If you own an index fund and you’re paying an expense ratio greater than 0.35%, you’re getting ripped off. I created a list of index funds from major brokers, like Vanguard, Fidelity, and Schwab, looked up their expense ratios on Google Finance, and then listed them in the order from cheapest to most expensive.

None of the funds on the list have a sales load of any kind and I was surprised to find a fund as cheap as 0.09%. I was even more surprised to find index funds that charged over 1%. Check out State Farm S&P 500 Index B – it has a 1.49% expense ratio and a 5% deferred load! (a deferred load is a fee that is charged when you sell an asset) It has $425M in total assets too and each one of their customers is getting ripped off.

(Click to continue reading…)

One of the biggest challenges in almost anything you do is knowing where your blind spots are. In simpler terms, you don’t know what you don’t know.

So today, I’ll point out four money mistakes you might be making that you don’t even realize you’re making! Hopefully, you’re making none of them. If you are making one of these, don’t beat yourself over it. Now you know you’re making it and you can take steps to fix it.

(Click to continue reading…)

On The Money, the personal finance show on CNBC hosted by Carmen Wong Ulrich, recently had a little web extra spotlighting Consumer Report’s list of best brokers. In their brief piece, they talked about the top three: USAA Brokerage Services, Vanguard, and Edward Jones.

(Click to continue reading…)

Every month I receive “In The Vanguard,” Vanguard’s monthly newletter, and scan it cover to cover. It’s a document you can find online (speaking of which, I should change to electronic delivery or cancel the mailings) This month, I was introduced to an idea by Dr. Burton G. Malkiel, author of the famous investing text, A Random Walk Down Wall Street. Malkiel, who also lists Princeton University economist as an accolade, recommends that you follow the 50-50 rule when selecting mutual funds. The 50-50 rule states that:

When choosing a mutual fund or exchange-traded fund, choose one that has an expense ratio under 0.50% and a turnover rate below 50%.

Malkiel warns against the most frequently used alternative, historic returns, because it’s not a reliable predictor (though it has value in terms of discerning volatility).

Expense Ratio

Expense ratios are an often discussed, pretty well known, characteristic about mutual funds. The expense ratio is how much the fund charges you each year to keep your money there. Mathematically, it’s the fund’s operating costs divided by its average net assets; which translate to a deduction from your account. An expense ratio of 1% means that every year a dollar will be taken out for each $100 invested. You can see how that can have a significant impact!

Open the fund’s prospectus, you’ll see expense ratios most often listed under fees. The value can be broken up into administrative and other fees but the end result is the same, the expense ratio is how much the fund costs you each year. While you’re there, check the load, that’s the sales charge when you buy or sell the fund. I always go with a no-load (no sales commission) fund.

Turnover Rate

Turnover rate is a less often discussed characteristic about mutual funds but it refers to the turnover in holdings within the fund. Much like how you may trade stocks, bonds, etc. within your other brokerage accounts, mutual funds are companies are do the exact same thing. The higher the turnover, the greater the number of transactions, and the greater the cost to the fund. Costs associated with turnover are usually not itemized out and not integrated with the expense ratio, they are usually not detailed out at all and only reflected in the fund’s value.

Why a lower turnover rate? All things being equal, the more activity a fund has, the more you will lose to transaction fees (like broker commissions) and taxes (more short term, vs. long term capital gains). In the fund’s prospectus, you will usually find discussion about turnover rates under portfolio management, or wherever they discuss holdings, P/E ratios, and other similar metrics.

The 50-50 rule is just a guideline, there are always exceptions, but I think that it’s a good starting point if you aren’t sure how to go about picking a fund. You can’t control returns, but you can certain minimize costs.

Every so often I get an email from a reader asking me whether they should open up a mutual fund account with a few hundred dollars or try to save up more before they enter the wild and crazy world of the stock market. My typical advice is that they should save up a little bit of money first because the minimum account balance required by many mutual funds is often much greater than a few hundred bucks. Even if you wanted to open up a regular brokerage account and trade stocks, it’s a bad idea because of commissions. Unless you trade for free with Zecco, even the $4.95 commission of TradeKing would be disaster on a few hundred dollars.

However, in my Vanguard-centric view of the mutual fund world, I overlooked some firms offering funds with much lower balance requirements. Vanguard’s lowest offering is the STAR Fund (VGSTX) at $1,000 but there are many mutual funds are need a mere $100 to start.

