Investing 
22
comments

Cheapest S&P 500 Index Funds

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.

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 Investing 
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Even Day Traders Recommend Index Funds

That’s right! A guy who actively buys and sells stocks is suggesting you should stick with Plain Jane index funds.

Why?

Because it’s too difficult for 99% (a completely unscientific statistic) of the general public to outperform the market over an extended period of time.

Every week, at least one person will ask me for a hot stock tip. Almost every single time, I tell them to buy a basic Vanguard S&P 500 index fund. If they keep up the pressure and want something more aggressive, I tell them to buy the Vanguard Small-Cap Index Fund which passively invests in smaller, higher growth, but higher risk companies.

Now, before the pro-index fund, Boglehead crowd showers me with kudos and the pro-trader crowd throws flaming bags of dog crap on my porch, allow me a few moments to debunk the Get Rich Quick by Becoming an Active Trader myth.
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 Investing 
28
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Beware Broker Transfer Out Fees

My wife’s Roth IRA currently sits at a TD Ameritrade account, where it’s been sitting for the last three or four years. With the majority of it in cash, mostly because we lost track of the account, we want to invest it in our retirement investment of choice, an index fund. Our index fund of choice happens to be the Vanguard 500 Index Fund because most of our retirement funds are with Vanguard. Vanguard does not have the cheapest index fund, I believe that title now resides with Fidelity’s Spartan 500 index. Paying the extra 0.08% seems reasonable considering we can manage it all in one place.

The only downside about this entire process is that TD Ameritrade has a $75 outbound full account transfer fee. :( Fortunately Vanguard does not charge you to transfer in an IRA (to my knowledge, no one does).

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 Investing 
16
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Comparing Fixed Annuities & Certificates of Deposit

Hand Painted Piggy BankWhen I first opened up my Vanguard account a few years ago, I requested all sorts of fancy investment brochures. I had just started Bargaineering and had a voracious appetite for financial information and fancy words like annuities, in all their flavors, really intrigued me because I had never heard of them. One of the books I requested was Vanguard’s booklet on annuities, an investment vehicle I would later learn is rife with ripoffs and unscrupulous characters.

I never read the booklet until my wife and I were cleaning out some documents and they remind me a lot of long term CDs, with a few wrinkles. If there’s anything I’ve learned in the last few years is that the financial community has a funny way of coming up with a million different ways to do the same thing, if only to be able to say they have a hot new investment option for you!

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 Investing 
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Consumer Reports America’s Best Brokers

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.

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 Retirement 
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Which is the Best Broker for an IRA?

Retirement Nest EggsOne of the most frequent questions I get is “Where should I open an IRA?”

Short answer: Anywhere, just open one! If you want mutual funds, open an account with the company that offers the funds you want, like Vanguard, Fidelity, etc; because they will let you buy and sell the funds for free. If you want stocks, open an account with a company that offers the lowest fees.

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 Investing 
9
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The 50-50 Mutual Fund Rule

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.


 Investing 
7
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Tax Exempt Money Market Funds: VMSXX

When I compiled a list of high yield savings accounts rates, a reader mentioned that tax exempt money market funds blow all those returns out of the water. He was totally right. In fact, I have a portion of our savings invested (I say invested because your principal is not protected by FDIC insurance in a money market fund) in Vanguard’s Tax Exempt Money Market Fund (VMSXX [Google Finance: VMSXX]).

About Tax Exempt Money Market Funds

The Vanguard’s Tax Exempt Money Market, and in general all tax exempt money market funds, seeks to maintain the $1 share price while generating a return using very safe assets. Specifically, they invest in “short-term, high-quality municipal securities issued by state and local governments across the United States.” That’s how they can guarantee that the earnings are exempt from federal personal income tax. With VMSXX, they invest in securities that are a year or shorter and a dollar weighted average of 37 days (as of this writing). You’ll find that most funds are structured this way regardless of the company. I am using Vanguard as an example because I have my money there.

Calculate Taxable Equivalent Yields

Since the yield is exempt from taxes, it’s not fair to compare them to other investments without some additional math to account for the tax exempt status. The easiest way is to find out which marginal tax bracket you’re in and divide the yield by (1 – marginal tax bracket).

If I’m in the 25% tax bracket and I want to find the taxable equivalent yield of an asset with a yield of 4%, I divide 4.0 by 0.75 = 5.33%. A tax exempt security yielding 4.0% is the equivalent of a taxable security yielding 5.33%. That 25% tax really takes a big chunk out of that return, huh? That’s why tax exempt securities are so attractive.

You can use this simple tax equivalent yield calculator to help you do the math.

Not FDIC Insured, Other Points

Some things to keep in mind about money market funds:

  • They are not FDIC insured, so they are investments. However, I believe that tax exempt funds are safer because they are investing in munis; rather than corporate bonds. When those money market funds broke the buck a few weeks ago, it was because they were invested in Lehman corporate bonds. While those were considered safe too, a company is far different from a state or local government. That being said, state and local governments can also go bankrupt, it’s just less likely.
  • Much like savings accounts, these fund yields aren’t guaranteed. With an dollar averaged holding period of 37 days, the yields can fluctuate very rapidly and much more so than the yield on a savings account.
  • Don’t invest in tax exempt securities in tax-advantaged accounts like a Roth IRA. Since the earnings in a Roth IRA are already tax free, it makes no sense to put it in a tax exempt investment. You take the teeth out of what makes the investment attractive in the first place.

If you want to get another opinion, Nickel also put some money in VMSXX and wrote about his experiences with the tax exempt money market funds.


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