Gardner: Investing in mutual funds Q&A (column) |

Gardner: Investing in mutual funds Q&A (column)

Eric writes:

In your last column you talked about mutual funds being the easiest way to invest. I was overwhelmed when I looked at them and saw that there are thousands of them! How do I choose? And how many should I buy?

Eric, if your employer offers a 401k, your choices are limited and it makes it easier to choose. You should be provided information on their performance and their stated purpose. If your company does not offer one or you are self-employed, then choosing can be daunting. A great way to start is with index funds. The fees are low and you do not have to manage them.

An index fund mirrors a stock index such as the S&P 500 Index by buying and holding the same 500 stocks in the same proportion. Index funds do not try to beat the market but try to match its performance. Over time they tend to outperform most stock funds partly because of their low fees. Another benefit is the very low turnover of companies in the portfolio which contributes to lower realized capital gains and less taxable income for you.

Investing in an S&P 500 Index Fund allows you to own an interest in the 500 largest companies in the United States such as Apple, Amazon and ExxonMobil without needing a fortune to do it. Or you could do a Total Stock Market Index Fund. In addition you would also need to invest in at least one bond fund so that you are not in all equity.

Vanguard Total Bond Market Index Fund is a good one if you are only investing in one. These two funds would give you a very basic portfolio, but you would want to add a money market fund to complete the fixed income component and possibly an international index fund and a sector fund, such as a real estate investment trust fund (REIT), depending on how much your initial investment is. You can add more mutual funds to diversify and round out your portfolio when you have more money to invest.

Once you choose your funds and before you purchase them, you will need to decide what asset allocation you want to use — meaning what percentage will be stock and what percentage will be fixed income. (Fixed income includes bonds, money market, treasuries and certificates of deposit.) The greater the percentage of stock you have in your portfolio, the greater volatility it can experience, both in growth and potential losses.

If you have a long time horizon before you need the funds, the up and down cycles of the market will not be an issue for you, but if you need the funds within the next five to eight years, a volatile market and more aggressive holdings could be problematic. Having been through a number of bear markets and having seen the resolve of my clients with nerves of steel crumble, I encourage my clients to stay away from all-equity portfolios.

A 70/30 (70 percent stock and 30 percent fixed income) asset allocation works well for an investor with a long time horizon and one who can live with the market gyrations during both bull and bear markets. This might be a portfolio earmarked for retirement. For someone who finds even the weekly moves of the market nerve-wracking, a 50/50 allocation might be more appropriate. It also would be an allocation to consider for a shorter time horizon.

Or you might start at 70/30, but as retirement draws closer, or no less than three years away, change your allocation to 50/50 to protect against negative market swings in the years just before retirement. The last thing you want is a bear market just before you plan to retire and not have time to recover because your portfolio was too aggressive.

I do not usually recommend a 30/70 asset allocation to a client who is in the accumulation period of his life unless he is truly terrified of the market and losing money. It takes so much longer to grow your assets when you only have 30 percent invested in stock. That said, A 30/70 allocation is quite often appropriate for retired individuals who want to preserve their wealth and take an income stream.

It is easy to set up an account at Charles Schwab in Frisco or on-line. They have their own index funds that mirror the various indices, and their representatives can help you determine how much to invest in each fund based upon your allocation.

Nancy Gardner is a Certified Financial Planner. She and her husband Bill and their dog Daisy split their time between Summit County and Montgomery County, Texas. Send questions to

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