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Plan Well, Retire Well

Saving and investing your money

Solutions for Investment Procrastination, Part 1


I would rather do lots of things than pick a mutual fund to invest in. Re-balancing my account isn't high on my list of fun things to do, either. My guess is that most people don't like these tasks any more than I do. So what happens? We procrastinate: these things are on my To-Do list, but I never seem to get around to them.

I have some good news for you. You may not have to do it all by yourself. Yes, you could hire an investment adviser and let them do decision-making, even manage the accounts for you, but that's not what I'm talking about. I'm talking about three tools (one older, two that are relatively new) that cost little or nothing and can make your life easier.

In today's post, I'm going to talk about just one of these, the one that you're most likely to already know about: index mutual funds. What you may not have realized about index funds is how they can simplify your life.

Most of us know that we should diversify, or spread our investments across different companies and industries. If we invest in just one company or one industry, we are taking on much more risk: there's a very slight chance that we could become millionaires! But there's also a very real chance that we could lose some, or even all, of our investment if the company does badly or goes belly up. Diversifying by investing in a range of different companies and industries reduces both possibilities. Our investment results are more likely to be somewhere in between those extremes.

Investing in mutual funds rather than individual stocks is an easy way to achieve diversification. (Note: There are funds that intentionally focus on narrow sectors of the economy like energy, technology, or health care. If your goal is a well-diversified portfolio, you can ignore those.)

You may not be choosing individual stocks or bonds, but now you have to choose mutual funds! The 2013 Investment Company Fact Book counted 7596 funds in 2012. Of those, 4514 invested in "equity" (stocks), 1962 in bonds, and 580 were money market funds which would be labeled "cash." And those numbers don't even include funds that invest in other mutual funds rather than investing directly in stocks or bonds.

Your retirement plan at work probably offers just a tiny, tiny fraction of those funds. But you still have to choose. How? Read the prospectus . . . Look at how long the fund manager has been there . . . Check how the fund performed in both good and bad markets . . . Figure out what its expenses are . . . Are you tired yet?

Let's look at how index funds can help us get past this roadblock.

While the fund manager(s) decide what to buy and sell in the typical mutual fund which is actively managed, index mutual funds are passive. They're not trying to pick the investments that will do the best over the next week, month or year. Instead, their goal is to simply mirror the performance of an index that represents either an entire asset class (like the entire US stock market) or a portion of it (such as mid-cap US stocks). You might recognize the names of some of these indexes, such as the Standard & Poor's 500 (large-cap US stocks), the Wilshire 4500 (small- and mid-cap US stocks), MSCI EAFE (Europe, Asia and Far East stocks), or Barclay's Capital Aggregate Bond Index (US bonds). The mutual fund will either own all the investments included in the index it tracks, or a mathematical representation expected to match its performance.

It's may seem counterintuitive at first, but indexing beats most actively managed funds in most asset classes, most of the time. (See USNews for a recap of one recent study).

One of the reasons is cost: index funds cost much less to operate so the investor gets more of the returns generated by the investment. There is still a range of costs among similar index funds from different companies. The lowest have expense ratios of about one tenth of one percent (0.1%) which is also referred to as ten basis points.

But there's no need to worry about how long the fund manager has been there, or how it did compared to other funds in up or down markets. All you really need to know is how you want to divide your money between different asset classes. Pick the index funds for those asset classes, and you're done! A lot of new or small investors start with just a large US stock index fund or one that covers the entire US stock market.

Your employer plan may offer index funds. For other accounts, you can access index funds by investing directly with a mutual fund company that offers them, or through a broker that gives you access to index funds from one or more mutual fund companies.

Index funds are just one of the tools that might help end your procrastination about investing. In future posts, I'll introduce you to two more.



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