17. Challenges of retiring early.
Let's say you have saved $600,000 by age 55 and you are thinking about retiring early. Let's discuss the challenges of this approach.
Savings Calculator - This should be your first step. Run your numbers through a couple of online retirement calculators to see if they think you can retire early. CNN/Money has a great one. AARP and Fidelity are good as well. Run them all and get a good concensus.
Health insurance - This is a biggie. If you can not wrangle your Health insurance, retiring early will be a huge challenge. You are not eligible for Medicare until age 65 (currently). So that leaves 9.5 years that you need to cover your own health coverage. Consider using a high deductible health plan paired with a tax differed HSA to get you through this period. If you are self employed you are already familiar with these challenges. Ironically it may be easier to pull the trigger and retire early if you are self employed.
Less Tax sheltering - If you stop working and have no earned income you can not participate in an Roth/IRA. The US government considers earned income as Wages, Salary, Tips, Union strike benefits, Long term disability, and Net earnings from self employment. This means your tax differed accounts must carry themselves with growth and dividends alone. Obviously you will no longer be able to participate in your 401k/403b once you retire. This means your only tax shelters left are tax exempt bonds and annuities. I hate annuities. They are an insurance product so they are not regulated by the SEC and have no guarantee either. If the insurance company goes out of business kiss your money goodbye! More on the evils of annuities in a future post.
4% withdraw rate - The rule of thumb for a withdraw rate retiring at age 65 is 4%. This should allow you to make it to age 100 without running out of money. If you retire early this percentage has to drop. If you can live on 2%-3% of your portfolio at age 55 then you might be a good candidate for early retirement.
Social Security - Currently you can start receiving (reduced) SS benefits at age 62. This will probably be increased to 63 or 64 very soon. If you want to make sure you get your full benefits you currently have to wait until age 65-66 depending on the year you were born. Can you live on only your money for 9.5 years?
You are not eligible to withdraw from your Roth/IRA - Until you hit age 59.5 you can not touch your Roth/IRA accounts. If you do you will be hit with ordinary income taxes plus a 10% penalty. That leaves you 4.5 years before you should take any money from your Roth/IRA accounts. You can start withdrawing from your 401k/403b at age 55. This is one of the only arguments for waiting to roll-over your 401/403b into your IRA. Can you live on your regular savings/brokerage and 401k/403b accounts for 4.5 years?
The exception - Internal revenue code 72(t)(2)(a)(iv) - There is a way to start tapping your Roth/IRA before age 59.5. You must take "substantially equal periodic payments." To be honest this option gets me a little nervous. If I were to employ the 72t option I would use my accountant to help me through the details. I have included some sites that do a better job explaining 72t than I ever could.
http://www.retireearlyhomepage.com/wdraw59.html
http://www.section72.com/html/72_t_.html
http://www.irs.gov/pub/irs-drop/rr-02-62.pdf
Thursday, March 22, 2012
Wednesday, March 14, 2012
16. Adjust your asset allocation as you age.
16. Adjust your asset allocation as you age.
As you age you will need to adjust your asset allocation. When you get closer to retirement you want to ratchet down risk and build up your stable investments. If you experience a set back in your 20's you have plenty of time to recover. If you get hit in your 60's it will lower the income you have in retirement. You may even have to work longer.
Since I have a slightly above average risk tolerance I set my stable investments to my age. I let it get a little equity heavy as I progress until I hit the 5th year of that tolerance level. I do this to add a little bit of risk tolerance to my portfolio. I am 41 years old and my current asset allocation is 60% Equities and 40% Stable investments. I will keep this allocation until I hit 45.
At age 45-50 my asset allocation will be 55% Equities and 45% Stable.
At age 50-55 my asset allocation will be 50% Equities and 50% Stable.
At age 55-60 my asset allocation will be 45% Equities and 55% Stable.
At age 60-65 my asset allocation will be 40% Equities and 60% Stable.
At age 65-70 my asset allocation will be 35% Equities and 65% Stable.
At age 70-75 my asset allocation will be 30% Equities and 70% Stable.
At age 75-80 my asset allocation will be 25% Equities and 75% Stable.
At age 80-85 my asset allocation will be 20% Equities and 80% Stable.
