want to avoid.
Since you don't have a particular investment philosophy, and since lots of very informed people (like the Random Walk guy referenced above) think it's folly to try to beat the market through active management, I think you might as well go with index funds. They're the cheapest, and they simplify the rest of your decision-making about which funds to pick.
I know I'm leaving some parts of your question unanswered -- your 401(k) may not include both a stock index and a bond index among your choices, and Vanguard may have several of each. Or, you may already know that you want actively managed funds instead. I trust other, more informed posters have/will direct you further (or I can try posting some more if you follow up with additional questions).
posted by daisyace at 7:13 PM on August 13, 2006
A target or lifecycle fund can do it for you. Such funds usually have higher expense ratios than other funds, and certainly higher than index funds.
Nope, not at Vanguard. The target retirement funds simply pass through the low expense ratios of the underlying index funds. They do not add additional fees. The fees are exactly the same as if you owned the funds individually yourself. I do not know if the same is true of other funds of funds from other companies.
posted by JackFlash at 7:42 PM on August 13, 2006
Nope, not at Vanguard. The target retirement funds simply pass through the low expense ratios of the underlying index funds. They do not add additional fees. The fees are exactly the same as if you owned the funds individually yourself. I do not know if the same is true of other funds of funds from other companies.
posted by JackFlash at 7:42 PM on August 13, 2006
Does your company offer an employee assistance plan? It's not just for alcoholics and druggies. Last month through my EAP I had a free one-hour phone consultation with a financial planner to sort out just the kind of question you asked. He advised me on the percentages of cash/stock/bonds I should be holding based on my risk tolerance and age, and didn't try to sell me anything. Earlier I'd found a fee-only financial planner, but she wanted an exhorbitant amount of money to advise me, more than my pitiful investments were worth. So try your EAP if you have one.
posted by Joleta at 7:49 PM on August 13, 2006
posted by Joleta at 7:49 PM on August 13, 2006
If you don't know much about the funds, choose the index funds, all they do is follow the market, and are in general the most headache-free.
posted by blue_beetle at 8:19 PM on August 13, 2006
posted by blue_beetle at 8:19 PM on August 13, 2006
I would like to second JackFlash's advice--the Vanguard Target Retirement program is really easy to understand for beginners and automatically adjusts risk for you as you get closer to retirement if you discover you're the type who doesn't like to fiddle with finances. And he's right about the expense ratio being excellent, which is true in general with Vanguard funds. That alone will net you a nice little bump in your interest.
Also, since it hasn't been mentioned, the general "getting started" investment strategy I was taught was: First set yourself up with monthly direct deposits into your Roth IRA so that you will max out the contribution for the year. After that, do the same for your 401k up to your company's matching level. The reasoning behind that is that the tax savings of a Roth IRA outweigh a 401k company match, so you do the Roth first. Seasoned financial advisors might have other ideas but it seemed like a good place to start for me.
posted by bcwinters at 4:06 AM on August 14, 2006
Also, since it hasn't been mentioned, the general "getting started" investment strategy I was taught was: First set yourself up with monthly direct deposits into your Roth IRA so that you will max out the contribution for the year. After that, do the same for your 401k up to your company's matching level. The reasoning behind that is that the tax savings of a Roth IRA outweigh a 401k company match, so you do the Roth first. Seasoned financial advisors might have other ideas but it seemed like a good place to start for me.
posted by bcwinters at 4:06 AM on August 14, 2006
JackFlash: Nope, not at Vanguard. The target retirement funds simply pass through the low expense ratios of the underlying index funds.
Wow, I'm really sorry for posting incorrect information! I had no idea that there was a firm that had the same expense ratios for target funds as for index funds. In that case, they seem like a good choice to me, too. I'm glad JackFlash caught that, and I'll know to make sure I've got my facts straight before posting any more attempts at financial advice!
posted by daisyace at 4:52 AM on August 14, 2006 [1 favorite]
Wow, I'm really sorry for posting incorrect information! I had no idea that there was a firm that had the same expense ratios for target funds as for index funds. In that case, they seem like a good choice to me, too. I'm glad JackFlash caught that, and I'll know to make sure I've got my facts straight before posting any more attempts at financial advice!
posted by daisyace at 4:52 AM on August 14, 2006 [1 favorite]
If you have limited money to invest, first contribute to your 401(k) up to your company's matching level. That's free money and can double your investment. You want to make sure that you take full advantage of that. Then contribute to your Roth IRA, up to $4000. If you have money left, then contribute the rest to your 401(k), up to a maximum of $15,000.
posted by JackFlash at 7:17 AM on August 14, 2006
posted by JackFlash at 7:17 AM on August 14, 2006
I would disagree with bcwinters about maxing out your (R)IRA before maxing out the 401(k) match. The 401(k) match is a 100% return on your investment. Yes, you'll pay taxes on the 401(k), but better to pay taxes on more money.
Also, for 401(k), you might want to look at fundadvice.com. He go through a fair number of 401(k) plans, and give target portfolios. Most of these portfolios are roughly equivalent to the "lifecycle" funds earlier posters have commented on. The one plus I can see in managing your own lifecycle fund is a little more flexibility in when you re-balance the funds. I would worry that in the future, lifecycle funds could get "top-heavy" to show better returns. (That is, they move away from their target allocation to a riskier portfolio to show better returns.)
posted by printdevil at 8:50 AM on August 14, 2006
Also, for 401(k), you might want to look at fundadvice.com. He go through a fair number of 401(k) plans, and give target portfolios. Most of these portfolios are roughly equivalent to the "lifecycle" funds earlier posters have commented on. The one plus I can see in managing your own lifecycle fund is a little more flexibility in when you re-balance the funds. I would worry that in the future, lifecycle funds could get "top-heavy" to show better returns. (That is, they move away from their target allocation to a riskier portfolio to show better returns.)
posted by printdevil at 8:50 AM on August 14, 2006
This thread is closed to new comments.
And uh, sorry if this post is confusing. Lots of information, and I didn't know where to start.
posted by echo0720 at 4:33 PM on August 13, 2006