Expert: Paul Henneman - 2/10/2007

Question
I have been long interesting in putting my foot in the shallow end so to speak and I am just wondering where to go from here.  I am 26 years old and have a 401K plan with 20,000 and just about no debt.  The only debt I have is a low interest federal school loan for 15K.  I don't have a house yet and my car is a 95 with 186000 miles but runs well.  I have always heard starting earlier makes it easier, so I thought I would wait to buy a car or house and fund my investments first.  Is this a good strategy? And where should I start?  I have looked at Vanguard retirement funds, simply because they do the managing for you, but I wonder if investing in my own mutual funds would just as easy.

Answer
Rob,
  Thank you for your email and question! And congratulations on thinking about these issues so early in your career, your lack of debt, and practical thinking about debt. You are rare in these things, and they will servce you very well as your career moves along.
   I think you are right on track, in my opinion. You are right to be contributing as much as possible to the 401k, the tax advantages are simply too big to ignore. YOu are also right that you can just as easily invest directly in mutual funds yourself, and avoid needless fees. You do so through any online brokerage account, two of my favorites with very low fees are www.FOLIOfn.com and www.Scottrade.com  The first is the lowest cost online brokerage I have found, the second is not quite as cheap, but offers more research and is a better service in general.
   I strongly suggest that you set up an IRA account, then purchase any mutual funds or other investments through that. An IRA will have strong tax advantages, similar to your 401k. The maximum you can invest currently is $4,000 a year. If you are able to invest even more than that, you will need to set up a stanard invdividual trading account and pay taxes on the profits each year.
   The easiest way to invest in mutual funds is to do so through an index fund. These are funds that track a major market index, they will never do better or worse than that index. For example, the S&P500 is perhaps the most suitable and stable index to copy, and the Vanguard fund with ticker symbol VFINX copies this index. There is a minium investment I believe of $3,000, and minimal fees. This type of investment can be 'forgotten' about, as it will always track the index. You do not need to research constantly to make sure the fund is performing. Some years will be bad, others good, but overall you should expect on average about a 10 to 12 percent return annually.
  To help keep you motivated, there is an investment calculator at this link:
http://www.ici.org/cgi-bin/calcs/SAV14.cgi/investment_company_institute

Here you can enter how much you plan to invest over time, what return rate you expect, and see how much it would be worth at a set time in the future. For example, if you invest $4,000 a year into an S&P500 index fund, see an average return of 11% a year until you are 65 (that is 40 years from now for you), you would have 2.3 million dollars at retirment! And that does not count your 401k, or other investments, just the IRA.  Feel free to plug in other numbers, it is addicting to see what a little bit of planning can do for you. You are young enough that you have time on your side, if you wait 10 years to start this, instead of 2.3 million you would have just over $700,000. BIG difference a few years make, the way returns compound over time.
  Perhaps the best know site for mutual fund research is www.morningstar.com. Another good site with various forums and articles is www.motleyfool.com   Keep in mind that to beat average market performance takes a huge effort of research and time. If you are interested in this, go for it. But spend a year or two research, tracking ideas, and learning everything you can before acting on any of your own ideas. The index funds are great until you gain experience and knowledge to try some things on your own.  A great book to start is "Investing for Dummies". While not exactly a flattering title, it will give you the basic knowledge needed for most forms of investing, and provide additional sources for further research on what interests you.
   Some of my favorite financial publications are The Economist (this is an excellent publication), The Financial Times, Forbes, The Wall Street Journal, and Fortune Magazine.
   I hope this gets you started to move beyond your 401k. With some minor sacrifices now such as keeping that old car until it no longer runs then buying something modest to replace it, you can achieve truly a remarkable financial situation for your second half of life. It takes a bit of discipline and planning that the vast majority of people in this country simply do not do, and they miss out. I congratulate you again on your early action, and wish you the best.
   Please do not hesitate to follow up with me if I can be of any further service,

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