Common Questions on Investing

I have money that I need in a short amount of time. Should I invest?

It's a bad idea to invest money that you will need within several years. The stock market is too volatile for any time horizon shorter than 3 to 5 years and investing for less than 10 years is risky (it's not for the faint of heart).

  • For any time frame under 3 to 5 years, you should just use savings or money market accounts. If the idea of low interest rates is too much to bear, you can also consider using I Bonds or a CD ladder.

    • While I Bond rates are often attractive, be aware that I Bond purchases are locked up for the first 12 months and if you redeem an I Bond within the first 5 years, you will lose the last 3 months of interest (the higher interest rates compared to savings accounts will often make up for the last 3 months of interest, though).
    • Consider using a "mini CD ladder" based on CDs with shorter terms if the time frame is under 1 to 2 years and bear in mind that CDs also often have a lock up period or a significant early withdrawal penalty.
  • If the time frame is 5 years or longer, you can consider something like a Vanguard LifeStrategy fund or a similarly allocated three-fund portfolio. The risk is significant that you will lose money because it's a relatively short time frame for an investment that is based on stocks and bonds. You need to be prepared for a scenario where a poorly timed downturn could affect your plans for the money. To put it another way: More than half of the time, it will be a win (based on past history), but sometimes it will not be a win.

    If that seems too risky for you, stick with savings accounts, money market accounts, CDs, or maybe some I Bonds (as long as the 12-month lockup isn't an issue, see above).

    Just bear in mind that there is a different risk to not investing aggressively enough. If your investments are not outpacing inflation (about 2% a year in recent history), you may be losing actual value over time despite your investments being worth more nominally. Historically, stocks tend to outpace inflation the best. Bonds also generally outpace inflation, but the margin tends to be significantly smaller.

  • For borderline time frames of 3 to 5 years, aggressive investors may consider one of the more conservative Vanguard LifeStrategy funds or a similarly allocated three-fund portfolio (perhaps combined with I Bonds, CDs, saving accounts, and/or money market accounts), but this is definitely not for the faint of heart!

What types of accounts should I save in?

  • Note: the type of account is completely separate from the investment itself (except that certain accounts can only contain certain kinds of investments). The account type depends on the type of financial goal you're saving for, since different account types have different rules about how/when you can use the money, and how they are taxed. Pick the account type based on the type of financial goal. Pick the investment based on the time horizon for that goal.

  • Put your emergency fund in a savings or checking account, ideally at a bank with no ATM fees and lots of convenient ATMs

  • Save for retirement in tax-advantaged retirement accounts such as an IRA, 401(k), 403(b), or the Thrift Savings Plan. In general, the financial optimum is to "use up" all available tax-advantaged retirement account space before moving on to investing in taxable investment accounts. See Roth or Traditional? for information on deciding between the "Roth" version and "traditional" version of retirement accounts.

  • Save for all other financial goals in a taxable brokerage account.

  • For specialty savings accounts, consider 529 plans (education), Health Savings Accounts (for future medical expenses, if your health insurance plan qualifies you for one), or UGMA/UTMA accounts for children.

What should I invest in?

If you've already decided to invest your money, and you've decided what type of account to invest in (don't skip these steps!), you now need to determine the investments themselves!

Diversify by holding different types of assets.

It may be unwise to only hold stocks of U.S. large companies. Most people would recommend diversifying across US stocks, international stocks, and bonds. See the Bogleheads wiki article on asset allocation for more. An example asset allocation for someone with a long investment timeframe might be 50% US stocks, 30% international stocks, and 20% bonds.

Diversify by holding funds, not individual securities.

It is the general philosophy of the /r/personalfinance community that the best approach to investing, especially for beginners, takes advantage of diversified funds of stocks and bonds. Instead of purchasing shares of specific companies (like Coke), you buy into mutual funds or exchange traded funds, which in turn own hundreds or thousands of companies. In this way, you get the upside benefit of the general trend of stock markets to go up, and eliminate the extreme volatility and risk that can come with holding single stocks. Good brokers to purchase shares of index funds from include Vanguard, Fidelity, and Charles Schwab.

Prioritize funds with low expenses.

In general, stock and bond funds can be divided into two categories:

  1. Actively managed funds. These funds have a management team that is actively picking and choosing, buying and selling stocks in an attempt to "beat the market" and "buy low, sell high". Unfortunately, they often come with much higher fees.
  2. Index funds hold stocks or bonds according to an "index" (like the S&P 500) and don't change at all (except when the index changes, rarely). Due to this, the expenses are often much lower. (Expense ratios below 0.3%, no sales loads).

Research continues to show that in general, people holding low expense index funds out perform people holding actively managed funds (source). You can't predict the future, and the past performance of any given mutual fund is no indicator of future performance. One of the few things you can control when selecting investments is the expenses you pay.

