Expert: Paul Henneman - 6/29/2004

Question
I have heard that investing in index funds is a good idea for long-term investing (5 to 10 years). I've put some money on a few stocks but have about $2000 and am thinking about putting it in and index fund (probably more later). Is diversity a good idea with index funds or should I stick to just one? Also, is $2000 too little for a large cap fund like S&P?

Finally I'm curious what you think about online brokerages like etrade. Sorry for the flurry of questions. Thanks,

Answer
Cheong,
  Thank you for your question! Yes, index funds are fine for long term investing. With an index fund you can make the assumption that your investment will be very similar to the overall market average. However, if you think the economy and stock market will decline over the next few years, then so will your investment. On average, over many years, you could safely expect an index fund to give you about 10 to 14 percent return each year, on average. Some years will be much better (like 2003), some years will be much worse (like 2001).
  $2,000 is not too little to get started. The important thing is to actually get going, so that time is on your side. The longer you have your money invested, the better off you are. The most important thing is to not withdraw profits. The way interest compounds over time, it would really hurt you in the long run to withdraw profits to buy something like a new car or downpayment on a house. Many people do this, then their investments are not what they had hoped when retirement rolls around.
   Online brokerages are fine, Etrade is a good one. That would be a fine way to purchase an index fund that you plan to hang on to for many years. If you plan to trade more often, then the $14 or so per trade fee will be too much for a $2,000 investment. For more frequent trading you may want to look at a service like www.FOLIOfn.com with just $20 per month fee for up to 200 trades. More frequent trading can really increase your returns, usually double them if you know what you are doing. But this takes alot of knowledge and practice. If you prefer to be 'hands off', then an index fund through Etrade will be good.  Perhaps the perfect solution would be to get started with the index fund right away, and also begin some reading and research to see if you like the topic of finance and are willing (and able) to manage your investments more actively. Free websites such as yahoo.finance.com allow you to set up and track portfolios, you can practice there with 'pretend' money to see how your ideas play out. It takes alot of work, but the reward can be a doubling or more in the returns you will see over time.
  There are a few great books out there I would suggest reading, just so you are sure that you are heading in the right direction. "Investing for Dummies" is available at most major bookstores and also www.Amazon.com, it gives a great summary on almost all types of investments. You can further research any specific topics that interest you.
  I hope this helps! Please do not hesitate to follow up with me if I can be of any additional service.

Sincerely,
Paul Henneman
President
ValuEngine, Inc.
www.ValuEngine.com