BusinessWeek Investor: Mutual Funds
Investing 101 For Twentysomethings
It's never too early to start building your portfolio
Twentysomethings often get short shrift on Wall Street. Even those who have extra money to invest rarely have enough to command a broker's attention. If you have only a couple thousand dollars, most brokers will simply hand you glossy brochures on mutual funds. But mutual funds really are a good way for new investors to get started.
Fund investing is not as hip as online stock trading. But if you have a life, it's a low-maintenance strategy. There's no need to punch up stock quotes 50 times a day. Funds give you diversification and professional management.
Funds come in two flavors: load funds, which carry big commissions and are thus the ones that brokers recommend, and no-load funds, which you have to find yourself. We'll show you how to do just that--and identify those that will help you build the foundation for an investment program. But before you invest in anything, set aside a stash for emergencies. The rule of thumb is three to six months' worth of living expenses. With today's low unemployment, three months' worth may be enough. Still, if you lost your job, how long would it take you to find another?
Investing is a long-term proposition, and you may have short-term goals as well, such as buying a house in a couple of years. In that case, it's wise to put the downpayment cash into a money-market mutual fund or a low-risk bond fund. "Young investors don't want to hear that," says Rosilyn Overton, a financial planner with Mid-Atlantic Securities in Little Neck, N.Y. "They think the stock market is always a sure thing."
Money-market funds, unlike bank accounts, are not insured, but they're virtually as good. The funds invest in government, bank, and, sometimes, corporate debt that's very short-term, usually maturing in about three months. Every fund-management company and brokerage firm offers several. The average yield on money funds is now 5.28%.HOME BASE. Ultrashort bond funds, such as Strong Advantage and SSgA Yield Plus, are good alternatives. They invest in maturities between six and 12 months, and they may hold lower-quality debt than money-market funds do. The rub is that shares of an ultrashort fund will fluctuate a little, while those of money funds stay at $1 per share. Still, significantly higher yields can offset the added risk. For instance, the current yield on the Strong Advantage Fund is 6.72%, some 1.5 percentage points better than money-market funds.
For your longer-term portfolio, you'd be smart to establish a home base. One way to ground your investments is to choose one large fund family--Fidelity or Vanguard, say--and select among that manager's funds. An alternative is to choose a mutual-fund supermarket, such as those run by Charles Schwab, Fidelity Brokerage Services, and TD Waterhouse. These firms offer thousands of no-load funds, most with a small transaction fee. Many have no fee at all because the fund management companies pay the fees.
Schwab has by far the most fund assets, but Waterhouse has the most funds--about 9,000. Fidelity Brokerage has all the Fidelity funds, plus nearly 4,000 more. Even Vanguard, whose low-expense index funds are popular with do-it-yourself investors, has a brokerage arm that offers some 2,600 funds from other managers. If you're opening an account with Fidelity or Vanguard, ask for a brokerage rather than a fund account. A brokerage account gives you more options later--to invest in other managers' funds or even buy stocks.MINIMUM INVESTMENT. Choosing a home depends partly on which funds you want to buy. If your first purchase is a Fidelity or Vanguard fund, it may make sense to use that company's supermarket. But also take into account how much you're going to invest. If you're opening a regular account with $3,000 or $4,000, most fund groups and fund brokerage units will welcome you. Schwab, for instance, usually requires minimum investments of $2,500, though the minimum for its own funds is only $1,000. Other fund brokerage units usually have lower minimums, and most funds--including Schwab's--require only $500 for individual retirement accounts. Also, if you plan to add smaller, periodic investments in your funds, a fund family may be more amenable than the supermarkets to accepting $200 or $300 increments.
The conventional model for a fund portfolio looks like a pyramid. The broadest-based funds form the pyramid's base. As your assets grow, you'll add more specialized, and usually riskier, funds further up the pyramid. Your first buy should be a broad-based U.S. equity fund that invests in large companies. Using BUSINESS WEEK'S Interactive Mutual Fund Scoreboard at www.businessweek.com/investor/, we screened for large-cap growth and blend funds with A ratings (the online scoreboard also has a glossary). That's BW's highest rating for risk-adjusted total return. It takes five years to earn a rating, so be assured that the fund is not a momentary whiz. Some of the choices: Fidelity Fund, T. Rowe Price Blue Chip, and Vanguard Growth Index (table).
The Fidelity and T. Rowe Price funds are "actively managed," which means that the managers choose the stocks. Vanguard Growth is an index fund designed to track the growth-stock half of the Standard & Poor's 500-stock index. Managed funds may or may not do better than an index, but an index fund should closely match its benchmark. Index funds have two other virtues: low expenses and minimal trading. Excessive trading may result in higher tax bills.
If you have the cash to add a second fund, spreading it around the world gets you greater diversification. Fidelity, T. Rowe Price, and Vanguard all have international funds. But if you are working with a fund supermarket, look at Acorn International, Janus Worldwide, and UMB Scout Worldwide. The Janus fund is a "world" fund, which now includes about one-third U.S. stocks. The other two are "foreign" funds, which generally do not own U.S. stocks.COVER YOUR BASES. The funds on the next tier invest in small-to-midcap U.S. companies. These are among the most dynamic in the market--and are often volatile. Fremont U.S. Micro-Cap invests in the market's smallest growth companies. When things work right, the returns can be enormous. Third Avenue Value Fund plies the small-cap universe for "value" plays, such as companies with undervalued assets. A value fund can serve as a good counterweight to the risks of small-cap growth funds. Another strategy is to cover all the bases at once: Vanguard Extended Market Index Fund, for instance, tracks 4,500 small-and-midcap stocks.
The top of the pyramid represents the riskiest but potentially most profitable investments. So why not put a technology fund there? A couple of good choices are Firsthand Technology Value and Invesco Technology II. They may not have the zip of the Internet funds, but they're broader and have been around long enough to show staying power.
What if you don't have enough cash to get to level four right away and you really want a tech fund? Buy it anyway. "How much can you lose?" says Louis Stanasolovich of Legend Financial Advisors in Pittsburgh. "Long term, it's still going to be a big winner." Remember though, if you start at the top of the pyramid, you should still build the other levels later.
Investing in mutual funds isn't going to make you a bundle overnight. But you're not in a hurry either. With your peak earnings years well ahead of you and retirement 40-plus years away, time is on your side. By Jeffrey M. LadermanReturn to top