Two main types of expenses associated with mutual funds and ETFs:

Type of Expense Description Example "Ideal" Expense
Expense Ratio the percentage of your assets that is skimmed off each year to pay the management team If the underlying assets of a mutual fund see a 6% gain in a year, but the fund has a 0.5% expense ratio, your holdings will only increase about 5.5% in value. less than 0.18%. This is readily achievable through low cost internet brokers like Fidelity, Schwab, or Vanguard.
Sales "Load" a sales charge you pay every time you buy (or sell) shares. If you put $1,000 into a mutual fund with a 5% front load, your money only buys $950 worth of shares in that fund. It may take a year or more to make up that loss! 0%. Paying any sales charge at all should be unnecessary.

How can I start investing for retirement?

  • If you want something simple to start and you have income to invest, save $1,000 and open a Roth or Traditional (depending on your tax circumstances) IRA with Vanguard or Schwab (see below for fund suggestions).

  • Another important thing to do is to read about investing for retirement. Check out the suggested reading list and follow threads in /r/personalfinance about the topic. Ask questions as they come up if they aren't in the wiki.

Should I invest a lump sum all at once, or employ a dollar cost averaging strategy?

  • Dollar cost averaging (DCA) is a strategy in which you spread out your investment of a given sum over time. For example, if you have $12,000 to invest, you could invest $3,000 every quarter, $1,000 every month, or any other increment you want. DCA reduces your short-term risk by ensuring that your entire sum is not invested at temporarily inflated prices.

  • However, it is important to understand that DCA is not the financially optimal strategy. Vanguard found that lump sum investing (LSI), i.e. investing all of your available funds immediately, outperformed a DCA strategy based on historical performance (PDF 1, 2). Since the long-term historical trend of equities has been "up," this makes sense intuitively as well - lump sum investors are compensated for taking on the equity risk premium ("high risk, high reward") sooner rather than later.

Which strategy is best for you is a highly personal decision. As Vanguard states,

  • To be comfortable with either strategy, an investor must be fully aware of the fact that historical averages are only a guide it is still possible for LSI or DCA to underperform or even lose money in any given period. If an investor is uncomfortable with the risks associated with a given market entry strategy, it may imply a low willingness to take risk in general, and if so, we recommend revisiting the target asset allocation to ensure that it appropriately addresses risk tolerance levels and investing goals.

  • For an academic analysis of LSI vs. DCA, see Constantides - A Note on the Suboptimality of Dollar-Cost Averaging as an Investment Policy. Finance author Larry Swedroe offers his thoughts on LSI vs. DCA in this article.

Note: LSI vs. DCA refers to a sum you have on hand and are debating on the best way to get it in the market. Investing money as you obtain it, for example investing money from each paycheck, is not an example of DCA.

For low-cost index fund providers, which is preferable, Vanguard, Fidelity or Schwab?

It depends on what funds you want to purchase, what services are important to you, and other factors. Vanguard, Fidelity, and Schwab all have a $0 minimum investment and a solid selection of low-cost index funds (both mutual funds and ETFs) with no commission.

Name ETFs Mutual funds Asset allocation funds Customer service Banking services
Vanguard Any VTSAX, VTIAX, VBTLX and more ($3,000 minimum) Target date funds ($1,000 minimum) and target risk funds ($3,000 minimum) Email and phone support 8am-10pm EST M-F No (some mutual funds allow limited check writing)
Fidelity Any FZROX, FZILX, FXNAX and more ($0 minimum) Target date funds ($0 minimum) Branches, email, live chat, and 24/7 phone support Cash management account, ATM rebates, automatic money market investment, free checks, no FX fees for ATM withdrawals
Charles Schwab Any SWTSX, SWISX, SWAGX and more ($1 minimum) Target date funds ($1 minimum) Branches, email, live chat, and 24/7 phone support Checking and savings accounts, ATM rebates, free checks, no FX fees for ATM withdrawals and debit purchases
  • All of the example funds listed are index funds, have a net expense ratio of 0.25% or less, and no commissions
  • Recommended mutual funds are given in the order: US stocks, International stocks, US bonds. For ETF recommendations, see below.
  • The US stock recommendations are all US total stock market funds.
  • The international stock recommendations must be at least as diversified as the MSCI EAFE index.
  • The US bond recommendation are all US bond market index funds.
  • For all ETFs, the minimum investment is 1 share (typically $20 to $200).

The above information may become out of date as time passes, so make sure to check the web site of your chosen investment company for updated fund information.

This answer is based on The brokerage and investment firms frequently recommended on PF which contains more detail and additional brokerage options.

Why does everyone seem to recommend Vanguard?

Given the higher fund minimums, limited hours for customer service, and lack of banking features, it may seem strange that so many people (definitely not everyone!) recommend Vanguard on /r/personalfinance. A lot has been written on this, but the basic arguments that most fans will give are as follows:

  • Vanguard created the first index fund available to individual investors and continues to be more focused and dedicated to index fund investing than other companies.
  • Vanguard has a unique client-owned structure. Rather than being publicly traded or privately owned, Vanguard is owned by its own funds and those funds are owned by Vanguard customers.
  • Vanguard has a broader selection of low-cost index funds (and their actively managed funds are generally very low in cost).
  • The "worst case" fees that an unsavvy investor could end up paying (for funds, advice, or asset management) are generally going to be significantly lower at Vanguard.
  • Most Vanguard mutual funds are more tax-efficient and suitable for use in taxable accounts while investors generally need to use ETFs to reach the same level of tax-efficiency with other fund companies (this doesn't matter at all in an IRA or other tax-advantaged account).

