Getting Started Early

[Guest Tumbler]

I am 19 years old and a second year student at the University of Georgia. I understand the benefits of investing early in life and that doing so could pay off significantly in the long run. I have about $3000 sitting in my bank account that I would like to use to get started on investing. I am unsure on where I should invest the money: Stocks, Bonds, Money Market, Mutual Funds, IRA, Roth IRA. I am not afraid of a reasonable risk with the investment and will not be needing the money for anything other than investing.

If you have any advice or knowledge that you could send my way on where I might want to get started and the ups and down of that route it would help me out tremendously. Thanks in advance for you time.

[John G]

Normally at your age you need some contingency money. However, if you think that your family resources cover downside events, then you might consider putting money into a retirement plan.

Assuming that you have the above issue under control, I will keep my recommendation short....

1. Roth IRA is likely to be your best option as long as you have earned income - like paychecks from an employer.

2. With a small amount of money, you want to use a NO LOAD mutual fund. NO LOAD means they do not charge either an up front commission or a back end commission. Further, I would recommend a low expense index fund. There are many of these but I would recommend that you choose VANGUARD and ask for the no load S&P500 index fund. You can use this vehicle for many years. You get very low expenses, a tolerably small annual IRA fee, and broad diversification. I recommend equities (aka stocks) because of your comments about risk and the fact your will be keeping this investment for many decades. If you don't understand why I suggest a mutual fund stock portfolio, post again and I will walk you through the various "typical" returns.

3. A decade from now, you may want a more elaborate plan, when your assets have grown. Right now, keep things simple and focus on the degree and your career options. Index funds are low mind maintenance investments.

4. Is now a good time to do this? No one can answer this question. You are right that starting early is good. You may want to buy into the Roth 1/3, 1/3, 1/3 over the year. I am not sure what Vanguard will want for an initial deposit. If that first check is too much, ask them about a monthly or periodic deposit program as these usually start lower.

[Guest crkhdpdl]

Hi, I am also a 19 year old college student who is interested in starting investing early, most people who I talk to seem to push me towards a ROTH IRA account, so I have been reading into those lately and they seem to be a good retirement savings plan, from what I've read I can contribut 4000 a year and am elligable to withdraw after I turn 59 1/2 or if I am withdrawing for educational purposes or to buy my first home, because I have never had an traditional IRA before all that rollover stuff doesn't apply to me. is all this correct? just to make sure I have the right idea about it, the main question I had concering Roth IRA's is how you enroll in them? where do I go to sign up for them, are they automatically taken out of my pay check? or can they be? well that's about all for now, if you have any other suggestions for someone starting to get into investing I'd be glad to hear them! thanks!

[John G]

Eligibility is a function of how you file your tax return, adjusted gross income and amount of earned income. If you file either a single or a married return you should be just fine, it is married filling separately that is a disaster given the IRS rules. As a college student, it is unlikely that your total income exceeds the upper threshold of eligibility, so no problem there. You can only deposit the higher of your "earned income" or $3,000 this year. (This max number is scheduled to change in future years.) Paychecks definitely qualify for earned income, but interest, dividends, gifts, etc. do not.

It seems that you would meet these qualifications. Your parents can fund your IRA, it does not have to be funded by your money.... maybe you should talk to your parents about a matching amount.

If you are eligible, the next step is to find a "custodian"... a financial institution that is set up to handle IRA accounts. You have lots of choices including: banks, mutual funds and brokerages. Since you are not initially going to have a lot to invest, I suggest that you stick with mutual funds - especially NO LOAD, INDEX funds. These give you diversification and have no transaction costs. You can get these directly from a mutual fund "family" like Vanguard, T Rowe, Strong, etc. or via a brokerage that has links to mutual funds like Schwab, Etrade, Scottrade, or Brown. You can find lots of choices on the web. They will vary in the annual fees that they charge, the minimum to start, and the investment options they support. Talk to at least three different firms and ASK THEM FOR THEIR BEGINNER PACKAGE. You will learn a lot from reading over this basic material.

