Help a Reader: Investing a Lump Sum

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

My wife and I are looking to max out our Roth IRA's for 2010 with one lump sum payment of $10k sometime before the end of this year. I intend to establish two Roth IRA accounts at Vanguard and invest in an S&P 500 index fund.  I certainly believe that cutting costs is the best way to invest and Vanguard fits that bill.  However, I'm a little hesitant because we are talking serious money. I've dabbled before with investing, but with only about $2000. 

Is this a good plan?  Do we need to go get a financial adviser?  I've considered contacting a few ELP's from Dave Ramsey's website, but I figure those guys are too expensive.  Vanguard is by far cheaper, but I certainly don't want to lose money.  Specifically, when do I need to consider hiring someone to invest for me as opposed to a self-directed plan at Vanguard? 

Note: in 2011 we will begin monthly contributions to our Roth IRA's to take advantage of dollar cost averaging.

What's your advice for him?

Comments

[Sam]

We were in a similar situation couple years ago. We chose target date retirement funds at vanguard.

[Romeo]

Well, it sounds like he should start small. He should first see if there are any other obligations that need the money such as debts or refinancing a home, etc.

And of course, like always, to make a really informed determination to see if this is right for him, we need to know a lot more information than what's given, i.e. age, salary, debts, total savings, etc.

But to answer the idea of the question, I would be hesitant to drop a huge $10,000 lump sum in the market right now. I understand that there is no true way to time the market, but with the unknown affects of QE2, I'd much rather drop $2000 a month in an IRA for the next 5 months in order to take advantage of dollar cost averaging.

If he already knows the he'd be investing in an index fund, then there is no need to prevent wealth by going to a financial advisor. It's best to go to the source itself, Vanguard, and start an online account to purchase the funds. So to answer the other question, I think it would make since to hire a professional if you just don't have a clue -- at all -- of what you are doing in terms of investing. There is so much information on the Internet, and so much empirical evidence to suggest that even a dart can do better at picking funds, that an advisor is rarely needed for the passive investor.

[Romeo]

BTW, just to be clear, he has until April 15th, 2011 to fully contribute to the 2010 tax year for their Roth IRA. This means that a lump payment isn't needed.

[Chalmers]

It's a fine plan, especially if it's for their retirement in 10+ years. Long term, a total market index fund is pretty stable. Also, if you're investing $10k with Vanguard, you can convert those shares to Admiral Funds, which have much lower costs (I think I pay 0.07% for my fund). I don't think a financial advisor is at all warranted when you're dealing with such a small sum for the financial world. Perhaps if you had a complicated estate, vast sums of money and needed to know the best way to reduce tax liability an advisor would be warranted. I wouldn't worry about having anyone manage it for you.

[Texas Wahoo]

"Also, if you're investing $10k with Vanguard, you can convert those shares to Admiral Funds, which have much lower costs (I think I pay 0.07% for my fund)."

Since he has to invest the money in two separate IRAs (one for him and one for his wife), he will not be able to convert the funds to Admiral shares.

[FURTHER INFORMATION]

Further information:

We are both 27, we make roughly $150k annually, we have no debts except our house (small second at 6%/ first locked at below 4% -15 year) We will need some cash in the future only for the purchase of a truck ($25k), paying off the second mortgage ($20k), and having babies! We will likely go to a single income home in the next year (roughly $110k/annually. We have only $3k currently invested for retirement.

So far, I like the target retirement fund at Vanguard.

Honestly, I think the primary benefit from going to an adviser would be to have someone other than myself explain investing to my wife. Are there any other considerations?

[Jeff]

I would recommend going the ETF route - and go with Ameritrade so you can restructure and rebalance your portfolio every few years with their free ETF trading. I would go say 30% bonds, 10% international, 10% commodities and the rest in an ETF focusing on dividend paying stocks. And, of course, be sure to reinvest the dividends in every ETF that you can.

[KaseyD]

Congratulations on getting started with investing early. And Vanguard is a great place to start. You earn a fantastic income for your age, and you've got plenty of time to grow your wealth. And there is no reason that you can't open the IRA now, fund it before April 15, 2011 and dollar-cost average your equity purchases at anytime; take as long as you wish to become fully invested.