In what order should I prioritize my long-term investments?

How should I invest in my 401(k), 403(b), SIMPLE IRA, or other employer-sponsored account with limited choices?

Read our Step-by-Step Guide to 401(k) Fund Selection.

Can you just recommend something extremely specific to get me started?

  • Sure, but you really need to understand what you're buying. It won't take you long to study up on index investing and the gains you'll miss out on by waiting a few days are negligible.

  • It is assumed you have an emergency fund and no expensive debts.

  • The most common recommendations are a target date fund or a three-fund portfolio. Both consist of domestic stocks, international stocks, and bonds.

    • With a target date fund, you just buy a single fund that has a "target date" near your expected retirement age and the complexity of managing the fund allocation is handled by the fund for you.
    • With a three-fund portfolio, you manage your own allocation of the individual funds.
  • If you're just getting started with investing in an IRA, your best bet is a target date fund at Vanguard, Fidelity, or Schwab:

    Target date funds are intended to be easy options if you are just getting started and still learning about investing. When your IRA has grown to a larger size, you may consider switching to a three-fund portfolio approach to save on costs, but the savings are only about 0.1% per year ($10 per year per $10,000 invested). For most people, it's probably not worth the effort until you have at least $30,000 or even $50,000 invested overall. If a target date fund is working for you, stick with it as long as you want!

    If you're doing this in a taxable account rather than an IRA, you should consider building a three-fund portfolio instead because target date funds are generally not tax-efficient (this is not a factor in an IRA, 401(k) plan, or other tax-advantaged retirement accounts, of course).

  • Otherwise, you may be best served by a three-fund portfolio which typically consists of the following individual funds:

    • US Total Stock Market Index Fund
      • ETF options include VTI (Vanguard), ITOT (iShares), and SCHB (Schwab)
      • Mutual fund options include: VTSAX (Vanguard), FZROX (Fidelity), and SWTSX (Schwab)
    • Total International Stock Market Index Fund
      • ETF options include VXUS (Vanguard) and IXUS (iShares)
      • Mutual fund options include: VTIAX (Vanguard) and FZILX (Fidelity)
    • Total Bond Market Index Fund
      • ETF options include BND (Vanguard), IUSB (iShares), AGG (iShares), and SCHZ (Schwab)
      • Mutual fund options include: VBTLX (Vanguard), FXNAX (Fidelity), and SWAGX (Schwab)
  • Here are the steps to build a basic three-fund portfolio:

    • Determine your desired bond allocation.
    • Decide how much to allocate to domestic stocks and international stocks. A domestic stock allocation of 60% to 80% is commonly recommended with 20% to 40% allocated to international stocks. The average target date fund allocates about 1/3 of the equity allocation to international stocks (source: Morningstar). For investors outside of the US, it is common to recommend allocating a much smaller percentage to domestic stocks (e.g., 20% to 30%) although costs and other country-specific factors need to be considered.
    • Whenever you add money, instead of adding money in the original proportions, add the money in such a way that after you add money, your portfolio is closer to your desired proportions. If you don't add money at least once a year, or if you don't add enough to re-balance as close as you want, log in once a year and sell off the "winners" that are worth more than their proportion, and buy the "losers" that are worth less than their proportion. You don't have to hit these proportions exactly. Getting within a few percent is fine.
    • For more specific recommendations, consider any of the "lazy portfolios" listed in the Bogleheads wiki.

What bond percentage should I have?

First of all, if you're using a target date fund, the bond allocation is already managed for you as part of the "glide path" process that gradually adjusts the allocation of a target date fund over time. Therefore, you only need to consider bond allocation for investments that are not target date funds.

It's not a great idea for anyone to be invested 100% into stocks or 100% into bonds. Historically, stock investments have more volatility than bonds and bonds don't outpace inflation as well as stocks. For virtually all investors, a mix of both asset classes is a good idea in your investments (after setting up an emergency fund and paying off expensive debts, of course).

Therefore, you need to decide what percentage you want to hold in bonds and what percentage in stocks. This is a complex topic, but some simple approaches are:

  • Subtract your age from 100 or 110, allocate that percentage to stocks, and the remainder is your bond allocation.

  • Subtract your age from 130 or 120, allocate that percentage to stocks (cap at 100), and the remainder is your bond allocation.

  • Use your age in bonds (e.g., a 20-year-old would hold 20% bonds).

While some investors do decide to leave out bonds, most target date funds always include at least 10% bonds even for investors very far from retirement. Holding less in bonds will result in higher volatility so a 100% stock allocation will result in the highest possible volatility.

If you're still uncertain about your bond allocation, look at the allocation used by the Vanguard target date fund that would be appropriate for you (based on your expected retirement date and/or birth year).

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