You are young and are planning to build your investments over many years. Right now your primary focus should be on school. Keep your arrangements simple. One general no load index fund. I recommend "equities" which is a fancy name for stocks. Stocks have traditionally given a very good return over long hold periods. Don't watch your account each day as stock prices flucuate. If you have a mutual fund, just checking it for accurate deposits and twice a year for performance is enough.

If you wish, you can set up with most firms to deposit a fixed amount each month from your checking account. Often firms let you start at a lower amount or may wiave there annual fees when you are a predictable customer. Ask for a fee waiver with each firm and see what they say.

You can take contributions out of an Roth IRA at any time, for any reason.... not that you should be thinking about robbing your personal tax shelter! I would definitely go the ROTH route as the retirement withdrawals will be tax free.

You may also get a fee waiver if you put your money in a firm that handles your parents accounts.

I would highly recommend that you take an hour at a local library to read the retirement planning articles in Consumer Reports each March issue - great for the beginner. You will also learn a lot about investing, IRAs, careers, loans, car buying and home buying by subscribing to Kiplinger Financial magazine which I think is under $20. You will easily get advice worth 10x that each year at your age.

Post again if you have further questions. You are wise to consider investing early.

[Guest Tumbler]

Hey I just saw that you had replied to my and the other students post. Thank you so much for all the help, it really helps to hear from other inverstors and get a little guidance before diving into this stuff. Thanks again for taking the time to give us some solid advice on getting started.

[dh003i]

If you have an earned income, a Roth IRA is a good plan. If you don't have an earned income, get one. Even working as a librarian at your university counts (plus, after a year or two of working at a University part time, you may get free courses). If your parents are self-employed, they can employ you.

As for investing in that RothIRA, other's here are right. Keep it simple, and focus on your studies. The stock market may go up, it may go down; you have no control over that. If you can leave your money in long enough, you'll probably have a gain (there has never been a 10-year period in which stocks haven't outperformed every other major investment vehicle; and there has only been one 10-year period during which the market went down, during the Great Depression). The best investment you can make in your future is doing well in college.

But, you should still invest your money. I've run some numbers, and at the current inflation rate (3.54%/yr), by the time you are done with 4 years of college, your $3,000 will only be worth $2,600 in today's dollars. If you have it in a money-market making 2%, it will only be worth $2,800. The longer you let it sit earning little or no interest, the more inflation munches away (so there is a risk if you do nothing). But, keep it simple.

I'll diverge from most people here, who tend to recommend index funds. Look for value-oriented funds, which tend to be less risky and more solid than the market as a whole. You want a fund with a low risk and a high return, given the investment medium (e.g., obviously low risk in the stock market is still a lot more risk than a money-market).

As a general guideline, if you want your money out in 1, 5, 10, or 20 years, you should pick a fund that has never been outpaced by inflation in any 1, 5, 10, or 20 year time frame during the manager's tenure, respectively. Once you narrow down the list of acceptabler funds for your time-horizon, you want to look at the top-performers among the remaining funds. Once you've found the top-performers, pick the one's that have the least volaitlity. What you want is a fund with a high return to risk ratio. Also consider the type of fund, and if you're comfortable with it. Don't invest in something you're not comfortable with or don't understand.

[John G]

DH, there are two very big reasons why I recommended an index fund. First, a college kid is unlikely to want to spend hours reading over material on different funds. If the hurtle for getting started is perceived too be high, they might just bag it. Second, index funds have a wonderful advantage of very low annual expenses that eat only a very small part of the annual return which makes their performance hard to beat.

I have no problem with a broadly based value fund, but you can not know today that they will perform equal to the marketplace over any few year snapshot. Value funds have had a wonderful run while the dot.com's burned... but that is history which may or may not continue. Frankly, one could make a very solid argument for someone in their 20s to put money into funds slanted towards growth. As long as its NO LOAD and broadly diversified (holding hundreds of different stocks) the initial choice is not a life and death issue. Getting off the snide is an issue, so keeping a beginners plan simple is important. After a few years of performance, curiosity will take its course and the beginner will want to know how it all works.