I agree with everyone that you shouldn't need an adviser. IMHO it is important that the decision of how and where to invest be a joint decision. Either your wife has an interest in the finances or she doesn't; and either way, an adviser won't help. Vanguards's website is very informative, and it should provide enough tools for you and your wife to learn more about how to plan for your future together. And for a lot less money than an adviser over the long term.

Given your ~40 year timeframe for retirement, a target-date fund would work fine. As would most of Vanguard's exchange-traded funds (ETFs) which you could use to build your own portfolio. (Do a google search on "Lazy Portfolio" for suggestions.) If you are concerned that your wife might second guess your choice of investment vehicles, then she should choose her own. You could even make it challenging...have a contest for who's IRA grows faster than the other.

[J.M.]

Can the lump sum not just go into a money market sweep? I don't use Vanguard, but I think most brokerages have a one or a few options for a money market sweep. The lump sum can just sit in the sweep account and be distributed via the dollar cost averaging next year

[MBTN]

If you have any doubts about whether or not you need a financial advisor, then you probably need one!

[KaseyD]

to J.M.

Yes. Vanguard has several excellent MMF options. That's what I was meant by "fund now" (to get the money in the IRA before the IRS deadline) and dollar-cost average over time. Thanks for clarifying my thoughts :-)

[Dave Farquhar]

No, no, no, no, a thousand times no on the financial adviser! (I lost 50 grand to an overly aggressive adviser's bad advice. He made plenty in fees though.)

Here's something you can do instead. Dump the 10 grand into Vanguard. Pick a balanced mix of funds, using index funds as much as possible, that you're comfortable with risk-wise. You'll want an S&P 500 fund, a Wilshire 5000 fund, some kind of bond fund, and some kind of international and/or emerging markets fund.

But don't spend all the money yet. Buy, say, 100 bucks worth of each, keeping the rest of your holdings in cash. Next week, buy another hundred bucks of each. Do the same until you've spent it all. Then determine a percentage that you want to hold (probably not an even 20% split of each--the younger you are, the more you want in emerging markets, and the older you are, the more you want in bonds), then set your account for automatic re-balancing. This forces your account to sell high and buy low.

Ideally, next year you should try to invest on a monthly or weekly basis, rather than doing a lump sum. Google dollar cost averaging to see why. Easier said than done, I know.

With dollar cost averaging and automatic re-balancing and low-load/no-load funds, you'll outperform 90-95% of financial advisers out there.

[Anonymous]

Seriously, skip the advisor. Go read "The Only Investment Guide You'll Ever Need" by Andrew Tobias, and follow something like Mr. Fahrquhar's plan above if you want to go slow, or put it all in at once to keep transaction costs a bit lower.

[Jim]

Hiring someone to manage your finances will cost too much in fees for what they'll get you. Target date fund could work fine for you. Its easy and gives you a simple mix of bonds and stocks. Vanguard is a low cost option as well.

He says: "I certainly don't want to lose money." There is a risk you will lose money with any kind of stock investment. If you really can't tolerate any risk evern over shorter periods then you may want to consider safer bond investments. But if you've got a long term to invest (20+ years) then understand that stocks will go up and down but generally provide higher returns in longer periods. (of course some will look at the past 10 years and doubt that still holds true)

[Jim]

"we make roughly $150k annually"

THat puts you in the 28% bracket.

Why are you choosing a Roth IRA?

DO you not have a 401k option at work or are you already investing in that? If there is a 401k and it matches any amount then you should put your money in a 401k at least up to the match first. I'd assume you don't have that option but it should be mentioned just in case.

[Jim]

"I think the primary benefit from going to an adviser would be to have someone other than myself explain investing to my wife."

You and your wife can learn a lot more about investing on your own than what an advisor will teach. I doubt advisors are going to explain how everything works in much if any detail. If they do explain things it will come at a steep hourly rate. You're better to get some books like Investing for Dummies or similar.

If you're looking for someone else to explain to your wife is that because she isn't accepting of your investment ideas? Is she risk adverse? You may need to compromise on investing strategy.

