Comments: Advice on Index Funds

I received a comment on my post Why I Like Index Funds earlier this week asking for help/advice from Free Money Finance readers. Here's the question:

I just started out in and would like to get my feet wet in investing. I have saved up $10K solely for investing purpose. I would like to put them into stock index funds. My question to you is: would it be better to invest one lump sum or invest the 10K using dollar cost averaging? Moreover, should I put 80% into stock index and 20% into individual stocks? I have a long way to go before I retire so I'd like to be a little aggressive and see my money grow over time.

Advice from you or your readers would be greatly appreciated. I hope my questions can also benefit others in my situation.

What are your thoughts? Please leave a comment below if you have some worthwhile advice that can help out this reader.

Comments

[Bored]

"The time to invest is NOW!"

I tried finding the article, but couldn't at the moment, but it compared investing lump sums vs. taking the lump sum and dollar cost averaging it over a year.

So, I don't have any backup here, but I've agreed with this method, and done it myself...bonuses, tax return, lottery winnings (i wish)...

I vote for the lump sum option!

[Dave]

I vote for lump sum also. In the end, what matters is that you invest it, and to me the simplest thing is the best. Also, it gets it out of your hands so there's no temptation to blow it on something you don't really need or want.

[HRP]

First -- FreeMoneyFinance, thank you for giving visibilty to comment!

Bored, I probably read the same article which lead me to my confusion. I read that d.c.a is a great tool, but after reading that article I learned over time it really doesn't matter.

Dave, your right. I want to take the money invest it in one place, never touch it, then look at what happen 5-10 years from now.

There was a comment from another read who suggested investing in Index funds via ROTH IRA. However, given that I contribute to 401(k) is ROTH neccesary right now?

You guys are great and FMF keep up the great work.

[Nathan Whitehead]

I just posted a reply at:
http://www.finance.paranoidbrain.com/blog/2006/03/09/getting-started-with-index-funds/

Since you described yourself as being a more aggressive investor, investing in a lump sum is the way to go. Holding money back as "insurance" through dollar cost averaging only hurts your overall return. The question becomes, where would you put the money you're holding back, in a savings account or CD? The markets are likely to outpace any return on a savings account or CD. (we hope!)

The dollar cost averaging approach is really an incentive to get people to invest a certain amount of money on a consistent monthly basis to build capital and naturally minimize risk over time.

Whatever you do, make sure you check the fees and other data for the index fund of your choice. The fees should be low since they are ideally only seeking to invest in a particular type(s) of stock found in the particular index.

Good luck!

[Eric]

I just saw this topic discussed in the Vanguard Diehards forum.
http://tinyurl.com/mnudg

[HRP]

Man, you guys are fast.

To the no-name poster.

Right now, the money is just sitting in Emigrant, so my orginal plan was to set up auto deduction and use d.c.a to put money into an index fund. However, as many have suggested lump sum is probably the way to go.

[FMF]

Wow! You all are fast! Thanks for the help/comments.

[Roy]

If you're nervous about lump-summing the whole $10k, you can always split it and put, say, half (could be any percentage, whatever you're comfortable with) in now and DCA the rest. While it's true that getting your money to work for you as soon as possible is definately better than waiting, you have to be sure you can stomach any sudden drops in the market without getting nervous and pulling your money out and not investing again for a while out of fear.

As for a Roth IRA, if this money is for retirement, then YES - do it right now. You can always withdraw your contributions at a later time if you need the money. But do it soon, so you can make the max 2005 contribution before tax day.

I suggest using The Vanguard Group, either for your Roth or straight-up (taxable) index investing.

Also check out the Vanguard Diehards www.diehards.org for more advice and information.

[Gringo]

OK, assuming from your post you are young I would suggest the following:

(1) Open a ROTH IRA immediately, if you haven't got one. If you open by April 15 (or possibly 4/17 since the 4/15 falls on a Saturday this year?) you can contribute $4000 for tax year 2005 and another $4000 for 2006. This would use up $8000 of your initial amount.

(2) Invest the remaining $2000 in a taxable account in some index fund of your choice (e.g., an S&P 500 index fund).

If you have a long time horizon (which it sounds like you do), putting your money in a tax-sheltered account such as a ROTH IRA will allow you to grow your money much faster than if you put it in a taxable account. You will not have free access to the money until you reach retirement age (with some exceptions - you may withdraw the original principle, or if you are buying a home). The advantages are well worth it though.

You will need to check what the income limitations for IRA contributions are to see if you are eligible to contribute.

[HRP]

Roy & Gringo -- Thanks!!

Well since I have been contributing to 401(K) I consider that my reiterment vechile. Are you guys suggesting I open up a ROTH in addition to the 401K.

I really don't have a purpose for that $10K right now, hence I just wanted to put it in an account which will earn a good return when I check back in 5-10 years. However, I did want the money available after 5-10years for a house, remodeling, baby, or something along those lines. If I put the majority of the $10K into ROTH, I'm afriad I wouldn't be able to touch it until reiterment.

Thoughts?

[Brian]

I have a 401(k) and I still fund a Roth IRA. I think there are several benefits to having a Roth IRA over the 401(k). First, you generally have many more options - you are not limited to the 8-15 funds that your 401(k) allows. Second, you have the advantage of diversifying your tax liability. That is, you already have the tax-sheltered retirement account that will require you paying taxes upon withdrawal during retirement. With the Roth IRA, you won't have any tax liability upon withdrawal at retirement. Third, the 401(k) requires that you begin withdrawals at a certain age (maybe 59 and half???). With the Roth IRA, you are never required to make withdrawals at any age. Fourth, you have the ability to withdraw the amount you've contributed to your Roth IRA without any penalties or tax liabilities. Although this is generally not recommended, it may prove helpful in buying your first home or in a major financial crisis.

In any situation, you are better off contributing to your 401(k) up to your company match before funding a Traditional or Roth IRA.

I hope these comments have helped you decide that having a 401(k) AND a Roth IRA simultaneously is a good thing.

[Gringo]

Yes, I am suggesting you open a Roth in addition to your 401(k). If you envision using this money in 10 or 15 years, than this might not be the way to go for you. Personally, I feel it is better to sock $ away in a Roth and 401(k) early rather than later. If you save enough early on, you can cut back your retirement contributions dramatically (or even totally) later on, and have more money for other things. The money won't be totally inaccessible - you can make withdrawals from a Roth for things like buying a house, etc., and you can always withdraw your original principal (the $8,000).

[Dennis Mangan]

Just don't use the S&P 500 Index. There are much better vehicles out there, such as the Russell Midcap Value Index or Dow Jones Select Dividend Index.

[Ben]

I agree that the time to invest is now. The accumulation equation is Time * Contributions * Rate of return. The most significant of these variables is time, followed by contributions. This does not mean you should not try to maximize your return. I know FMF is a big fan of index investing and it is a great way to get started or as a buffer in your portfolio - so I don't want to discredit that. I do believe that American Funds (most of their funds) will usually perform better than index funds even considering they require a comission and have higher fees than index funds.

PS - FMF, I'm a regular reader, strongly agree with most of your posts, and generally enjoy taking a few minutes to read each day. Cheers.

[FMF]

Ben -- Thanks for reading and for the kind comments.

Everyone -- Thanks again for joining in the discussion. It's great how you all have pitched in.

HRP -- Yes I agree. Thank you all!

Based on situtation and the comments I have recieved, I am going go the lump sum route.

Now I just need to pick a good brokerage firm (Fidelity, Vanguard, T Rowe) or a discount broker (ET, Sharebuilder, Scottstrade).