I have taken about five people in the 18-26 year age group through the process. They may not mind spending a little time learning about their choices... but most of them do not have the experience or judgement to evaluate what they are reading. When given 3 to 5 no load funds to consider (all respectable, two index, a growth, worldwide and value) they invariably turn and say to me ..... "what would you pick?".

One of these kids now has 50k in her Roth and is just amazed by the process. They typically don't learn about this in school and sadly many adults either don't know or forget to talk about investing with their kids.

[dh003i]

Regarding Index funds, your points on them are right. They are simple to understand and have very low expense ratios.

The reason I dislike index funds is that they tie you to the irrationalities of Wall-Street more so than other funds (in technical terms, beta). Aggressive growth-oriented funds are even more turbulent than is Wall-Street as a whole (e.g., the Nasdaq). I think that over the past 5 and 10 years, value funds have typically outperformed aggressive growth funds enough to justify purchasing them instead. The Nasdaq -- which is basically all growth stocks -- illustrates the dangers of buying stocks that are over-priced, in the hope that they will grow into their current price. Nasdaq stocks soared to astronimical highs, then came crashing down almost as fast.

Of course, ideally, one wants to invest in companies that are both selling at a discount (low PE, PEG) and that have a huge potential for growth. Determining funds that do this, however, may be difficult.

One thing clear to me is that index funds have no potential to be anything but average, and will always be hit about as hard as the market overall by economic fluctuations. The performance of the DJIA -- barely breaking even over the past 5 years -- is hardly impressive, compared to the 8+% offered by many value and even aggressive growth funds (alot of the select-funds in specific areas like electronics, health-care insurance, etc, have had impressive growth over the past 5 years, though experiencing volatility greater than the Nasdaq). Furthermore, the performance of the S&P 500 over the past 5 years has been disappointing, as it actually underperformed the DJIA.

Of course, it is almost certain that over the long-run (10, 15, 20, 25 years), index funds will have impressive average yearly percentages (7-8%). However, value, growth, and value/growth blend funds could have even more, while avoiding some of the stings of the down markets.

[John G]

DH, you are posting inaccurate investment information at this website and need to stop posting on topics were your information is shakey.

In your prior response, you have said that index funds have a high turnover rate. {subsequently edited out of prior post} Compared to what? Index funds are based upon a mathematical process based upon a list of stocks. Stocks are occasionally added or dropped from an index due to merger/acquisition or a significant change in market capitalization (shares * price = market cap). Some lists on which indexes are based change only one time each year. Each index fund makes small adjustments during the year to adjust the portfolio to reflect the percent mix of various stocks. But... the overall turnover is extremely low compared with actively managed funds. To say "extra-ordinary high turnover rates" is just flat out wrong.

You make a statement the the NAZDAQ is all growth stocks. This is not correct. While MSFT, INTL, CSCO and DELL are part of the bigger firms, the overall NAZ includes a substantial number of other companies. For example, a big component is banks, thrifts and other financials. REITs and other stocks you would not call growth stocks can be found on the NAZ.

You link turnover rate to taxable gains. No link has to exist. Some index funds have a tax management component to them so that they try to reduce or eliminate even the small capital gains at year end. The Schwab 1000 was design for this purpose and last time I looked at it they had operated for many years with no capital gains to report. They sold a few stocks that were down to offset the gains from small changes. In a taxable account, you would have little or no tax implications of the little turnover that might have occured.

Index funds used to mean S&P500 funds. In the past decade all major mutual funds have created index funds to keep up with Vanguard's 500. The group includes S&P500, total market, Russell 1000, Russell 2000, etc. Some of these indexes are narrowly cast and drift away from the general principles of mathematical determination (as opposed to actively managed) and low annual expense. My comments are directed to the big general market versions of index funds, not the sector specific indexes.

