Investment Strategies With $10,000 or less #2: Index Mutual Funds
Last Tuesday, we looked at how to create a bond ladder with less than $10,000. While certificates of deposit are good to balance out your portfolio and provide peace of mind with security like a comfy blanket while sitting in front of a warm glowing fireplace, they will definitely not provide the growth to make your retirement savings account jump.
Some people won’t be able to endure the cruel market fluctuations and that is fine. This is why they should (even at an early age) setup their bond ladder and minimize their risk. However, if you understand that although your investments drop at times, over the long haul they have always gone back up (if you have a sane asset allocation”¦which will be explained in another post).
The problem is that if you have only $3,000 to invest, you don’t really feel like you should hop on the stock market roller coaster by buying a fraction of one or two companies. The transaction costs will be too significant and your risk due to the fact that you are concentrated only two stocks is too high. Therefore, you can already forget about stock trading with small amounts. Most people do it thinking they will hit a homerun but many end up like any other player facing the 5 time CY Young Winner, Randy Johnson…. 3 Strikes and out!
You are trying to build a safe retirement savings account here, not to impress your brother-in-law at the next Christmas party (I bet it would even be better if you can do both, right?).
Why I am a big fan of index mutual funds:
#1 Cheap cost
I don’t really like mutual funds because most of them charge an awful lot in management fees. For example, if you make an 8% return and the fund took 2% for management fees, you just has a 10% investment yield and the company took 20% of it off the top for their own pockets!
Index mutual funds, such as Vanguard, have very low management fees. They are not trying to beat the market, they are just trying to mimic it (considering that 70% of the professional portfolio managers on Wall Street can’t beat the S&P 500, you may want to try to match the index ;-) ).
You should be able to find index mutual funds around 0.50% fees (managemegement expense ratio) or even less. Therefore, when the markets are trending up, you are making money, and the mutual funds manager takes a fair cut!
The other thing that I really like about index mutual fund is their diversification. You can buy various index funds that follow different markets. The American stock market is pretty huge and well diversified. However, if the economy is not going anywhere during 3-4 years, your investment won’t do much either. This is why it is important to consider investing in Canada, European countries, Asia, the South American economy and/ or emerging markets.
The beauty of index mutual funds is that with very low capital (most of them start at $500), you can build a well diversified portfolio and invest in different countries. You may want to invest most of your savings in the American markets for several reasons, but investing elsewhere could make the difference.
#3 Low trading fees
If you start with a small amount of capital, the last thing you want are heavy trading fees. If it cost you $50 on a $1,000 transaction, that’s 5% gone from your investment even before starting!
Index mutual funds are part of the cheapest investment products you can trade on the market. Therefore, you keep the money in your retirement savings account and not in the hands of a broker ;-)
I still have a few investment strategies I want to talk about and then, we will discuss how we will build the portfolio.