At age 85-90 my asset allocation will be 15% Equities and 85% Stable.
At age 90-95 my asset allocation will be 10% Equities and 90% Stable.
When you re-balance your portfolio it's a great time to check your asset allocation and adjust for your increasing age. Your risk tolerance may change over time as well. The rule of thumb is to set your stable investments to match your age. If you have more risk tolerance you can subtract 10% from your age, If you are more pessimistic about equities you can add 10% to your age. These are extremes in risk tolerance. I would not in percentage exceed + or - 10 of your age.
In your 50's you may want to start trading in bond funds for individual bonds. The reason for doing this is that individual bonds have a face value that you can count on. A bond fund can theoretically lose all of its value. Individual bonds add even more stability to your stable investments. Some financial advisers prefer individual bonds for life. While this would be ideal, the individual bonds would require more homework or an adviser who is adept at bond picking. More on using a financial adviser when nearing retirement in future posts.
As you age you will need to adjust your asset allocation. When you get closer to retirement you want to ratchet down risk and build up your stable investments. If you experience a set back in your 20's you have plenty of time to recover. If you get hit in your 60's it will lower the income you have in retirement. You may even have to work longer.
Since I have a slightly above average risk tolerance I set my stable investments to my age. I let it get a little equity heavy as I progress until I hit the 5th year of that tolerance level. I do this to add a little bit of risk tolerance to my portfolio. I am 41 years old and my current asset allocation is 60% Equities and 40% Stable investments. I will keep this allocation until I hit 45.
At age 45-50 my asset allocation will be 55% Equities and 45% Stable.
At age 50-55 my asset allocation will be 50% Equities and 50% Stable.
At age 55-60 my asset allocation will be 45% Equities and 55% Stable.
At age 60-65 my asset allocation will be 40% Equities and 60% Stable.
At age 65-70 my asset allocation will be 35% Equities and 65% Stable.
At age 70-75 my asset allocation will be 30% Equities and 70% Stable.
At age 75-80 my asset allocation will be 25% Equities and 75% Stable.
At age 80-85 my asset allocation will be 20% Equities and 80% Stable.
At age 85-90 my asset allocation will be 15% Equities and 85% Stable.
At age 90-95 my asset allocation will be 10% Equities and 90% Stable.
When you re-balance your portfolio it's a great time to check your asset allocation and adjust for your increasing age. Your risk tolerance may change over time as well. The rule of thumb is to set your stable investments to match your age. If you have more risk tolerance you can subtract 10% from your age, If you are more pessimistic about equities you can add 10% to your age. These are extremes in risk tolerance. I would not in percentage exceed + or - 10 of your age.
In your 50's you may want to start trading in bond funds for individual bonds. The reason for doing this is that individual bonds have a face value that you can count on. A bond fund can theoretically lose all of its value. Individual bonds add even more stability to your stable investments. Some financial advisers prefer individual bonds for life. While this would be ideal, the individual bonds would require more homework or an adviser who is adept at bond picking. More on using a financial adviser when nearing retirement in future posts.
Friday, March 9, 2012
15. Save for your goals.
15. Save for your goals. Down payment on a house. college fund for your kids. Vacation of a lifetime. etc....
Let's say you want to save for a down payment on a house and save for your child's college education. The college savings is a long term goal and the down payment is a short term goal.
Go to your companies payroll dept or person and ask to redo or update your direct deposit form. Have two predefined amounts deposited in two separate accounts. The Down payment savings should go to a liquid savings account that has as good of an interest rate as possible. I would use an online savings account for this. You should be able to find 2% out there. Check bankrate.com for the best interest rate. The college fund should go to a 529 tax exempt education savings plan. The 529 is tax advantaged so it's the obvious choice for educational goals. More on 529's in a later post.
If your goal was more than 5 years out and not educational I would recommend using your online brokerage account. That way you could invest the money long term.
For the self-employed. You need to treat these monthly savings goals as if they were bills. Put the monthly amount and the goal down in your budget. You can use an online bill pay service to set up regular monthly deposits. It's as close to auto-pilot as you can get while self-employed.