The quickest way to find them is to use Morningstar’s mutual fund screener. You can set all sorts of factors but the minimum initial investment factor is listed under Cost and Purchase. While you’re there, I’d definitely set Load funds to “No-load funds only” (as in no sales commission) and Expense ratio less than or equal to: to “1.00%.” That will, as of this writing, get you that hits the screener maximum of 200.

As for which one is best, I’d just tick the 5-star setting and pick from one of the 26 results. There are several options in there that could yield good results. I’d ignore the YTD returns as a factor since all stock funds will have suffered huge losses (and bonds have eeked out tiny gains) this past year.

One caveat, the tool will list funds that are closed to new investors. Those who picked out the Fidelity fund listed in the screen above, the Fidelity Congress Street fund, will notice that it’s closed to new investors.

Has the stock market decimated your portfolio too? Yeah, us too. Fortunately, there’s something called tax loss harvesting and it can help anyone get a little edge on the recovery. The idea behind tax loss harvesting is that you sell a particular holding, take the capital loss, and then immediately invest it in something similar but not the same as the original holding. By doing this, you “harvest” some of your losses to offset gains or ordinary income, and by investing in a similar but not a “substantially identical security,” you also benefit from the recovery. The key in this strategy is that you invest the tax savings, from the loss, back with the original sum.

Some words of advice on tax loss harvesting:

• The reason why you can’t by something “substantially identical” has to do with the wash sale rule. If you want to deduct the loss, you have to follow wash sale rules.
• Don’t do this in a retirement account. There is no capital gains or losses tax in retirement accounts. 401(k)’s and IRAs appreciate without taxes and taxes are only assessed at distribution time (with the exception of Roth IRAs, which are never taxed).
• Substantially identical is a gray area because the IRS hasn’t clearly defined it but make sure it passes the sniff test. One interesting thing of note is this explanation on IRS Publication 564: “Substantially identical. In determining whether the shares are substantially identical, you must consider all the facts and circumstances. Ordinarily, shares issued by one mutual fund are not considered to be substantially identical to shares issued by another mutual fund.” The key word there is ordinarily. Just pass the sniff test, I’m sure your nose works well.
• If your capital losses exceed your gains, you can deduct $3,000 of capital losses against your ordinary income. If your losses exceed that, you can carry those losses forward each year without limit.
• You don’t have to wait until the end of the year to do this, in fact it’s probably better to give yourself the flexibility of doing this earlier in the year because of wash sale rules.

Why Tax Loss Harvesting Works

Let’s consider the scenario where a fund has dropped 10%, the investor opts to harvest losses and immediately invests in a fund that closely mimics the original fund. Both the original fund and the new fund appreciate by 11.1%. The investor invested $10,000 and is in the 25% tax bracket. Who wins?

Does not tax loss harvest: This scenario is simple, the investor has effectively had no change because the original fund has return to its original value. He sells and has no capital gains or losses.
Does tax loss harvest: The fund fell in value from $10,000 to $9,000 and the investor does some tax loss harvesting to extract the $1,000 in loss. The $1,000, come tax time, will yield him $250 in tax savings. He reinvests the $9,250 into a similar but not “substantially similar” fund and it appreciates by 11.1% to $10,276.75. When he sells, he pays taxes on $1026.75 of capital gains – or $256.69. Subtract that from his $10,276.75 and he’s left with $10,020.06, which is $20.06 ahead of what he had if he hadn’t harvested losses.

Tax Loss Harvesting with Placeholders

Let’s say that you really like a particular mutual fund, your brokerage doesn’t offer anything similar, and you aren’t about to open up another account at another brokerage just to do this tax loss harvest. A potential option is to use exchange traded funds (ETFs) as a placeholder for the wash rule period. Sell your loss, buy into an ETF, wait 31 days, then sell the ETF and get back into your fund. By selecting a similar ETF, you can catch any rises in the industry without sitting on the sidelines.

Please consult with an accountant to clarify your particular situation before doing anything I’ve talked about here.

(Photo: tonivc)

Popular Mechanics created a list of 100 Skills Every man Should Know, which naturally gravitated towards DIY/physical skills like jump starting a car and split firewood. The Frisky listed 30 Skills Every Woman Should Have Before Turning 30, which actually touched on more than physical skills (though #12 is physical ), with a handful of financial skills (#17 – #20).

This isn’t a checklist of things you need to necessarily do in your life, it’s just a list of things that you should know how to do (in case the need arises).

