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!

Also consider a life-cycle fund. These are “funds of funds”, that, given a target retirement year, automatically maintain an “appropriate” allocation.

Of course “appropriate” is subjective, but if you want to retire in 2035, but are more aggressive than some, you could invest in a 2045 fund which will be more heavily weighted toward equities.

All major fund families have life-cycle funds, for example:
Vanguard Target Retirement Funds

A good life-cycle fund will have extremely low overhead, and will automatically change the fund’s allocation as you age. You avoid the need to rebalance periodically, and avoid the urge to chase hot funds.

Those fees are icky. A few years ago, I moved my accounts to Scottrade. I’m not affiliated with them at all, but I think that they are a great broker and they really don’t hit you with those inactivity fees. I hated etrade because of those things!

One drawback to scottrade is that the universe of potential mutual funds is a little bit smaller, but since I tend to invest in Powershares, I have not found this to be much of a major issue.

If I had the account size, I think I would probably also open an account with brownco. I am not sure how good Ameritrade’s Izone is, but when it was Freetrade, that truly was the best brokerage for me.

Good luck, and keep up the good work.

A couple points…

1) Why any bonds at all? I’m curious about the details behind your 25% number. Is that what Graham recommends as a minimum? Even for twenty-somethings?

Personally, unless I feel the market is going to do particularly badly, I’m trying to avoid bonds until I’m at least 30. I just don’t have that much capital to preserve. And if I feel the market is going to do poorly…

2) I would stay away from index funds during bear markets. There are a lot of indicators pointing towards a bear market right now. In these markets, index funds are going to (by definition) lose money on average. The way to make money during a bear market is to pick specific stocks and sectors which are going to grow despite the fact that the rest of the market is gloom. Think any stock we’ve recommended here 😉 Think “Internet Stocks”. Think “Alternative Energy Stocks”.

Now, moving away from index funds would go against your diversification goals. I would maybe give yourself some time to fully diversify. Pick a decent growth/emerging-markets fund and a couple stocks you think solid (read: not speculative) enough to ensure you don’t lose your shirt. Every year, add to your positions and pick up one or two more stocks. In five years, you’ll have a decently diversified portfolio.

p.s. I’ve been talking a bit about the bear market threat. And I really need to post my real intuition about how the market is going to do over the next few years. It’s not going to be all bad. In any case, investing in specific growth stocks and sectors doesn’t stop working during a bull market. It just may end up being a bit of wasted effort when similar results could have been obtained by simply buying everything (index).

I think there’s some very valid points in your post, Jason. Let me just address some of them.

The basic foundation for a bond / stock mix is that when stocks go bad, bonds are good and visa versa. By owning bonds, especially when you think there is going to be a bull market as you stated, you protect yourself from negative or stagnant earnings from stocks. Mind you, it’s not about asset protection, it’s about creating solid, consistent returns, until i learn enough to create better returns with stocks.

Instead of the bond index fund, I’ve ended up chosing 2 bond funds: an emerging market fund that over the last 10 years has earned over 10% annually, and a long-term investment-grade fund which has earned over 8% annually. Long term bond funds with longer durations are more volatile in light of interest rate pressure, and if the market turns south, prices will skyrocket, leaving me with more valuable assets. Additionally, foreign government bonds do not follow US market trends additionally counteracting a bear market.

Now as you mentioned, my primary investment is going to be in an S&P Index fund. Do I think that’s the ideal situation? No, but if I own a couple focus funds and the market turns, I could have trouble. Plus, if the market turns south, I’ll be able to take my index fund and dollar-cost average my way to pretty returns when the market rebounds. On the other hand, if the market continues it’s climb, then I’ll be glad I got in when I had the chance.

When I’m picking a mutual fund, I not only want strong fundamentals, but returns that consistently outperform its benchmark index over 10 years. Remember, the vast majority of mutual funds can’t beat an index over the long term, for many reasons – be it management, or carelessness, or being a victim of its own sucess.

While looking for stock funds to complement the index fund, I was very hot on the Berwyn Fund (BERWX). Having strong fundamentals and stellar returns for the last 5 years (over 20% avg), over 10 years it had just barely beat out the Russell 2000, which incidently had just barely eeked out the same return as the S&P 500.

I ended up not going with the fund, and instead going with the S&P Index fund because since expenses were about 1% lower, I actually would be earning more money than with the Berwyn fund. Despite it’s high ratings, and stellar fundamental, at almost any point in the last 10 year period except for the last year, shared in the index fund would have been worth more money.

Here’s the bottom line. I believe that individual stock investing is the way to go… eventually. However, in my opinion, investing totally or primarily in stocks without fully understanding fundemental and technical analysis, and also not having at least 10 stocks that meet my valuation criteria is really asking for trouble, and frankly, speculation.

Honestly, let’s call a spade a spade here. If you don’t fully understand a company’s business model, value it at a price that is attractive with a good margin of safety, and haven’t determined that fundemantally it is a good company, then you are gambling — plain and simple. Now you go out and prove to me that you’ve built a portfolio with a half dozen or so of those companies, and not only will I stick my foot in my mouth, I will stick my money in your brokerage account.

Warren Buffett and Ben Graham both agree that dollar-cost averaging and index investing in both stocks and bonds is the safest way to get started. We have a LOT to worry about before we get setup with stocks. We have brokerage accounts to worry about setting up, books to read, companies to research… why lose sleep over investments we are not 100% confident about?

I’ll leave you with this thought: true investing should be boring.

Thanks for the response. You addressed my concerns marvelously and made a lot of sense.

Two things that specifically struck me:

1) While bonds are mostly sold at 2-5% rates, it’s exciting to see that a fund that trades bonds can make up to 8-10% per year.

2) I like how you always kept fees in mind when deciding which fund to go with (a major point of your post).

One more thought… It is “common” wisdom that us youngens can afford a little more risk early on, and you seem to be avoiding risk more than is often suggested. Being risky goes against the fact that lower consistent returns can often be better than higher but more deviating returns. Consider:

Fund A 5% 5% 5% 5% avg=5%
Fund B -10% -5% 10% 25% avg=6%

$100 invested in Fund A would have a value of $121.55.
$100 invested in Fund B would have a value of $117.56 even though the average return is higher.

I still have to fully process the implications of this against the common wisdom that I should be gambling more in my early life.


Phenomenal article. I see you are in the same position as I. Seeing as I can’t ‘properly’ diversify with individual funds in the way that I would like to, I am in the process of moving towards an index fund or two as my core investment, with individual stocks playing a supporting role.

I think you are on the right track, specifically in regards to low-cost investing. As you stated, an overwhelming majority of actively managed funds do not outperform their respective index over the long haul.

“Over the 35-year period from 1971 to 2004, the average annual return on all actively managed equity mutual funds trailed the S&P 500 Index by 87 basis points a year, and the broader-based Wilshire 5000 Index by 105 basis points a year. Over long periods, this difference in return amounted to substantial differences in wealth.”

And, even when a fund does outperform their index, the substantial increase in fees usually negates any advantage!

Anyways, keep up the great work. Sounds like we are in the same boat!

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