Chomping at the bit? -- how to start an investment portfolio

Most of my posts so far have been about debt. This post is for those of you out there that are thinking “enough already, I want to get on to investing.” We will be talking a lot about investments in later posts. The main issue with starting with investments is that you need money to invest (at least $3,000 in most cases). It is also hard to start with investing because there is a lot to learn in order to invest successfully. For those of you chomping at the bit I want to show you how to get started. I want to provide you with a simple, low risk (note that this does not mean NO risk) method for investing small amounts. Putting myself in your shoes, I am seeing that this may sound easier than it is. I have just spent several hours researching this topic on the internet. There is a ton of information on investing for beginners but none of it is presented in a concise manner. So, here is my attempt.

1. First, take advantage of any tax deferred plans offered by your employer – if your employer has any saving plan you should first invest in this. Not only are taxes deferred on many of these plans, but many employers match contributions. This match almost guarantees that you will earn more on these investments that you earn elsewhere. The issue is that there are restrictions as to when withdrawals can be taken from these plans so you need to know the rules. While I started investing in these plans, I quickly moved to other investments because I knew that I wanted more access to my funds. To get the best of both worlds, you will likely need to invest more – this requires strong discipline in delayed gratification which you may or may not aspire to. As a student, this may not be an issue for you so we can move on.


2. Invest in an index rather than individual stocks – study upon study shows how very few investors – professional or otherwise – are able to outperform the market. Standard & Poors reports that “actively managed mutual funds underperformed their relative S&P benchmark in 8 of 11 general domestic equity styles during the first half of 2006.”[1] When you start out, you have the added disadvantage of having limited funds which would result in inappropriate concentration. While stock pros like Warren Buffett have the appropriate skills to make concentrated bets, diversification is an important tool for the beginning investor. Don’t worry. Once you have accumulated some knowledge and funds, we will move on to investing in individual stocks. To start, however, stick to the index funds.


3. Dollar cost average – don’t you hate it when you buy something and then find it on sale a week or two later? Dollar cost averaging means that you make systematic investments at over time rather than all at once. This reduces risk and helps to establish a good habit of saving. Just as the pinch of tax payments are lessened as they are taken from your check before you see it, making an automatic investment on pay day helps you to think of this money as unavailable.


4. Invest only those funds that intend to keep invested for at least five years – we are talking about investing not gambling (that will be a subject of another post). Investing in a diversified portfolio over an extended period of time should result in a fairly predictable return. Most studies will show you that you can expect to earn 8% to 12% on large cap U.S. stocks over a 5 to 10 year period. If you want more information on historical returns, I suggest that you read an interesting article from TAM Asset Management, Inc.[2] This return is only expected over long periods of time. There are years that you could lose up to 20% of your investment. Since, no one can predict up and down years, it is important to keep this money invested for the long term.


5. Minimize expenses – the nasty hidden secret is that many investor returns are eaten up by expenses. Keeping expenses to a minimum helps avoid that. This is also a topic for another post. For now, I will just tell you that, in my opinion, you should never invest in a fund where expenses are greater than 1%.


6. Restrict initial investment to large cap U.S. securities that is a blend of the value and growth styles – Investing in large cap securities should result in performance that is consistent with the U.S. economy. While other asset classes are sexier and could result in higher returns, they also involve more risk. To start, it is better to investment in the broad market.


7. Make sure that you keep some funds in cash or other low risk investments – investing in stocks involve risk and it is important that you plan on keeping these investments for a long period of time. Accordingly, it is important that you only invest funds that you will not need for the short term. You need to think about you day-to-day expenses as well as maintaining a “rainy day” fund.


8. Know what you are investing in – It is important to know what you are investing in. While I am attempting to provide you some useful information, it will be important for you to do your own homework.

Based on these pointers, I found a few funds that you might want to look at. If you are interested in investing in one of these funds, I would suggest that you go to their web site for further information.

			# of	Price as of		Expense	5 Yr Total	Minimum	Investment
Mutal Fund Name	Ticker	Style	Stocks	11/24/06	Yield	Ratio1	Return	Initial	Subsequent
Vanguard 500 Index	VFINX	Large/Blend	513	$129.38	1.65%	0.34%	7.13%	$3,000	$100
T. Rowe Price Equity Market Index	POMIX	Large/Blend	1,849	$15.35	1.20%	0.80%	8.53%	$2,500	$100
Schwab Inv 1000 Index	SNXFX	Large/Blend	990	$41.25	1.13%	0.72%	7.70%	$2,500	$500

1 Expense and Management Fee

Source: Standard & Poors Mutual Fund Reports

Data quoted represents past performance. Past performance is not an indication of future results and investment returns and prices for exchange-traded funds will fluctuate. Your investment may be worth more or less than your original cost at redemption. Current performance may be lower or higher than the performance data quoted. Before investing you should consider the appropriateness of this investment based on your individual circumstances. You should also obtain updated information regarding this investment from sites such as http://finance.yahoo.com or https://us.etrade.com and obtain and read a copy of the investment's prospectus.

There may be some of you out there that don’t want to wait until you have $2,500 to $3,000 to invest. While I think it is generally better to wait, I don’t want to discourage anyone. My opinion is that we learn the most when we have a vested interest. Another way to invest is to invest using ETFs or Exchange Traded Funds. These funds trade like stock and you can buy them through an online broker. Kiplinger Personal Finance’s latest ranking of online brokers[3] named the following as the top brokers for accounts of $50,000 or less:

Kiplinger Ranking of Best Brokers for $50,000 (and less) accounts1. OptionsXpress
2. Muriel Siebert
3. Wells Fargo
4. Firsttrade
5. Fidelity
6. Vanguard
7. TradeKing
8. Schwab
9. E*trade
10. Scottrade

I have listed a few ETFs in the chart below that should be appropriate to start your investment portfolio. While these funds provide essentially the same performance as the index funds and expenses are typically lower, the issue is that you are charged a commission every time you buy an ETF. Even with low cost brokers, commissions are likely to be between $10 and $20 a trade. This adds considerably to your cost. The upside is that you can start you investment with much less than $2,500. You can buy at little of one share but you must remember the commission cost.

			# of	Price as of		Expense	5 Yr Trailing
ETF Name	Ticker	Style	Stocks	11/24/2006	Yield	Ratio	Returns
iShares Dow Jones US Total Market Index	IYY	Large/Blend	1,629	$ 68.33	1.52%	0.20%	6.75%
iShares Russell 3000 Index	IWV	Large/Blend	2,959	$ 81.39	1.50%	0.20%	6.95%
iShares S&P 100 Index	OEF	Large/Blend	100	$ 65.38	1.55%	0.20%	3.69%
SPDRs	SPY	Large/Blend	500	$ 140.35	1.69%	0.10%	5.71%
Vanguard Total Stock Market	VTI	Large/Blend	3,764	$ 139.31	1.66%	0.07%	7.53%

[1] http://www2.standardandpoors.com/spf/pdf/index/071906_SPIVA_pr.pdf
[2] http://www.tamasset.com/pdf/assetclass/may06ac2.pdf
[3] http://articles.moneycentral.msn.com/Investing/Extra/TheBestOnlineBrokers.aspx