You also said "The reason I dislike index funds is that they tie you to the irrationalities of Wall-Street " Index funds are on the opposite end of the spectrum from actively managed funds. They drive Wall Street stock pickers crazy because they often provide better returns. They are unemotional. The PC that calculates the list and therefore portfolio percentages does not read the Wall Street Journal. It does not play golf with corporate execs on a site visit. It does not attend road shows. I have a hard time figuring out how a list based, mathematically determined fund is tied to "irrationalities"

You also said "One thing clear to me is that index funds have no potential to be anything but average" You seem to think this is a negative, it is not. It is actually the goal of index funds to mimic the performance of the market on which they are based, except that due to lower annual expenses, the investor is likely to keep a great portion of the annual result. Actively managed funds often have annual expenses between 1.2 and 2.5%. Index funds come in around 0.2 to 0.4 percent. That gives them anywhere from 1 to 2% edge immediately over actively managed funds. This is not theory, this basic fund history. The proponents of index funds often say something like "index funds beat the annual performance of 80% of all actively managed funds". I have not vetted that statement, but I have seen it in the WSJ, Worth, Money and Kiplinger and every reporter/editor plus all the active managers have had lots of time to take shots at the statement.

You also make the statement "it is almost certain that over the long-run (10, 15, 20, 25 years), index funds will have impressive average yearly percentages (7-8%)" What is so impressive about 7-8% returns? This level of return is more commonly associated with long term bonds or high dividend utility stocks. The returns of broadly based index funds like the S&P500 and total market indexes are likely over the long haul to be about 3% higher. The reasons are many but include the premium based upon growth potential and market risk. No one can tell you with complete certainty what the return for various asset classes will be over any time period in the future. However, for a century the relationships between asset classes have stayed similiar. Guarenteed products provide the lowest return, and tax free bonds are very similiar. Corporate bonds are higher. Equities (aka stocks) are a notch higher. These relationships are based upon the free movement of money back and forth across and within markets. Short term snapshots can vary, but the long term relationships have been consistent.

You assert: "most index funds are S&P500, as a DJIA-index fund would be impossible" {also subsequently deleted from prior post} Because of the success of S&P500 funds, the first half of this quote is likely to be correct. The second half is completely wrong - it is not impossible. There are hundreds of index funds and some mimic the DOW 30, the DOW transports and the complete NYSE. Firms are inventing new index funds every week. If you can define a list, someone can create a fund. I have no idea why you would think any index fund would be impossible. It just doesn't make sense.

You make the incredible statement "However, value, growth, and value/growth blend funds could have even more {annual returns}, while avoiding some of the stings of the down markets." This is completely wrong. First, value and growth funds are almost always actively managed, with average to above average annual expenses (I observe that the smaller the niche, the higher the annual expenses). Your comment flies in the face of what we have just witnessed. In the most recent down market, the growth funds were hit the hardest. Some of the Janus funds lost 70% of their value. You statement defies a basic principle of investing - the broader the base (greater diversification) the less a portfolio is effected by negative events. You also suggest that value funds might somehow avoid market downturns. Sometimes they do, but there have been prolonged periods when value funds underperformed the overall market and fell woefully short of anything with a slight growth component.

Finally, you dwell on recent history of funds or the stock market. Following hingsight will get you into trouble. Past track records are not a valid predictor of future results. The SEC requires this kind of statement in promo material. All types of investing run in cycles. Tech and telecom were hot for most of the 1990s. Plastics and the Nifty 50 were equally hot decades earlier. Security stocks caught fire after 9/11. Neither you nor I can accurately predict in advance when any of these cycles will start or end. Making recommendations for the future based upon what worked well in the past few years is extremely foolish. You can readily get caught up in a "buy high" mode. In the industry it is called chasing performance. Investment success does not come from jumping on the bandwagon after it has been circulating town for a few years.

DH - If you plan to post on this message board, please restrict your posts to areas where you have accurate information. You are free to post opinion, but please label it as such.

Disclosure: I have never worked for any mutual fund or brokerage and have never had any business relationship with either except for my personal accounts.

