CNN Money thinks you only need 7 investments. I think that is four to six too many for the average investor.
Here is the list of investments Money Magazine thinks you need:
- A blue chip US-stock fund (track the S&P 500 index) (Fidelity Spartan 500 Index, FSMKX)
- A blue chip foreign-stock fund (track the international stock index) (Vanguard Total International Stock Index, VGTSX)
- A small company fund (T. Rowe Price New Horizons, PRNHX)
- A value fund (Vanguard Value Index, VIVAX)
- A high-quality bond fund (Vanguard Total Bond Market, VBMFX)
- An inflation-protected bond fund (Vanguard Inflation Protected Securities, VIPSX)
- A money-market fund (Fidelity Cash Reserves, FDRXX)
If you made it to the end of that long list, congratulations. For the 50% of you asleep at the computer, I apologize.
Seriously, 7 funds is “all” you need? The above is just fine. It covers every single aspect that you might ever want to possibly cover.That’s great and all, but…
7 Funds is Complicated
We live in a society with a negative savings rate. You’re telling me that I am somehow going to convince Mr. Average American to invest not in one fund. Not in two. Yes, seven sounds is just right.
7 funds is very complicated. Here’s a few reasons why (I’ll show you the alternatives in a moment):
- Each fund has a minimum required investment. The more funds involved, the more minimum required investments required. The combined minimum required investment for the above seven funds is $24,500! The Vanguard funds are all $3,000 (four funds), the T.Rowe Price Fund is $2,500, and the Fidelity S&P 500 fund is $10,000. The money-market fund isn’t publicly traded from what I can tell; I’m not sure if it has a minimum or not. Even if you dropped the Fidelity S&P index in favor of its Vanguard brother (VFINX) your minimum required investment is still $17,500. If you gave each fund equal weighting, or $3,000 for each of the seven, you would need $21,000. That’s a ton of money if you are just getting started.
- There are three fund companies on the list. “What’s wrong with three companies? Shouldn’t you pick the best funds?” I’m pro-Vanguard and not afraid to admit it. However, You should not stick with a fund company if there are better options out there. In this case, suppose you’re investing in a Roth IRA. To get all of the above mentioned funds, you first have to find a brokerage that gives you access to all of the funds. After that, you’ll be paying fees to trade your mutual funds. Fees = less money for retirement. If you stuck with one company such as Vanguard and swapped out the funds for comparable ones, you would avoid a lot of those fees.
- If you’re investing in an IRA (traditional or Roth), you are limited on the amount of money you can invest each year. This goes with my first point — you would need $17,500 to $21,000 to get started with this plan. An IRA limits you to $5,000 worth of contributions per year right now. You now have to enact this plan over a four year period, making it all the more likely you will never complete it.
- ETFs might serve you better. If you are investing a lump sum — that is, if you had $21,000 to invest right now — ETFs might serve you better. You would pay a brokerage fee ($6.95 at Firstrade) and then a much lower annual expense fee versus the mutual fund. If you’re invested over time (e.g. $3,000 at a time) then a mutual fund would be the better option for you.
Two Alternatives
Investing and retirement do not have to be that complicated. Honest. Remove the glitz, the glam, and the extras. In my eyes, you have two easier options.
Here’s what I recommend:
- One fund. A Target Retirement Fund will take care of everything for you. These funds are a “fund of funds”… so they buy other funds to hold in the fund’s portfolio. For example, many of Vanguard’s funds invest in the Total Stock Market, Total Int’l Stock Market, Total Bond Market, Euro/Pacific funds, and allocate them base on what fund you buy (the later the year on the fund, the more stock-heavy it will be). A target retirement fund is a “set it and forget it” option if you don’t want to think about which funds to invest in.
- Example Portfolio:
- Vanguard Target Retirement 2050 (VFIFX)
- Example Portfolio:
- Three funds. If that is just too simple for you, invest in an all encompassing US-stock fund, an all encompassing Foreign-stock fund, and a bond fund.
- Example Portfolio:
- Vanguard Total Stock Market (VTSMX)
- Vanguard Total International Stock Market (VGTSX)
- Vanguard Total Bond Market (VBMFX)
- Example Portfolio:
The best thing about a Target Retirement Fund is it is easy to get started. With the Vanguard fund mentioned above, you need $3,000 to invest. Once you’re invested, you not only have instant diversification, but you can then contribute as little as $100 at a time. With each additional fund you want to participate in, you need another $3,000.
I think Money’s intentions were good here and I don’t have anything personal against the funds they mentioned. (Well, except the Fidelity S&P 500 fund. $10,000 minimum investment? Are you kidding?) I sincerely think seven funds is too much. You end up sharing a lot of the same stocks in many instances.
(Photo by Kevin… not me.)
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My only question is why does the target retirement fund have investments into bonds? When you have a 2050 target date shouldn’t that be 100% stocks, and not in bonds?
That said, right now my money is going into a Vanguard retirement fund, with a cut going to International (VGTSX)
I agree with you 100%. I love love love the target funds. I have one and so does my husband. I like knowing that it’s adjusting for me as I get older. I don’t pretend to know enough about investing to think I could readjust my retirement account properly.
@Philip: That’s something I don’t really understand either. I guess Vanguard is taking a more conservative stance — it’s only 10% in bonds, but it’s still 10%. For my age, that’s about 6% too much. But like I said this was our first foray into the Roth IRA world so we picked the most diversified option to start. Later on we can add additional funds like more of the Total Stock Market fund to help tweak our allocation.
Sounds like we are in very similarly then, I look forward to seeing what changes you may make in the future also.
Great Post because Money is trying to have you invest in EVERYTHING … doesn’t work.
But, I hate, hate, hate funds … any, but mostly the ones with fees (eg Target Funds).
The again, investing directly in a few select investments is a strategy of the rich and those who want to BECOME rich.
Of course, not everybody wants to be rich, so for them I agree with your second strategy – but, drop the bonds, just Funds #1 and #2 will do.
You might be interested to know that Warren Buffett agrees 100%: I was just at his Annual General Meeting in Omaha where he said that IF you don’t want to take the time to learn about investing directly then you should just dollar-cost-average into a broad piece of “American Business” … which he went on to clarify as meaning Fund # 1 (except he specifically named Vanguard for its very low costs, but I know that Fidelity fund is pretty cheap, too).
I think the reason for having bonds at all is discussed later on in the article, or the magazine at least. Specifically: Asset diversification studies have shown that portfolios with 10-20% bond exposure can generate 90% of the returns of an all stock portfolio, but with significantly less of a roller coaster effect. Given the panic that is common to most investors when the market is climbing toward the stratosphere, Money probably though it wise to provide an asset mix that would be easier for those investors to swallow and hence stick with over the long term.
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