Help a Reader: How to Invest

Here's an email I recently received from a reader:

Back story:  For 2 years I had a Fidelity PAS Roth IRA (Portfolio Advisory Services), which is basically a managed account based on the timeline of your retirement.  Well after reading time and time again about index funds and why people used them, I decided to look at my managed account rate of return and many indexes the market tracks.  Turns out the indexes were beating my managed account AND I was pay A LOT more in fees.

Present Time:  I just liquidated my managed account and had the balance put into a Fidelity Tradition IRA cash account for the time being.  I will use this cash to purchase my index funds.

My question to everyone is:  what sections of the market should I invest in and at what percentage?  I.e. what % of small cap should I buy vs. large cap, etc.?  Also, should I purchase ETF's or mutual funds, and what is the reasoning?

What's your advice for him?

Comments

[Kathy F]

Several Fidelity allocation portfolios are suggested by the article "New Fidelity 'Lazy Portfolios' are winners"

http://www.marketwatch.com/story/at-last-winning-lazy-portfolios

Be sure to look at both pages.

[DG]

Looking up different lazy portfolios is a great way to start. A lot of it depends on your appetite for risk and your time horizon. Personally, I use something like this:

Bonds - 20%
Total Market Fund - 20%
European Fund - 10%
Pacific Fund - 10%
Emerging Market - 10%
Small Cap - 10%
Mid-Cap 10%
REIT Fund - 10%

I would also suggest looking at ETFs. I switched over from Vanguard mutual funds to their ETFs about a year ago and find them easier to trade (no day long delays), easier to track (prices move throughout the day)and in some brokerage accounts they are also cheaper to trade.

[jim]

There is no single right answer to the question.

What to buy really depends on your circumstances, goals and risk tolerance. If you're younger or more risk tolerant then you could lean more heavily towards emerging market and growth assets. IF you're older or less risk tolerant then you might want a higher % of bonds.

There are many different schools of thought on how to diversify your holdings. I'd look at the Lazy Portfolios for a number of different ways to do it:
http://www.bogleheads.org/wiki/Lazy_Portfolios
That would be a good starting point at least.

[Jake]

I agree that ETFs are a good option, esp now that Fidelity/Vanguard are both offering zero commission trade on those depending on your portfolio size. As to the mix to use, it depends on age.

[Matt]

Not enough information to comment. Age, risk tolerance,how much, etc.

I saw way to many older friends at work who were to heavy in stocks before the crash that were too close to retirement. Basically they could not retire but needed to due to being laid off.

Also too many young people scared to death of the market.

Must have balance in the forces of investing

[JeffinwesternWA]

With current tax laws figure your stock market risk and allocation, use your IRA for your INCOME protion (cash , bonds, real estate trusts, etc., ) since the IRA's are not taxed. Keep your allocation so that your personal (non-IRA) monies are virtualy all stocks and thus, taxed only at capital gains rates. Index funds in personal accounts will also keep trading costs and capital gains down. Don't forget to count your non-IRA accounts for an overall look at your "portfolio". Consider a QUALITY variable annuity with the appropriate riders - if you don't have a guaranteed pension other than social security for some protion of your IRA. Keep the VA in your IRA since annuity income is taxed at ordinary rates anyway. (Naysayers who don't have wealth of $1M+ will abhor this idea but, those with high net worth appreciate and USE this PROVEN strategy for ortfolio protection and income later in life)You may do well contacting a registerd financial planner with a series 65 license. I was one for 16+ years, hard, rewarding work...g'Luck, the markets are "fixed" against the small investor,for institutional timer banks and bigwigs, so think long term, keep costs reasonable, use trands and time, don't overexpose to market risk!!j

[KaseyD]

Without knowing more about you - your goals, risk levels, age etc. - its difficult to be specific.

Nonetheless, others have already mentioned Lazy Portfolios. And I agree - for someone who would like to put their investments on autopilot. MarketWatch's Paul Farrell analyzes eight different approaches to Lazy Portolios at:

http://www.marketwatch.com/lazyportfolio

He goes into more detail about how to go it on your own at:

http://www.marketwatch.com/lazyportfolio/howto

Keep in mind that even if you use a simplified approach, always keep your eye on your investments. Reassess your goals and how your investments are helping/hurting in reaching those goals. I recommend conducting a review at least once a year, more often as your portfolio grows and your grow older (and wiser).

[DIY Investor]

If you read my blog it will take you through a simple asset allocation online calculator, a risk tolerance questionairre, and show you explicitely how to implement that into specific etfs.
You have the online tools to do-it-yourself.
If you need to bolster your understanding watch http://www.youtube.com/watch?v=Y0LSG2omvEg
and/or read "How a second grader beats wall street" by Allan S. Roth.
Good luck.

[Peter]

Same comments as the other commenters.
Your age is the critical of all the questions.
Assuming you are in 30-35 age group , look at this one.

http://www.mymoneyblog.com/archives/2009/09/2009-q3-investment-portfolio-update-92109.html

[Tyler]

Two questions were asked:

1. Where to put the money? Well that's the million dollar question that is very hard for anyone to answer for you. Do you work for a particular industry or sector? I would start there- with what you know. Do you think that sector is going to grow? Is the outlook good or bad? Then you weight it more or less.

