Wed, 17 Sep 2014
Morningstar's Christine Benz highlights some of her favorite ETFs and low-minimum-investment funds for new investors.
Jason Stipp: I'm Jason Stipp for Morningstar. Young investors often hear that they should get started with investing and let the power of compounding work for them. But sometimes it's hard to know where to start, especially if you don't have a lot of money to work with. Here to offer some low-minimum starting ideas for those investors is Christine Benz, our director of personal finance.
Christine, thanks for joining me.
Christine Benz: Jason, it's great to be here.
Stipp: So, a low-minimum-investment idea is one where you don't need a lot of money to get into the investment; you have some good ideas for those. But before we get started, let's talk about what investors should think about their company retirement plans because they might want to look there first before they go to some of these ideas?
Benz: Do a little bit of due diligence on your company retirement plan, whether it's a 401(k), 403(b), or a 457 plan. And there are a couple of key reasons to take a look at that first. One is that you may get matching contributions from your employer on your own contribution, so that's a big incentive to take a look at that plan. The other thing is that there aren't any minimums to invest in a 401(k), 403(b), or 457 plan, so that's another thing that can make it very easy for smaller investors to get started. You get automatic dollar-cost averaging, so the money comes out of your paycheck--whether you like it or not--which tends to be a really good way to invest. It fights against some of those behavioral issues that investors can run into.
And another reason I like 401(k) plans as a starting point for beginning investors is that, even though some of the investments might not be very best of breed, they are generally not too kooky either. So, you generally get very broad market index funds, you usually get some target-date funds. Those are all really strong core building blocks for starter portfolios.
Stipp: So, definitely take a look at that company retirement plan. But we do know a lot of folks don't have access to these plans, some folks might not be getting matches, other folks might look at their 401(k) and say, "It's really not that great, and I'm not getting a match." So, for folks like that who want to go out on their own but don't have a lot to get started, you have some low-minimum-investment ideas. What are some of those?
Benz: One of the big ideas--and this has been kind of a breakthrough for investors over the past several years--is that a lot of platforms, a lot of brokerage firms and fund companies, are offering exchange-traded funds without a commission. So, you can buy with a very low initial investment and just gradually add to your position over time as you have the money. So, this is a very investor-friendly breakthrough.
For investors who are looking to go this route, even though there are a lot of more specialized exchange-traded funds that have cropped up, I would recommend just a good broad-market index fund (assuming that it's someone with a fairly long time horizon); a total stock market index fund I think makes a lot of sense in this context.
A couple I would mention would be Vanguard Total Stock Market ETF (VTI) as well as Schwab US Broad Market ETF (SCHB). I would also note that Schwab has a lineup of index funds, and traditional funds--not exchange-traded funds--that are available with just $100 minimums and very low expense ratios. So, that's another place to look if you are a pretty small investor just trying to get a start.
Stipp: And you mentioned something about how these ideas are for very long-term-oriented investors. So, these options are not for people who need money in the short term.
Benz: That's right. So, if you have money that you are setting aside for some near-term purchase--maybe you are saving for your home down payment or a car down payment or something like that--you don't want to tie the money up in stocks because you may need it at a time when stocks are at a low ebb. So, definitely sock that money away in some sort of a cash account. Right now, when you look at cash yields, they are not very promising. But some of the online banks tend to have the most competitive yields currently for your safe money.
Stipp: So, for those longer-term investors, they can have the option to start with a very small amount of money. If you have a little bit more, though,--let's say a $1,000 to invest--what options might you have available to you?
Benz: I would look to a target-date fund. And here, Vanguard's and T. Rowe Price's series of target-date funds are available to people who have a $1000 to get started with. So, that can be a nice way to go. The reason the target-date fund is so appealing is that it gives you a lot of different asset classes under the hood of a single vehicle. If you are someone who is very young, chances are your target-date fund will be mostly equity. But if you are someone who is a little further along, a little closer to retirement, your target-date fund will skew more heavily toward bonds and more conservative asset classes. So, it's that all-in-one simplicity that can be very, very attractive for people just starting out.
Stipp: If you can pull together $2,500, that opens your options up even a little bit more. What are some of your favorites with that minimum?
Benz: If you have $2,500 to invest, that's the minimum at a lot of top fund firms. Dodge & Cox would be one; FPA is kind of a boutique, but it has a number of funds that we like. You can get a lot of Fidelity funds at that $2,500 price point; T. Rowe Price funds are available to you as well as Primecap funds.
If I were to point to a single fund that I think is very attractive for younger folks just starting out, I would point to Dodge & Cox's Global Fund (DODWX). It is a fund that combines U.S. and foreign stocks. So, if that's your sole nest egg to start out with or it's the fund that you are going to keep adding to for a period of years, that seems like a really solid way to get globally diversified equity exposure.
Stipp: And you get active management in that case. Why do you like the active management Dodge & Cox?
Benz: There are a lot of reasons to like Dodge & Cox, but I like their value-oriented style. I like that they have a very experienced team. And Dodge & Cox, when we look at corporate cultures of the active firms that we cover, Dodge & Cox is second to none--where they have that very long-term mindset, a very shareholder-friendly mindset. They have very few funds; they tend not to roll out trendy funds or gimmicky funds. And when they come out with new products, they tend to be pretty low cost, certainly relative to the investment expertise that you get with Dodge & Cox. For people who are perhaps a little further along in their investment careers, closer to retirement, they might look at a fund like Dodge & Cox Balanced (DODBX), which holds equities but also holds some fixed-income investments as well.
Stipp: And you said that there are also a few things, in general, that smaller investors should watch out for as they are going out into the investing world. What are some things that should maybe be a yellow or red flag for me?
Benz: Well, I think the key thing is to not just look at that minimum investment and say, "A-ha, I found my match!" To really dig into the fine print and make sure that you aren't getting nickel-and-dimed with account-maintenance fees. If you are a small investor paying commissions, oftentimes it won't make sense because that will eat into the amount that you are contributing from the get-go. So, do your homework on what the additional fees might be associated with starting small. Sometimes, those fees will go away if you are able to build some critical mass in your account, but you just want to make sure that you are not paying more than you need to from the get-go. And there are some very low-cost ways, such as the commission-free ETF providers to circumvent the fees altogether.
Stipp: So, the smaller investor can get ahead with the right strategy and the right funds. Thanks for coming with these ideas today, Christine.
Benz: Thanks you, Jason.
Stipp: For Morningstar, I'm Jason Stipp. Thanks for watching.