[dh003i]

I did make two incorrect statements regarding index funds. (1) I was thinking of something else when speaking of high turn-over rates. Index funds do not have a high turnover rate. (2) I was thinking of the entire NYSE when saying "it's impossible to make an index fund of that", not the DJIA (which is only 30 companies, and can easily be made an index-fund of). The larger the list of stocks that you want your index fund to mimic, the more difficult it will be to mimic that list. Perhaps not impossible. I do not see how, given the huge number of stocks you'd need to invest in to mimic the NYSE, one could accurately mimic it's performance.

If one wants S&P 500 performance, it may make sense to have an index fund. However, why waste time with an index fund for the DJIA? Since it's only 30 stocks, any individual can handle that himself or herself, probably at even lower expenses than an index fund. So, the question becomes, why would anyone pay any expense ratio for a DJIA index fund, unless the cost of stock-transactions is higher than the yearly fund-expenses?

Index funds are very much tied to the irrationalities of Wall-Street. True, there is no subjective emotionality in managing an index fund; it can essentially be done by a computer. However, the value of an index fund is very much affected by the irrationality of wall-street. They have no chance of escaping the irrational highs of wall-street.

Your praise of index-funds is also difficult to understand. Index funds essentially create an average. They will beat half of the stocks in the index in which they invest, and lose out to the other half. Maybe they do beat 80% of all actively managed funds. That's still no reason to take them over the 20% of funds that they don't beat (I assume the 80% figure compensates for the higher expense ratios of normal funds).

History has shown that value-investing produces impressive results that beat the index' (see the school of investors who followed Graham's principles). And even fund-managers with other strategies have beaten the index' over long-term periods (e.g., Lynch). There are funds today -- managed by the same manager for the past 10 or more years -- that have beaten the index' applicable to them over the past 10 years. Considering that the managers have been there for significant periods of time, and outperformed their index', this is not "chasing hot performers". It is choosing to invest in competent management.

Some people don't believe in that. They think that those who have beaten their index' just happened to luck out. This is the Vanguard philosophy. I don't really buy that at all, because many fund-managers have beaten their index' over very long periods of time, and it's very unlikely that they did it by pure chance. But if you do buy that philosophy then you should be questioning the value of mutual funds. Why make mutual-fund managers rich when their work is done almost entirely by computers? It is probably necessary for large index', but I don't see it as necessary for a DJIA index (which usually outperforms the S&P 500 anyways).

I did not say that the Nasdaq is all growth stocks. I said it is mostly growth stocks. Look at the Nasdaq's chart -- outrageous growth over a 1yr or so period, then decline just as rapid. This reflects stocks growing way beyond their intrinsic worth.

[John G]

DH: your reply has additional errors.

[1] You said "The larger the list of stocks that you want your index fund to mimic, the more difficult it will be to mimic that list. Perhaps not impossible. I do not see how, given the huge number of stocks you'd need to invest in to mimic the NYSE, one could accurately mimic it's performance.

The above quote indicates that you do not understand index funds. What you think is difficult or impossible has existed for many years. Index funds are almost completely automated - it is how they can have low annual expenses - and automated systems do not have problems working with a large lists of stocks. The index fund programs are set to periodically evaluate the "list" (usually selected from a third party source), they then create automated trades to adjust the portfolio. There is virtually no difference between modeling just 30 or 500. They trade in the wholesale environment, and this step is often automated. By "Accuracy" I assume that you mean ability to mimic the performance of the underlying list, which is by definition nearly automatic. This is not theory, it has been done. There is no limit on the number of stocks that can be on a list. Many of the broadly defined total market indexes can include 5000 stocks.

[2] You also said "However, why waste time with an index fund for the DJIA? Since it's only 30 stocks, any individual can handle that himself or herself, probably at even lower expenses than an index fund. So, the question becomes, why would anyone pay any expense ratio for a DJIA index fund, unless the cost of stock-transactions is higher than the yearly fund-expenses?"

