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Investing early for retirement

Dr. Don TaylorDear Dr. Don,
I have a small Roth IRA and am wondering where would be the best place to invest my money. I am 30 years old, so I am willing to assume risk. I currently have 25 shares of PFE and 25 GE. I have $3,000 to invest. I am thinking about opening up a Scottrade account and buying 25 more of a bank stock, retail stock, etc., to diversify. I have also been thinking about just investing in a mutual fund such as the Vanguard 500 index or a total stock market fund. Do you have any suggestions or opinions for me? If you think mutual funds, do you have any opinions on certain ones?
-- Candy Capital

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Dear Candy,
It's great that you're getting an early start on saving for retirement. It's hard to make that a priority when you're young, but doing so can make it a lot easier to reach your financial goals for retirement.

The advantage of opening a brokerage account for your Roth IRA is that you can trade in the account without worrying about the tax ramifications of taking short-term or long-term taxable gains in the account. Qualified distributions out of this account are free of federal income taxes. That advantage is also a disadvantage if your focus is on trading stocks vs. investing for your future.

You don't need a passel of stocks to have a diversified stock portfolio. An efficiently diversified portfolio can consist of as few as six to 10 stocks. However, it's hard to effectively diversify on your own. Naive diversification is where you assemble a portfolio of stocks that you hope will reduce the variability of the portfolio's return. How do you classify GE as a company when it competes in eleven different industries, including health care, which is also one of Pfizer's three industrial classifications?

My preference for retirement investors that are just starting to invest is to choose a no-load index mutual fund based on a broadly defined market index. If the investor wants some bond exposure, too, then investing in a no-load hybrid mutual fund that invests in both stocks and bonds provides diversification in both asset classes.

A total market index fund will give you exposure to small-cap and medium-capitalization stocks that you can't get in a large-cap index, such as a mutual fund that invests in the Standard & Poor's 500 index. Exchange traded funds, known as ETFs, are a viable alternative to the mutual fund that you can hold in a brokerage account.

Whether an ETF is better than a mutual fund based on the same index depends on the commission costs and fees in the brokerage account vs. the annual fees and expenses for the mutual fund. IndexInvestor.com has a page on its Web site that discusses this choice in greater depth.

Editor's note: Dr. Don has a Scottrade account and owns shares in the Vanguard 500 Index.

 
-- Posted: May 2, 2005
     

 

 
 

 

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