[MBTN]

With all due respect to Jim and Dave Farquhar, I don't think that an advisor is such a bad idea for this gentleman. First, there are plenty of honest, fee-only financial advisors. Fee-only means that they get paid a flat fee regardless of what you invest in, so they don't have any incentive to steer you towards something with high commissions. Second, there are plenty of things this gentleman says which indicate that he might need some "hand holding":

1. As Jim points out, a Roth IRA may not be a good idea given a higher tax bracket.

2. His initial inclination to invest in an S&P 500 fund indicates that he may not understand the benefits of diversification.

3. His statement "However, I'm a little hesitant because we are talking serious money. I've dabbled before with investing, but with only about $2000." indicates that he may not have the stomach to stay the course if the market goes down a little, so having an advisor talk you off the ledge is helpful so you don't panic sell at the first sign of trouble.

4. As others point out, the desire to invest a lump sum all at once may not be the best course of action.

Yes, you can read books to educate yourself on this stuff. However, if you have any doubts and you are new at this, which the poster seems to be, there is nothing wrong with admitting that you need a little help to get you pointed in the right direction.

I believe even our esteemed host has make the case for having an expert do your taxes as opposed to doing it yourself, and that is coming from somebody who appears to be comfortable with all things financial. There is no shame in asking an expert for a little guidance if you think you need it.

[Robert @ The College Investor]

A few things to understand:

- You will lose money and gain money (the stock market goes up and down everyday)
- Your money will grow over the long term (years...)
- Investing in a S&P500 mutual fund is about the safest way to invest in the stock market
- Investing in a lump sum can be better than dollar cost averaging because you usually have to pay an commission with EACH transaction, and since a lump sum is one transaction, it can save you (some mutual funds let you add to your position without charging, however).

[billy-bob]

Congratulations on your windfall.

You do NOT need to hire an advisor. You also do NOT need to rush into anything.

The most important thing you should do is start off by educating yourself.

Read William Bernstein's book, "The Four Pillars of Finance". You may also want to read "The Coffeehouse Investor", and "The Bogleheads Guide to Investing". All these books advocate a balanced, low cost, indexed approach.

You should also get onto the Bogleheads Forum online and start reading in the "Help with Personal Investments" section. You can post questions about your situation and the folks there are incredibly helpful and knowledgeable.

Vanguard is a great company with an excellent philosophy and approach and very low cost index funds.

Good luck!

[Travis@Plain Money Talk]

If you are a conservative investor that isn't looking for custom stock portfolio than there is really no need for an advisor just for the purposes of investing. I can see rationale in going to one for a full look at your finances including college savings, income protection, and insurance needs to get a full pack and to help with your future decisions.

However, in this instance I see no need. I would go with a balanced fund or a target date fund. Forget the dollar cost averaging if you have the money now. Studies have shown it doesn't really give you much of an edge if any over lump sum investing. The main advantage behind dollar cost averaging is that people actually invest versus holding on and waiting which makes it more likely to spend the money elsewhere.

I would also avoid the EFTs unless you want a more active management. EFTs do not automatically reinvest the dividends which can trigger a tax liability since they paid out to you. Mutual funds will reinvest these automatically for you making it an easy choice for low time management. Vanguard is a good place especially for low ongoing costs and are an established investment place that you can trust.

Lastly if you're concerned about your wife understanding investing the easiest/simplest book I've found on it is the "The Wall Street Journal Guide to Understanding Money and Investing". This should give her a basic understanding of investing in general and is a quick easy read.

[TJ]

Considering time to retirement and yearly income, this is chump change (which is the opposite of the criticism it may sound like, way to go on big income and saving so early).

Given the yearly limits on retirement accounts, getting it into a retirement account is the key, most other investing decisions can be changed if you dont like what you've done...

Sounds like you're doing what Buffett advises young people to do with their chump change, now get back to work ;-)

[billyjobob]

Skip the advisor. Do go with ETF's like Jeff said. There is plenty of info to get you started with ETF investing on the internet. If you invest with Fidelity, they will give you personal advice ...free.

[Harm]

Re: the guy who said your money will go up and down in the short term (true),
but up over the long term. Yes, probably. There are NO guarantees.
It will ALMOST certainly go up over the long term.

[mysticaltyger]

Your plan isn't bad...but if I were you...I'd put the money in Vanguard Wellington. It has matched or beat the returns of the S&P 500 over the long term with less volatility. The premium you pay for active management is so small, that this fund is worth it. And once your account balance gets to $50,000, you get the even cheaper Admiral share clas.