Your suggestion makes no practical sense. You raise two issues: wasting time and cost of do-it-yourself. I think most folks would have problems with the amount of effort required and their costs to build a DOW portfolio. An index fund is normally a weighted portfolio, which is very different from just owning a block of each company. An index fund is not only weighted but periodically adjusted. Let's look at the simplest example, a DOW 30 industrial. Here is the list of DOW industrials as of July 18 and the rounded stock prices:

Alcoa Inc. 25 Altria Group 40 American Exp 46

AT&T Corp. 19 Boeing Co. 33 Caterpillar Inc. 66

Citigroup Inc. 46 Coca-Cola Co. 45 DuPont Co. 43

Eastman Kodak 26 Exxon Mobil 35 G E 28

Gen Motors 36 Hewlett-Packard 23 Home Depot 33

Honeywell 28 Intel 25 IBM 84

Internatl Paper 38 JP Morgan/Chase 35 Johnson & Johnson 53

McDonald's 21 Merk 62 Microsoft 27

3M 130 Procter & Gamble 90 SBC Commun 24

United Technol 74 Disney 21 Wal-Mart 57

To own just one share of each of these firms requires about $1,300. To own 100 shares each would require $128,000. This is a simplistic example because you would have a different numbers of shares for each firm and because prices change, the weighting should change over the year. Assuming that you could make single block trades for $15, your commissions just to purchase the portfolio would be about $450, and another $450 to sell. It would cost more to make periodic adjustments to the list.

In my opinion, there would be a lot of work for an individual to create and maintain a portfolio. Setting that problem aside, lets compare the costs for a individual's do-it-yourself DOW portfolio with a DOW index fund. A no load index fund might have annual expenses of 2/10 of one percent, so on a base of $128,000 would cost $256 in the first year. For a million in assets, the index fund would take $2,000.

100% contrary to your assumption, my example shows that it would be both expensive and a waste of time to create a do-it-yourself DOW 30 portfolio for the average investor. It might not even be efficient use of time or cost effective if the individual has assets that exceed 1 million. A do-it-yourself approach to any broader index like the S&P500 or Wilshire 5000 would be rediculous.

[3] You said: "Index funds are very much tied to the irrationalities of Wall-Street"

Well I guess you want to make a theoretical argument.

The word "irrationalities" appears to be a bias you bring to investing. ALL markets move up and down, sometimes in a boom and bust mode ... commodity, real estate, stock. I am not sure were the "irrationality" part fits in. I sure hope that you are not implying that some investments areas manage to avoid this. Every bright person I know invests in one form or another. I don't think of them as "irrational". The market is not some abstract beast that has a mind of its own, it is a reflection of investors... us.

You said: "Your praise of index-funds is also difficult to understand. "

I think if you read all of my posts at this message board, you will realize that I have tried to explained how index funds work and why they might be useful to beginners or as a component of peoples portfolios. No load index funds are useful for anyone with modest assets, little knowledge of investing, is just begining or does not want to devote a lot of hours to research, analysis, stock selection and portfolio tracking. I do not currently own any index funds as I am a stock picker. I devote approximately 1000 hours a year to evaluation of investments and would not assume that others have an inclination to do what I do.

You said "That's still no reason to take them {index funds} over the 20% of funds that they don't beat ."

You comment is absurd and has no practical application. Exactly how do you expect to determine in advance the 20% of funds that at year end are going to beat index funds? Everyone would love to only pick the winners, regardless of what type of investing. The problem is that you must know in advance who will be the winners and there is no reliable method of doing this. If there was, the "losers" would die off completely. Backing just the winners is not a strategy but an impossible dream.

You said "History has shown that value-investing produces impressive results that beat the index..... and .....There are funds today -- managed by the same manager for the past 10 or more years -- that have beaten the index' applicable to them over the past 10 years."

You the first remark about a general style of investing and your statement is false. It may be true if you compare selective timeframes or selective funds. But that is historical cherry picking. There have been periods of time when a style of investing or a specific fund or fund manager has had outstanding results, and other periods when they have performed poorly. Yes, Peter Lynch was a great stock picker at Fidelity Magellan for about a decade if my memory serves. But, he no longer runs any fund. Tom Marsico had a great run at Janus, but left to start his own fund and stumbled. There is no mechanism to determine which fund managers over the next ten years will have a great record. You can't even guarentee that the fund manager will even be at the same fund for ten years. The idea of moving money to fund managers with a great track record has some elements of "chasing performance". If you did this in the 1990s, you would have lost a ton of money by backing funds that were momentum players of the dot.com bubble.