Type "GICS" into google and look at the other sectors. Learn about these sectors. When does the Utilities sector do well? When does Consumer Staples do well? Every GICS sector has an ETF. I can provide a list upon request. Bespoke Investment Group offers a nice ETF guide on their website.

2. ETFs vs Managed funds? Well ETFs tend to be cheaper and easier to trade. I would stay in the ETF world. Make sure the ETF is liquid and doesnt have massive tracking error. What is that? USO is the Oil ETF. It is designed to track the price of Crude Oil. For a number of reasons, it has completely failed to track Crude Oil. Make sure your not in something like USO. (Commodity based ETFs tend to have this "tracking error" more than other ETFs.)

The only time your age is of any relevance is in relation to the date you want to retire (and I would argue this is a weak and minor issue). As you approach retirement (tend to be older), the common wisdom is to move more of your money into Bonds or low volatility investments. The one flaw in this logic is that Bonds can have massive volatility, and the investment that was low volatility at one point can have high volatility at another. So my advice would be to follow this general rule of thumb but be careful and know when it wont work.

[Tyler]

Oh and you could always buy the entire stock market if you really didnt want to do any work.... SPY, DIA, QQQQ etc

[Rick Francis]

We don't really have enough info to tell... I would suggest you get a about index investing- for a good overview I like Mike Piper's Investing Made Simple: Investing in Index Funds Explained in 100 Pages or Less. For more details my favorite is The Bogleheads' Guide to Investing, but it helps to have the basics down before reading it.
> I just liquidated my managed account and had the balance put into a Fidelity Tradition IRA cash account for >the time being. I will use this cash to purchase my index funds.

You liquidated the managed account- which is a GOOD thing, but did you really move it to a traditional IRA? Or did you move to a self managed ROTH IRA?
If you did really move to a traditional IRA - did you do so knowing the tax consequences?

-Rick Francis

[myPost]

I originally proposed this question to FMF and I am sorry I did not provide enough details. I am 31 years old and do not mind taking risks as I am fairly young and have time on my side.

@Rick Francis
I did "sell off" my managed tradition IRA and put it into a mutual fund, still considered in a tradition IRA though. I did not liquidate it in the sense that I moved it out of the IRA, I just moved the funds so they are not in the market at the moment.

Thank you to everyone that has commented... this is all very informative!! From what I've read so far I'm thinking I'll my trad. IRA with Fidelity (since they administer my 401K as well) and use fidelity's "Smart Money" portfolio (http://www.marketwatch.com/story/at-last-winning-lazy-portfolios - Thx Kathy F). This leads me to my next question though. Should I follow that portfolio is both my 401K and IRA or should each account follow a different portfolio? JeffinwesternWA mentioned that an IRA should be used for income growth (cash, bonds and real estate, etc) since it has tax benefits. These questions are another reason I am staying with Fidelity. They have a branch up the street from me and hopefully they can answer these questions when I meet with them face to face.

Again, thanks for all the comments!

[myPost]

Error Fix:

@Rick Francis
I did "sell off" my managed tradition IRA and put it into a ** money market **

[jim]

JeffinwesternWA was talking about the tax implications of putting some investments in retirement accounts (IRA, Roth IRA, 401k) vs putting some investments in non-retirement accounts.

THe IRA and 401k are both tax sheltered retirement accounts. So theres really no reason to split bonds in one and stocks in the other.

[KaseyD]

@Rick,
While reading your followup I thought of a couple of things I'd like to point out.

Fidelity does not have a "Smart Money" portfolio, it was devised using William Bernstein's nine-fund version in one of his SmartMoney magazine columns years ago. It is meant to be age adjusted and was just mentioned in the referenced article as one way of creating one's own "Lazy Portfolio". If you ask Fidelity about it, they probably won't know what you are talking about. I recommend you read a couple of Bernstein's books, particularly "The Four Pillars of Investing" and "The Intelligent Asset Allocator" for a great foundation on investing.

Also, Fidelity now offers commission-free iShares' ETFs - Exchange Traded Funds that track a variety of stock indices. You might want to check them out and compare them to Fidelity's index funds for expenses and style. Fidelity doesn't offer iShares' European index fund as a commission-free ETF, but it does offer iShares' combo Europe-Far East-Asia. But, if you want to stick to Europe only you can buy iShares' IEV or Vanguard's VGK; the $8 commission is not a deal breaker, assumming you are rebalancing only once a year. Vanguard's expense ratio for VGK is only 0.16% vs 0.60% for iShares. Fidelity's FIEUX's expense ratio is 1.09%

Even if you stay with Fidelity (fair disclosure- I have accounts with both Fideliity and Vanugard), that doesn't limit you to Fidelity's mutual funds or ETFs.

I agree with Jim above about taxes, however your 401k will most like have more trading activity (every pay day?) than your IRA (once a year?). That might change how you want to invest in each, as you wouldn't want commission-based ETFs in your 401k.

Sorry this was so long winded, but I hope it helps.