If you have a specific amount as a goal lets say $2000 in two years. Divide 2000 by the number of pay periods between now and then, in this case it's 52. That gives you $38.46 or $39 deducted from each paycheck. You can redirect multiple amounts to multiple accounts. You won't even notice it's gone. This is how I fund my wife's Roth IRA. The self-employed divide 2000 by 24 months which gives you $78. Pay $78 per month to your goal account as if it were a bill.
Looking at your goals totals can be overwhelming. Breaking them down to small monthly chunks makes it much easier. If you can save for those goals on auto-pilot, even better.
Let's say you want to save for a down payment on a house and save for your child's college education. The college savings is a long term goal and the down payment is a short term goal.
Go to your companies payroll dept or person and ask to redo or update your direct deposit form. Have two predefined amounts deposited in two separate accounts. The Down payment savings should go to a liquid savings account that has as good of an interest rate as possible. I would use an online savings account for this. You should be able to find 2% out there. Check bankrate.com for the best interest rate. The college fund should go to a 529 tax exempt education savings plan. The 529 is tax advantaged so it's the obvious choice for educational goals. More on 529's in a later post.
If your goal was more than 5 years out and not educational I would recommend using your online brokerage account. That way you could invest the money long term.
For the self-employed. You need to treat these monthly savings goals as if they were bills. Put the monthly amount and the goal down in your budget. You can use an online bill pay service to set up regular monthly deposits. It's as close to auto-pilot as you can get while self-employed.
If you have a specific amount as a goal lets say $2000 in two years. Divide 2000 by the number of pay periods between now and then, in this case it's 52. That gives you $38.46 or $39 deducted from each paycheck. You can redirect multiple amounts to multiple accounts. You won't even notice it's gone. This is how I fund my wife's Roth IRA. The self-employed divide 2000 by 24 months which gives you $78. Pay $78 per month to your goal account as if it were a bill.
Looking at your goals totals can be overwhelming. Breaking them down to small monthly chunks makes it much easier. If you can save for those goals on auto-pilot, even better.
Thursday, March 8, 2012
14. Open an online discount brokerage account.
14. Now that all of your tax shelters (Roth/IRA 401k/403b) are maxed out open an online discount brokerage account.
Once you are sufficiently saving for retirement by maxing out your tax shelters, It's time to open a taxable brokerage account. For convenience I have one at the same place I keep my Roth/IRA. This is a great place to invest money that would otherwise sit idle in a bank account (Not your emergency fund!). It's also a good place to put any found or sudden money. As always, Watch those fees!
Tax efficiency - There is another way to think about diversification when using a brokerage account. If you put tax advantaged investments in your taxable brokerage account you can free up potential in your non-taxable Roth/IRA or 401k/403b. Since Treasuries or Municipal bonds are already tax exempt you could hold these types of investments in a taxable brokerage account.
I am not quite there yet but I do have a brokerage account just in case. My Roth IRA is maxed out but until my 403b is maxed out I won't touch the brokerage account. I am ready for any found money though!
Once you are sufficiently saving for retirement by maxing out your tax shelters, It's time to open a taxable brokerage account. For convenience I have one at the same place I keep my Roth/IRA. This is a great place to invest money that would otherwise sit idle in a bank account (Not your emergency fund!). It's also a good place to put any found or sudden money. As always, Watch those fees!
Tax efficiency - There is another way to think about diversification when using a brokerage account. If you put tax advantaged investments in your taxable brokerage account you can free up potential in your non-taxable Roth/IRA or 401k/403b. Since Treasuries or Municipal bonds are already tax exempt you could hold these types of investments in a taxable brokerage account.
I am not quite there yet but I do have a brokerage account just in case. My Roth IRA is maxed out but until my 403b is maxed out I won't touch the brokerage account. I am ready for any found money though!
Wednesday, March 7, 2012
13. Re-balance annually.
13. Re-balance annually.
Every year you need to re-balance your investments. Don't forget to adjust your asset allocation as you age (See steps 12a-12c). Use this adjusted allocation as your goal. Your Birthday or the New year are great cues to remind you to re-balance.
Re-balancing means selling issues that you are overweighted in. You then buy into investment classes that you are underweighted in. For a simple example let's say I set my Small Cap allocation to 5% of my portfolio. Last year that grew to 7%. I also set my international stock fund to 5%. Last year it fell to 3%. To keep my investments in line with my asset allocation I should sell 2% of the Small Cap fund and buy 2% of the international fund. This forces you to sell high and buy low.
