If you have less than $50,000 to invest in securities you kinda get screwed. All of us here at InvestorGeeks are just starting out, in our Mid-20s and have less than $50k in investments. Now I love to learn about investing, but I’m nobody’s fool, and so I want to build a foundation of safe diversified funds until I master selecting value stocks. However, because of my low account balances, I get whacked with maintenance fees that can be pretty stiff. This is a problem because I’d like to diversify my portfolio, but lose more and more of my returns because of these fees. So I’ve come up with an action plan, and I’m hoping you’ll provide feedback before I go ahead an implement it in the next couple weeks.
The Situation: Just Starting Out
I have my Roth IRA and 401(k) accounts with T. Rowe Price and while I really tend to like them (although their site is ugly) they do have some costs associated for small investors like me. Nothing usurious, mind you, but still enough to hurt. $10 here and there really adds up when you are only earning a couple hundred dollars annually.
My 401(k) isn’t really a problem. For one, there are no fees for minimum balances, which is great. For another thing, I really view my 401(k) as a high interest savings account while I collect my employer matching funds. Eventually, I’ll roll it over to a Traditional IRA where I can do some real investing. Within my 401(k) I own four great funds that are relatively diversified across sectors and stock types, and am seeing a decent return (8.8% overall YTD).
My big problem is with my Roth IRA. This is where the magic happens because this is where I can invest in individual companies, and therefore where I stake the future of my retirement fund. However, fees are charged for low account balances, and I don’t want to get whacked.
IRA Problem #1: The Fees
Although my 401(k) doesn’t charge me for small account balances, funds in my Roth IRA cost $10/yr for each account with a balance of less than $5,000 unless I have total assets of more than $50,000 with T. Rowe Price. So to address this problem I want to minimize the number of accounts I have, so that I have fewer accounts with balances over $5,000.
IRA Problem #2: Diversification
While I don’t want to overdiversify, I do want to put my money in at least a 4 or 5 different sectors or investment groups to protect myself against internal market movements. Because I’m just starting out, I don’t want to take too many leaps before I’m satisfied with my stock selection. To solve this problem I want to own a number of highly rated mutual funds with different focuses, including bonds.
IRA Problem #3: Problem #1 vs. Problem #2
As I’m sure you can see there is a conflict of interest between minimizing fees due to small balances and creating more mutual fund accounts to better diversify. So what do I do? I think I’ve come up with a solution for the interim.
My Solution: 60/25/15
So, here’s my thought. What better way to get diversified than to own an index fund? And what better market index is there than the S&P 500? If I own this fund, sure I’ll be overdiversified, but if you’re going to overdiversify, why not own the whole market? Plus, many great investors, including Warren Buffett, suggest index funds as the way to go for new and defensive investors. I’ll set that at 60% of my portfolio.
Additionally, a good mix of stocks and bonds is necessary in any portfolio, so owning an index fund for bonds, namely the one and only Lehman Aggregate Bond Index, wouldn’t be a bad idea either. I’ll take Graham’s advice on this and make this 25% of my portfolio.
Finally, I want to be able to have money to buy individual stocks. I’m not prepared to bet the entire farm on this, but I do want to have some cash available, so I’ll dedicate 15% of my money to opening a brokerage account. If I loose all this money would I be a bit upset? Well sure I would, but I probably won’t loose the entire amount, and I could certainly tolerate loosing 10% of my assets in a year.
By breaking it up into these three separate accounts, my two index funds would be more than $5,000 each, and I’d have some cash to start investing. I think it works out, at least in my head.
Wrapping it up
Will indexes make me rich and famous? No, of course not, but it’s a heck of a lot better than risking my whole nest egg before I know what I’m doing. Plus, until I get my account balances up, it seems that index funds will make up for lackluster performance by providing lower expenses and eliminating my maintenance fees, saving me a couple percentage points a year.
Now please please please comment, cause I’m really looking forward to some feedback on this. Is it too conservative? Is it too risky? Let me know!