Unless you are spending a lot of time researching various investment options, it can be daunting to try and decide what to do with your money.
If you are someone who doesn’t know much about investing, this article offers my simple explanation for what to do to get started. Later you can learn more and make changes to your investments.
When investing for retirement you want to minimize your risk and maximize your return. To do that you need to have a proper balance of two major kinds of investments – fixed income investments and equities.
Fixed income investments are like IOUs; they include bonds, money market funds and certificates of deposit(CDs). A company or government entity promises to pay you back your investment at a certain date in the future with a fixed rate of return. The interest you earn on these investments are relatively low, but they also have a relatively low risk.
Equities are investments in which you assume some ownership of an asset, such as a company in which you buy shares. These investments include stocks and real estate. Equities have a potential high return and a potential high risk.
You want some of each type of investment. You don’t want to put all of your money into fixed income assets because your return will be too low to beat inflation.
You don’t want to put all your money into equities because their value may decline abruptly just at the point when you want to start withdrawing money to live on.
So, what is the best mix of these two types of investments?
Here’s two simple options:
60% in the Vanguard Total Stock Market Index Investor Shares Fund
40% in the Vanguard Total Bond Market Index Investor Shares Fund
45% in the Vanguard Total Stock Market Index Investor Shares Fund
25% in the Vanguard Total Bond Market Index Investor Shares Fund
10% in the Vanguard REIT Index Investor Shares Fund
20% in the Vanguard Total International Stock Index Fund
Here’s why I selected these options: To get the broadest possible exposure to the stock market, invest in a total stock market fund that invests in a representative sample of all companies. You are spreading the risk of equities by buying into the entire stock market.
To get the broadest possible exposure to bonds, invest in a total bond market fund that buys the various types of bonds (short term, long term).
Invest in index funds because these have the lowest management fees. The most important factor that will determine the performance of a fund is the annual costs of the fund, according to a 2004 study by Standard & Poor’s, an investment research and rating firm. Since then the basic conclusions of this study have not been challenged.
Your choice about how much of your money to put into fixed income and equities can be influenced by your age, your willingness to take risks, your health, and other personal circumstances. My suggestions above are a starting point.
See my article “Where Should I Invest My Money For Retirement?” for a detailed discussion of where to invest and why you should invest in index funds.
Note: I chose to use the Vanguard company in my options because they are the biggest investiment company that offer the most choices for index funds. Here are three other companies that offer many index funds. I’ve listed the names of their funds that are the same as Option #1:
Fidelity: Spartan Total Market Index Fund and Fidelity U.S. Bond Market Index
Charles Schwab: Schwab Total Stock Market Index and Schwab Total Bond Market Fund
T. Rowe Price: Total Equity Market Index and U.S. Bond Index
Don’t know much about investing? Choose Option #1.
If you are a little more knowledgeable about investing and want to diversify more, choose Option #2.
Caution: Don’t invest in something if you don’t understand it. My Option #1 is very basic, but if you don’t understand it, don’t do it. Begin to educate yourself about investing for retirement so you can make informed decisions later.
Tom Copeland – www.tomcopelandblog.com
Image credit: www.quizzle.com
For more information about investing, see my book Family Child Care Money Management and Retirement Guide.