Keep in mind the 1% rule of expenses. If it would cost more than 1% to re-balance don't bother. This happens in the beginning of your investment life. Values are so small it doesn't make sense to sell. In this case you want to buy into balance. This is done by monthly buying into the class you are lowest in until you hit your allocation in that class. Then move on to the next lowest class.
Here is an example of a 50 year old with a little over 100k invested. With a $4.00 transaction fee you can move up to $400.00 at a time. If you are out of balance by less than that, It is not worth the fee to re-balance that class.
I have an asset allocation excel spread sheet starter I can email you if you like. You plug in your numbers and it will do the math for you. Just drop me a line at thefettler@yahoo.com
Every year you need to re-balance your investments. Don't forget to adjust your asset allocation as you age (See steps 12a-12c). Use this adjusted allocation as your goal. Your Birthday or the New year are great cues to remind you to re-balance.
Re-balancing means selling issues that you are overweighted in. You then buy into investment classes that you are underweighted in. For a simple example let's say I set my Small Cap allocation to 5% of my portfolio. Last year that grew to 7%. I also set my international stock fund to 5%. Last year it fell to 3%. To keep my investments in line with my asset allocation I should sell 2% of the Small Cap fund and buy 2% of the international fund. This forces you to sell high and buy low.
Keep in mind the 1% rule of expenses. If it would cost more than 1% to re-balance don't bother. This happens in the beginning of your investment life. Values are so small it doesn't make sense to sell. In this case you want to buy into balance. This is done by monthly buying into the class you are lowest in until you hit your allocation in that class. Then move on to the next lowest class.
Here is an example of a 50 year old with a little over 100k invested. With a $4.00 transaction fee you can move up to $400.00 at a time. If you are out of balance by less than that, It is not worth the fee to re-balance that class.
| Age 50 Mortgage 90% payed off | Old total | Sell | Buy | Fee | New total | Goal |
| 7% Large Cap stock fund | 6,500.00 | 500.00 | 4.00 | 7,000.00 | 7,000.00 | |
| 6% Mid Cap stock fund | 7,256.00 | 1,256.00 | 4.00 | 6,000.00 | 6,000.00 | |
| 6% Small Cap stock fund | 8,400.00 | 2,400.00 | 4.00 | 6,000.00 | 6,000.00 | |
| 10% International stock fund | 7,400.00 | 2,600.00 | 4.00 | 10,000.00 | 10,000.00 | |
| 6% Growth stock fund | 6,050.00 | 6,050.00 | 6,000.00 | |||
| 7% Value stock fund | 6,223.00 | 756.00 | 4.00 | 6,979.00 | 7,000.00 | |
| 8% Emerging market stock fund | 8,500.00 | 500.00 | 4.00 | 8,000.00 | 8,000.00 | |
| 5% US bond fund | 4,100.00 | 900.00 | 4.00 | 5,000.00 | 5,000.00 | |
| 10% TIPS bond fund | 11,700.00 | 1,700.00 | 4.00 | 10,000.00 | 10,000.00 | |
| 7.5% International bond fund | 6,400.00 | 1,100.00 | 4.00 | 7,500.00 | 7,500.00 | |
| 7.5% Corporate bond fund | 7,300.00 | 7,300.00 | 7,500.00 | |||
| 5% Cash in a Money market | 5,025.00 | 5,025.00 | 5,000.00 | |||
| 5% CD's | 4,000.00 | 5,000.00 | 5,000.00 | |||
| 10% Real estate value | 10,000.00 | 10,000.00 | 10,000.00 |
I have an asset allocation excel spread sheet starter I can email you if you like. You plug in your numbers and it will do the math for you. Just drop me a line at thefettler@yahoo.com
Sunday, March 4, 2012
HSA Health Savings Account question
A reader asked me this question. "I am considering a high deductible health plan that qualifies me to fund an HSA. What happens to my HSA if I get employer based coverage and am no longer HSA eligible?"
Money in your HSA is your property the moment it is deposited. If you no longer have an HSA eligible policy you can no longer make deposits to your HSA account, The funds remaining in your HSA are still available for qualified medical expenses regardless of your coverage type.
