The Default investment

This post was originally published on my blog on 7/27/2007. Due to blog moves it was not correctly moved to this blog so I have reposted it. 

In what should you invest if you know nothing about investing? While there are plenty of people (most readers of my blog) who enjoys spending time seeking out new and attractive investments, there are plenty of people who do not enjoy that, do not have the time, or do not have the knowledge or the desire to gain the knowledge necessary to invest well. Luckily, there are some good solutions for such “defensive investors”. The standard advice for defense of investors has been to invest in index funds. This is a great idea.

Unfortunately, there are now hundreds of different index funds in many different asset classes. So even choosing in which index funds to invest is now a complicated decision. Luckily, there are now many target date funds. These are funds that are set up for investors who wish to withdraw their money gradually starting on a certain date, usually because of retirement but for other reasons such as paying for college for children as well. So let’s say that you are investing for retirement starting approximately 2040 and paying for your children’s college education starting in 2025. You estimate that it will cost $200,000 for each of your two children and that you will need at least $2 million at the start of retirement. You can plug these numbers in any of various online retirement or savings calculators to calculate how much you will need to save. Then, you invest in two different target date index funds through Vanguard: a 2025 target date fund and the 2040 target date fund.

You use those handy online calculators again to determine how much you’ll need to put into each fund to reach your goals. All that is left for you to do is to faithfully put away money into each of those funds every month like clockwork. You will never have to think about your investments again, except for occasionally checking to make sure that you are progressing well towards your goals. Those target date funds will do all the work for you, investing mostly in stocks at first and gradually sticking more money into bonds as your target date approaches. And the only target date funds you should consider are Vanguard’s funds, because they have the lowest fees around, about 0.21% per year. I think the above plan is the easiest and most generally appropriate plan for the majority of individual investors. However, your investment needs may differ, in which case you may wish to seek out a certified financial planner (CFP) who is compensated on an hourly basis to offer you unbiased and personalized investment advice.

Disclosure: Disclaimer: I own some Vanguard index funds in an IRA and my wife owns a Vanguard ETF in an IRA. We have no target-date funds–all our investments in retirement accounts are in cash or stocks. This blog has a terms of use that is incorporated by reference into this post; you can find all my disclaimers and disclosures there as well..

4 thoughts on “The Default investment”

  1. I guess there are a lot of people that work for companies that use Vanguard as their investment engine, we do and I think they are very good.

    I have been maxing them out for years, using the maximum amount the company will match, and the maximum amount I can contribute and watching it grow. There are also a good number of selections you can choose to contribute to, selections that allocate your money across many different funds.

    Even though these are slow moving and sometimes it will appear that your money is just sitting there, they are really good and I recommend them for everyone they are available to.

    At 42, I wish I would’ve started much earlier, as buffet says; “I started buying stocks at 14, and that was to late”.

  2. I respectfully disagree. As you know, the broad market has been flat over the past five years, and I can’t agree that index funds are a wise long-term investment. As I learn about derivatives and all of the ingenious ways to siphon money out of capital markets, I realize that even the most spectacular increases in productivity can be easily countered by financial acrobatics.

    1. Sure equities have been flat for five or ten years. That is beside the point. The important thing is that in a world of 2% 10-year Treasury bond yields the only investment that has a chance of offering a nice amount of appreciation is equities.

      And once you determine that equities are the place to be (or at least one of the places to be) the conclusion that index funds are the best is simple. Most people do not have the time, talent, and luck to be able to beat the market. Because of fees, the vast majority of active mutual fund managers underperform comparable index funds (and that isn’t even taking tax efficiency into account). Index funds are the only remaining option.

      1. You also need to consider that the company I work for matches up to the first 5 percent, making that free money, or money I don’t earn.

        Another thing is the tax deferral benifit that comes along with it, even though I fall into the highly compensated bracket and it doens’t apply to me. If you are in a standard 401k the money deducted from your check comes out before taxes are deducted, lowering the amount of money you are taxed on per pay period.

        I would advise anyone to participate in their employers 401k program, it’s another way to stockpile money for retirement.

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