You said "DJIA index (which usually outperforms the S&P 500 anyways). Where do you come up with these facts? First, the DOW30, DJIA and S&P500 have a large amount of overlap. They don't track each other perfectly, but over a long period of time they are very close. I have added a link that may show the SP500, DJIA and Nasdaq from 1950. There are major differences between investment classes (stocks, bonds, cds, etc.) but much less differences within an asset class.

href='http://finance.yahoo.com/q?d=c&c=&k=c1&t=my&s=%5Egspc&a=v&p=s&l=on&z=m&q=l&y=on&w=on'>http://finance.yahoo.com/q?d=c&c=&k=c1&t=m...m&q=l&y=on&w=on</a>

The fundamental flaw in your posts is that you assume that it is possible to avoid bad investments and only pick winners. Tell that to Warren Buffet and see if he hires you. If you went to a brokerage and made that claim your interview would be over at 5 minutes. The concept is deeply flawed. Please stop misleading people on this site that there is some magical style of investing that always beats everyone else. It does not exist. Investing is organic in nature, we attempt to understand investment options in a dynamic environment. What works in one year or one cycle is often the worse investment in the following cycle. Simple solutions should be ignored.

[dh003i]

Looking at various index funds, I do not think that they accurately mimic the performance of the index they're trying to match. In many cases, they exceed the losses, and the wins, of the index. Of course, it all depends on how accurately you want to mimic the performance. I would consider less than 0.25% points to be an accurate mimic.

Regarding managing a personal index-portfolio vs. using a DJIA-index, I did not say that it was a good option for everyone...just that in some cases, the value may be questionable. There's also the fact that the people "managing" the fund are getting rich for basically doing nothing.

Regarding the irrationalities of Wall-Street, I am not brining any bias. People act irrationally. Irrationality is one reason why the stock-market cycles as it does. Growth to unrealistic highs, and then sinkings to irrational lows. This is because of the typical investment model that most people follow -- to always try to buy when the market is going up, and usually when it is going up at the craziest pace. Then, when the market is low, they stay out of stocks and sell. That is, they are overly optimistic when they should be most cautious, and overly pessimistic when there is the largest room for growth. Yes, the market is a reflection of investors -- us. And we -- most of us, maybe all of us -- are irrational. Buffet made a simple observation on this in an interview: "That's the way the stock market behaves. It overshoots in both directions because people get entranced with the rear view mirror. And they go to excesses in both directions." If ignoring current fundamentals because of past-performance and under or over-valuing a stock isn't irrational behaviour, I don't know what is. (the interview also has some other interesting stuff...it's really admireable that, despite having billions of dollars, Buffet basically lives like the average person).

I am not suggesting that anyone can determine the 20% of funds each year that will beat the index. I'm suggesting that people can make intelligent decisions with long-term impact -- not perfectly, but certainly better than random. Naturally, in regards to mutual funds, a rational person would place their money with a manager who has proved over the long-haul that s/he can outperform the applicable index, and not in an incompetent one that is slaughtered over the long-term by the index. Are you suggesting that there is no reason for people to look for quality management when placing money in a mutual fund? By the way, if you argue that you have no way of picking the mutual funds (thus, necessarily the stocks) that will beat the index', then I don't see what business you have picking stocks. Sounds like a futile effort to me.

Moving money to top-performers in the dot-com era would have been disastrous because you wouldn't be paying attention to long-term records (which they didn't have, because dot-com was new). It also would fly against common sense. The idea that companies can somehow make money by giving stuff away for free online, and paying for it by advertisements, or hoping that people will pay for "upgrades", or whatever other crazy business models these "give-stuff away for free" dot-coms had is absurd. Most people investing in those companies were trend-hopping, and had no idea of the business plan of these companies. In general, if you don't understand how a company makes money, you probably shouldn't invest in it. I never got how dot-coms (some exceptions, like Amazon, which actually has a real business model) were going to make money. I still don't understand the convoluted schemes.