An interesting HSA fact. You can roll over one years worth of HSA deposits from an IRA ($3100.00 for 2012). I would not recommend doing this unless you are in a medical/financial bind. You can only rollover funds once in your life and you can't roll funds back to the IRA.
When comparison shopping for HSA providers try to compare expense ratios. Lower fees will help you get a better return on the investments in your HSA. This may be harder than checking stock or bond expense ratios. Insurance companies are not legally required to be forthcoming with their fee schedule (yet!). But ask the rep. when you call anyway.
Make sure to keep detailed records of your medical expenses. That will save you a bunch of time and heartache at tax time.
Money in your HSA is your property the moment it is deposited. If you no longer have an HSA eligible policy you can no longer make deposits to your HSA account, The funds remaining in your HSA are still available for qualified medical expenses regardless of your coverage type.
An interesting HSA fact. You can roll over one years worth of HSA deposits from an IRA ($3100.00 for 2012). I would not recommend doing this unless you are in a medical/financial bind. You can only rollover funds once in your life and you can't roll funds back to the IRA.
When comparison shopping for HSA providers try to compare expense ratios. Lower fees will help you get a better return on the investments in your HSA. This may be harder than checking stock or bond expense ratios. Insurance companies are not legally required to be forthcoming with their fee schedule (yet!). But ask the rep. when you call anyway.
Make sure to keep detailed records of your medical expenses. That will save you a bunch of time and heartache at tax time.
Saturday, March 3, 2012
12c. Create an asset allocation. Part C - Equities
In Part C we will discuss different types of Stocks or "Equities".
There are two types of stocks Common and Preferred. With both types, face value is market determined. Common stocks are the most popular. They come with voting rights and the dividend can be adjusted or eliminated at will. Preferred stocks offer a permanent dividend level set at purchase and can be "Called" or bought back by the company (at a premium). In bankruptcy they are payed back before the common stock is. But the downside to Preferred stocks is no voting rights. We will be dealing with common stock in this blog.
As we discussed in part B there is a huge difference in homework between buying individual issues and funds. I do not, nor do I recommend buying individual stocks. Even professional fund managers have a hard time beating the market. From here on out we will be discussing the different types of stock (equity) funds.
Large Cap funds
Or large market capitalization are funds holding stocks of US companies that have 10 billion or more dollars of market capital. You get this number by multiplying the number of outstanding shares by the price per share. GE, Google, and Apple are examples of large cap companies.
Mid Cap funds
Or middle market capitalization are funds holding stocks of US companies that have 2-10 billion dollars of market capital. They tend to be a little more volatile than the large cap companies. Monster Beverage corp, Del monte, and American building maintenance, are examples of Mid cap companies.
Small Cap funds
Or small market capitalization are funds holding stocks of US companies that have 300 million - 2 billion dollars of market capital. They tend to be more volatile than the large or mid cap companies. The reason there can be such an upside to small cap funds is that you beat out institutional investors that have market cap minimums. Buffalo wild wings, Playboy, and Spherion, are examples of Small cap companies.
International stock funds
Funds that invest in companies outside the USA. They can invest by country, region, continent, or everything but the US.
Growth stock funds
Funds that invest in companies that are considered to have above average earning potential. Most technology companies are growth companies. You make your money when the company grows and the stock value increases. Growth stocks rarely pay out dividends due to reinvestment of the profits into the company.
Value stock funds
Funds that invest in stocks that are undervalued compared to their peers. They usually have a high dividend to attract investors.
Emerging markets stock funds
Funds that invest in companies that reside in countries that are financially progressing. The country must have a unified currency, stock exchange, and some sort of regulatory agency. The potential for for large growth is tempered by high risk.
Dividend stock funds
Funds that invest in companies that pay out high dividends. You make your money from the dividend stream not as much from growth.
There are plenty of other types of funds out there. I feel that most of them tend to be niche funds. This works against diversification. It is a lot like buying individual stocks which is a fools errand.
The biggest thing to consider when choosing funds is expenses. Low fees are a great indicator of a well run financial institution. You should never pay more than 1% per year in annual expenses (preferably under 0.6%!). If the fund is part of a 401k/403b you can accept up to 1.5%. To find a funds total annual expenses find the expense ratio in the funds prospectus. You may have to add all of the various fees listed. I have a short list of 5 companies that I buy funds from for my Roth IRA. They are Vangaurd, Ishares, Global X, Fidelity, and Morgan Stanley. You will have less choices in your 401k/403b.
