When investing, you cannot control your return rate. Nobody knows how stocks will perform in a year let alone thirty. This is why it’s important to maximize what you can control — one of the most important being the fees you pay.
When searching for investments, look at the operating costs carefully. Greater returns can be offset by greater costs. An expense ratio of 2% might seem small, but since average returns are in the 2-10% range, a 2% fee can take away 20-100% of your returns. This is bad. See the table below if you need more convincing.
This is the reason why I love Vanguard index funds. Index funds in general have low fees in comparison to buying individual stocks or typical mutual funds, but Vanguard’s are even lower than most index funds. When I was younger, I used to buy and sell individual stocks at $9 per trade. Not only are individual stocks not the safest bet for investment, but if I invested $1000 that $9 fee was 0.9% of my investment. Most Vanguard funds offer an expense ratio of less than 0.4%. My Vanguard Retirement Fund has an expense ratio of 0.16%
Finding The Funds
You’ve opened a retirement account, either a 403b or IRA, but now you need to figure out what to invest that money in. Finance professionals typically recommend index funds with very low expense fees. Vanguard funds are a great place to start if you have access to them.
There are thousands of index funds that invest in various assets. Some invest in the stock market as a whole, others on bonds, and some others on emerging international markets. What to choose?
To protect yourself from downturns, try to diversify your account — invest in a little of everything: stocks, bonds, emerging markets, etc. Advisers suggest that younger professionals invest more aggressively. This means to focus a majority of your investments on stocks rather than bonds. Although stocks are more likely to suffer from a major drop (10-50%), over the long-term, they produce higher returns than bonds. So, if you are young, even if the market drops, you have plenty of time to make that back. If you are closer to retirement, a majority of your assets should be devoted to safer bonds.
Now, you could follow formulas to determine what percentage of your funds go to what, and then every year re-balance your account… or you could just use Vanguard’s Target Retirement funds. I have these. Not only are they quite inexpensive (expense ratios of less than 0.15%), but they come automatically diversified and rebalanced. This is a great fund for investors like me who have little free time on their hands.
If you don’t have access to these funds, try to find something similar or create your own mix following the model in the link in the previous paragraph. My 403b does not have full access to Vanguard funds. See the story below if you are interested.
For my 403b, I do not have full access to Vanguard’s funds, so, I created a balance similar to what is listed in Vanguard’s Target Retirement funds. When setting up my account, I was asked whether or not I was interested in low, moderate, or high risk funds. Since I am relatively young, I chose the higher risk. The account automatically setup which percent of my assets would go towards which funds. I looked into each fund, and found that a few of them had quite high annual fees (greater than 1%). So I changed the fund balance a bit to take more advantage of the low-cost funds.