The Five Rules

  1. Invest for the long run 
    • The more time before you need your money, the more risks you can afford to take with it. This means investing in stocks, bonds, and real estate.
    • Understand your risk tolerance.
  2. Balance your investments 
    • Fixed income (30%-40%) 
      • Bonds, money market funds, certificates of deposit (CD)
    • Equities (60%-70%) 
      • Stocks, real estate
  3. Diversify your investments 
    • To reduce your risk buy funds that hold a diverse group of investments rather than buying individual stocks, bonds, or real estate 
      • Stock mutual funds
      • Bond funds
      • Real estate investment trust (REIT)
  4. Shop around for low fees 
    • Choose investments that have low expenses – they are the most important indicator of how well the investment will perform
    • As a rule, index funds have the lowest expenses
  5. Educate yourself about investing 
    • You are ultimately responsible for your own investing decisions               
    • There are many resources to help you learn about investing

Where should I Invest?

Let's say you have a little money to put away for your retirement. You want to put some of it in the stock market because that's where you have the best chance to earn a return that will exceed the inflation rate over time. You decide to put your money in a stock mutual fund. Your money will be used to invest in a variety of companies that meet the goals of the particular fund. For example, some funds invest in particular industries (health care, energy, transportation, etc.), or in the size of a company (small or large), or in the type of company (potential for rapid growth or payment of dividends).

But when you look closer you discover that there are thousands of stock mutual funds to choose from. How do you decide which one to pick? Is it all guesswork? How can you make an intelligent decision?

When choosing where to invest your money for retirement, there is one factor that is a critical determinant in the long-term performance of the fund. Is it the past performance of the fund, the director of the fund, or the type of companies the fund invests in?

The answer is none of the above. The most important factor that will determine the performance of the fund is the annual costs of the fund, according to a 2004 study by Standard & Poor's, an investment research and rating firm.

The study calculated the average expenses for nearly 17,000 mutual funds and then sorted the funds into two groups: those with expenses below the average and those with above-average expenses. The higher cost funds' average expense was 2.08% per year, versus 1.06% for the lower cost funds. So if you invest $10,000, you will pay about $100-200 per year in fees. Over time these fees add up.

How well do these funds perform? The study looked at the annualized returns of these funds over 10 years and found that the lower cost funds performed better than the higher cost funds in eight of nine fund categories. The annualized return of the higher cost funds averaged 9.17% while the lower cost funds averaged 10.94%--a difference of 1.77% each year!

This means that a higher cost fund must earn 1.77% more per year than the lower cost fund just to stay even in overall performance. Very few funds can achieve this over a long period of time. Therefore, all investors should pay close attention to the annual expenses charged by their fund.

You can find what your fund charges in expenses by looking at the prospectus published by each fund. If you didn't save a copy of your prospectus, you can look for it on the fund's Web site. Each prospectus must publish a chart that shows how much you would pay in expenses on a $10,000 investment after one, three, five and ten years. Use the ten-year comparison. For example, the Oakmark Select Fund's fees over ten years are $1,225 whereas the similar fees for the Vanguard S&P 500 Fund are $230. This is a significant difference that will continue to grow over time.

Compare with Index Fund Expenses

When you look at the expenses of a fund you own or are considering investing in, make sure you are comparing expenses from similar funds. In other words, if your fund invests primarily in large companies, you should compare expenses with other funds that also invest in large companies.

The mutual funds that will consistently have the lowest expenses are index funds. Index funds follow a passive investment strategy by purchasing stock in companies that represent a benchmark and then holding onto the stock. (Actively managed funds, on the other hand, regularly buy and sell stock from different companies, thus increasing fees for the fund.) The benchmark can be the S&P 500 (the 500 largest U.S, companies), the Russell 2000 (a representative of the smallest U.S. companies), or the Wilshire 5000 (a representative of all U.S. companies). There are many other types of index funds that track particular industries or other benchmarks. But the S&P 500, the Russell 2000, and the Wilshire 5000 are the most popular benchmarks that index funds track.

Here are some examples of index funds and their expenses (using as a comparison a $10,000 investment over ten years):


Spartan 500 Index Fund (S&P 500 Index): $128

Spartan Total Market Index Fund (Wilshire 5000): $128

T. Rowe Price

Equity Index 500 Fund (S&P 500): $493

Total Equity Market Index Fund (Wilshire 5000): $505


Large-Cap Index Fund (S&P 500): $230

Small-Cap Index Fund (Russell 2000): $293

Total Stock Market Index Fund (Wilshire 5000): $243

Use the above examples to compare against expenses in the stock mutual funds you are currently invested in. If you invest in index funds and pay attention to fund expenses, you will greatly increase your chances of getting a higher return for your money.

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