Here are a few ways to buy into these types of funds.
Mutual funds
A mutual fund is a basket of funds that are actively managed by a fund manager. There is usually a minimum amount that must be invested at a time (5k is common). They have a higher expense ratio due to management costs. Mutual funds tends to cost more in capital gains and taxes. This is due to the amount of trading the fund undergoes.
Index funds
An index fund is a basket of funds that "index", follow or mimic a certain market. Index funds are cheaper because they do not require active managing. Software re-balances the fund to keep it in line with what it's indexing. Since there is much less trading in an index fund the capital gains costs are very low.
ETFs
Or exchange traded funds are index funds that are traded like stocks. There are no minimums and the low cost and tax efficiency makes them my personal favorite flavor of fund. Their only drawback (or benefit if you invest a larger sum) is that you pay the same brokerage fee if you buy 1 share or 1000. Just make sure your purchasing fees do not exceed 1%.
Here are some examples of diversification of all of your investments with an average risk tolerance.
Age 20 renter
10% Large Cap stock fund
10% Mid Cap stock fund
10% Small Cap stock fund
10% International stock fund
10% Growth stock fund
10% Value stock fund
10% Emerging market stock fund
10% REIT fund*
Remember to factor in all of your investment vehicles in your asset allocation. 401k/403b, Roth/IRA, Brokerage account, and Bank holdings (CD's Savings etc...) Your 401k/403b may have less choices. This may cause you to pick up the slack with your Roth/IRA. Remember, This is not an exact science. The goal is to not let any one investment class get too big.
*REIT or Real Estate Investment Trust are funds that hold investment grade mortgage backed securities (Commercial and or Residential). Don't be scared of these funds. If you buy from a quality issuer they are safe enough and a good stand in for home equity.
There are two types of stocks Common and Preferred. With both types, face value is market determined. Common stocks are the most popular. They come with voting rights and the dividend can be adjusted or eliminated at will. Preferred stocks offer a permanent dividend level set at purchase and can be "Called" or bought back by the company (at a premium). In bankruptcy they are payed back before the common stock is. But the downside to Preferred stocks is no voting rights. We will be dealing with common stock in this blog.
As we discussed in part B there is a huge difference in homework between buying individual issues and funds. I do not, nor do I recommend buying individual stocks. Even professional fund managers have a hard time beating the market. From here on out we will be discussing the different types of stock (equity) funds.
Large Cap funds
Or large market capitalization are funds holding stocks of US companies that have 10 billion or more dollars of market capital. You get this number by multiplying the number of outstanding shares by the price per share. GE, Google, and Apple are examples of large cap companies.
Mid Cap funds
Or middle market capitalization are funds holding stocks of US companies that have 2-10 billion dollars of market capital. They tend to be a little more volatile than the large cap companies. Monster Beverage corp, Del monte, and American building maintenance, are examples of Mid cap companies.
Small Cap funds
Or small market capitalization are funds holding stocks of US companies that have 300 million - 2 billion dollars of market capital. They tend to be more volatile than the large or mid cap companies. The reason there can be such an upside to small cap funds is that you beat out institutional investors that have market cap minimums. Buffalo wild wings, Playboy, and Spherion, are examples of Small cap companies.
International stock funds
Funds that invest in companies outside the USA. They can invest by country, region, continent, or everything but the US.
Growth stock funds
Funds that invest in companies that are considered to have above average earning potential. Most technology companies are growth companies. You make your money when the company grows and the stock value increases. Growth stocks rarely pay out dividends due to reinvestment of the profits into the company.
Value stock funds
Funds that invest in stocks that are undervalued compared to their peers. They usually have a high dividend to attract investors.
Emerging markets stock funds
Funds that invest in companies that reside in countries that are financially progressing. The country must have a unified currency, stock exchange, and some sort of regulatory agency. The potential for for large growth is tempered by high risk.
Dividend stock funds
Funds that invest in companies that pay out high dividends. You make your money from the dividend stream not as much from growth.