(Click to continue reading…)

There isn’t a single reason why you shouldn’t like index funds. They’re cheap, they offer market rates of return without fail, and they are simple to buy. They beat actively managed mutual funds a majority of the time and they are often advocated as the best investment the average Joe can put their money in. So why not put all your money into an S&P 500 Index fund like the Fidelity Spartan 500 Index or the Vanguard 500 Index, call it a day and enjoy more time with the family? Because that would be a huge mistake.

(Click to continue reading…)

The key to a successful investment plan is to pick one that fits your personal style. If you’re always busy and simply can’t find the time to pay attention to your investments, you need to pick a style that matches your life. There’s no sense adjusting your life to your investments, it should be the other way around. It’s difficult to pigeonhole anyone into one particular bucket but find the various suggestions in each grouping to see how best to use them to match your life.

The Novice

Everyone starts as a novice, there’s absolutely no shame in being a beginner when it comes to the stock market. In fact, it’s probably better that you’re a beginner. It was the experts that got us into the whole sub-prime mortgage mess. Until they closed their doors, the halls of Bear Stearns was full of experts. That being said, if you’re a novice when it comes to the stock market, put your money into a high yield savings account and start playing with a “play portfolio” at one of the finance sites. While you’re learning, your savings will still earn a nice interest rate.

(Click to continue reading…)

Ever heard of the Margarita portfolio? How about the Couch Potato portfolio? Or the No-Brainer portfolio? No?

They’re all Lazy Portfolios.

A Lazy Portfolio is one that you can just set it and forget it and relies on low cost index funds or ETFs. There’s nothing particularly special about any Lazy Portfolio, besides their use of low cost index funds, and one isn’t necessarily better than another in all economic scenarios. As with any investing strategy, there are pros and cons. The pros, that it’s simple and you make few decisions, results in cons in that you may become complacent and ignorant of your investment decisions. It’s better to keep it simple and well understood than to make it complex and obfuscated. I’d rather make a choice that turned out wrong than make a decision I didn’t understand.

How They Perform

Paul Farrell of MarketWatch tracks eight Lazy Portfolios each year and in 2008, they have extended their winning streak of beating the S&P 500 for the sixth year (on a three-year and five-year basis). In other words, having a one of the eight Lazy Portfolios over the last six years has gotten you a better return than the stock market itself. (This year, three of the portolio’s got beat because they had a lot of REIT funds, but they are still besting the S&P over the last few years).

Here are the funds with the best names: (some of which weren’t featured in Paul Farrell’s wrapup)

Couch Potato Portfolio

This portfolio is the brainchild of Dallas Morning News columnist Scott Burns and is as simple as they come. All you need is 50% in the Vanguard 500 Index Fund (VFINX) and 50% in the Vanguard Total Bond Fund Index Fund (VBMFX). That’s it. You can go a little more aggressive with the variant Sophisticated Couch Potato Portfolio of 75% in the Vanguard 500 Index Fund and 25% in the Vanguard Total Bond Fund Index Fund.

Margaritaville Portfolio

This portfolio is also another one of Scott Burns’s creations and is the second simplest portfolio with equal parts of three funds: Vanguard Inflation-Protected Securities (VIPSX), Vanguard Total International Stock Index (VGTSX), and Vanguard Total Stock Market Index (VTI).

No-Brainer Portfolio

Created by Dr. William Bernstein, a neurologist known for his work in modern portfolio theory and his book The Four Pillars of Investing, the No-Brainer Portfolio consists of four funds of equal weight: Vanguard 500 Index (VFINX), Vanguard Small Cap (NAESX) or (VTMSX), Vanguard Total International (VGTSX) or (VTMGX), and Vanguard Total Bond (VBMFX) or (VBISX). There is also a No-Brainer Coward’s Portfolio that includes 9 funds.

Coffeehouse Portfolio

This little gem was created by money manager Bill Schultheis, author of The Coffeehouse Investor: How to Build Wealth, Ignore Wall Street, and Get On With Your Life, created the Coffeehouse Portfolio that consists of seven funds:

• 40% in Vanguard Total Bond Index (VBMFX)
• 10% in Vanguard 500 Index (VFINX)
• 10% in Vanguard Value Index (VIVAX)
• 10% in Vanguard International Stock Index (VGTSX)
• 10% in Vanguard REIT Index (VGSIX)
• 10% in Vanguard Small-Cap Value Index (VISVX)
• 10% in Vanguard Small-Cap Index (NAESX)

Those are the cooler sounding ones but there are many many others out there!