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
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
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
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.