There are plenty of other types of funds out there. I feel that most of them tend to be niche funds. This works against diversification. It is a lot like buying individual stocks which is a fools errand.
The biggest thing to consider when choosing funds is expenses. Low fees are a great indicator of a well run financial institution. You should never pay more than 1% per year in annual expenses (preferably under 0.6%!). If the fund is part of a 401k/403b you can accept up to 1.5%. To find a funds total annual expenses find the expense ratio in the funds prospectus. You may have to add all of the various fees listed. I have a short list of 5 companies that I buy funds from for my Roth IRA. They are Vangaurd, Ishares, Global X, Fidelity, and Morgan Stanley. You will have less choices in your 401k/403b.
Here are a few ways to buy into these types of funds.
Mutual funds
A mutual fund is a basket of funds that are actively managed by a fund manager. There is usually a minimum amount that must be invested at a time (5k is common). They have a higher expense ratio due to management costs. Mutual funds tends to cost more in capital gains and taxes. This is due to the amount of trading the fund undergoes.
Index funds
An index fund is a basket of funds that "index", follow or mimic a certain market. Index funds are cheaper because they do not require active managing. Software re-balances the fund to keep it in line with what it's indexing. Since there is much less trading in an index fund the capital gains costs are very low.
ETFs
Or exchange traded funds are index funds that are traded like stocks. There are no minimums and the low cost and tax efficiency makes them my personal favorite flavor of fund. Their only drawback (or benefit if you invest a larger sum) is that you pay the same brokerage fee if you buy 1 share or 1000. Just make sure your purchasing fees do not exceed 1%.
Here are some examples of diversification of all of your investments with an average risk tolerance.
Age 20 renter
10% Large Cap stock fund
10% Mid Cap stock fund
10% Small Cap stock fund
10% International stock fund
10% Growth stock fund
10% Value stock fund
10% Emerging market stock fund
10% REIT fund*
5% US bond fund
5% TIPS bond fund
10% Cash in a Money market account
Age 30 new home owner
8% Large Cap stock fund
8% Mid Cap stock fund
8% Small Cap stock fund
10% International stock fund
8% Growth stock fund
8% Value stock fund
10% Emerging market stock fund
10% REIT fund*
5% US bond fund
5% TIPS bond fund
5% International bond fund
5% Corporate bond fund
5% Cash in a Money market account
5% CD's
I left the International and Emerging funds alone. This helps keep your foreign exposure balanced.
Age 40 Mortgage 60% payed off.
8% Large Cap stock fund
8% Mid Cap stock fund
8% Small Cap stock fund
10% International stock fund
8% Growth stock fund
8% Value stock fund
10% Emerging market stock fund
5% US bond fund
5% TIPS bond fund
5% International bond fund
5% Corporate bond fund
5% Cash in a Money market account
5% CD's
10% Real estate value
As your home equity is established you can pull back on your REIT fund holdings. If you do not own real estate you can keep 10% in a REIT fund perpetuity.
Age 50 Mortgage 90% payed off
7% Large Cap stock fund
6% Mid Cap stock fund
6% Small Cap stock fund
10% International stock fund
6% Growth stock fund
7% Value stock fund
8% Emerging market stock fund
5% US bond fund
10% TIPS bond fund
7.5% International bond fund
7.5% Corporate bond fund
5% Cash in a Money market account
5% CD's
10% Real estate value
Age 60 House paid off
5% Large Cap stock fund
5% Mid Cap stock fund
4% Small Cap stock fund
10% International stock fund
5% Growth stock fund
5% Value stock fund
6% Emerging market stock fund
10% US bond fund
10% TIPS bond fund
10% International bond fund
10% Corporate bond fund
5% Cash in a Money market account
5% CD's
10% Real estate value
Remember to factor in all of your investment vehicles in your asset allocation. 401k/403b, Roth/IRA, Brokerage account, and Bank holdings (CD's Savings etc...) Your 401k/403b may have less choices. This may cause you to pick up the slack with your Roth/IRA. Remember, This is not an exact science. The goal is to not let any one investment class get too big.
*REIT or Real Estate Investment Trust are funds that hold investment grade mortgage backed securities (Commercial and or Residential). Don't be scared of these funds. If you buy from a quality issuer they are safe enough and a good stand in for home equity.
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