The idea that you cannot avoid bad investments is also questionable. If you can't avoid bad investments, then why bother to look for companies with good fundamentals (e.g., low debt, quality management, etc)? Through a number of quantitative and qualititative methods, you can find companies which are likely to be good investments, or at least avoid those that are likely to be losers. Would you advocate investing in a company with insurmountable debt-problems, for example? You can't always pick stocks that will be the winners. That's impossible. But what's more important than that is realizing when you've picked stocks that are losers, and not holding onto them out of sheer hope. Simplistic quantitative screening approaches won't make your investments winners, but they can at least filter out a lot of crap that you shouldn't even waste your time bothering with. From what's left, more qualitative analysis can be done on the quality of management, products, etc at companies.

A simple analogy would be basketball. I can't tell you who's going to win the next NBA championship (though I'd place the best odds on the Lakers), but I sure as hell can tell you who doesn't even have a shot (Heat, Wizards, Bulls, etc). This is because I can look at the members of those teams -- coaches and players -- and say that they are nobodies with little talent and a track-record of failure (Pat Riley aside). The same kinds of analysis make sense in the corporate world. Would you even think about investing in a company managed by Gary Wennig, the unrealistic dreamer who bankrupted Global Crossings)?

You seem to be distorting my argument. I am not arguing that anyone -- even the greatest investors like Buffet and Lynch -- can pick only the winners. (Indeed, Buffet admitted in his latest letter to investors of Berkshire that he made a mistake in investing in a certain insurance company). If they can't do it, then certainly no-one else can. What I am arguing is that every investor can -- through careful examinations of investments -- reduce the number of losers picked and increase the number of winners (compared to random investment, which would over the very long-haul mimic applicable indexes). If people spent the same time evaluating stocks and mutual funds when buying into them as they do cars, then there would be alot less excesses on Wall-Street. This would eliminate the opportunity for above-average performance. Of course, that isn't going to happen. The majority of investors will continue investing in stocks like they buy clothes or the latest fashion items, leaving opportunity for those who take the time to thoroughly analyze stocks of companies that they can understand.

[John G]

DH - you have now posted on this message board at total of 11 times. As Barry Picker and I have pointed out, you have made a number of inaccurate statements both on factual and procedural issues. I am not sure why you feel compelled to post in areas where you have no expertise. You are trying to pass on your personal viewpoint as fact, rather than your opinions. Some of these message threads are viewed by over 300 people, you have an obligation to post accurate information.

From your prior posts, you clearly do not understand how index funds work. You do not know about the wide range of types that have been created, their relatively low portfolio turnover rate, the historical performance, the role they might play in personal investment portfolios, and why they often out perform actively managed funds. In the most recent message you declare that index funds do not mimic the underlying list on which they are based. This would be news to the fund industry. I have never heard anyone else make such an assertion.

Time to stop posting about investment issues on which you have no knowledge.

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Other readers can tap into a range of web sources on index funds. Here are a few articles:

http://www.fool.com/mutualfunds/indexfunds...ndexfunds01.htm

http://invest-faq.com/articles/mfund-index.html

http://www.geocities.com/dalemaley/faq116.html

http://flagship.vanguard.com/web/planret/A...ntIndexing.html

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Other comments:

You said "There's also the fact that the people "managing" the fund {index] are getting rich for basically doing nothing." This is a childs view of business. Folks who run a business are motivate by profit, which gives them an incentive to be innovative and efficient. We live in a free market system. If the operators of a mutual fund are "getting rich", others will enter the marketplace and offer to slightly undercut the original providers.

How ironic that you complain about the incomes of index fund managers, rather than actively managed funds. It is the index funds that have entered the market to undercut the high expenses of managed funds. Index funds have very little adminstative overhead - so the concept that a bunch of managers are "doing nothing" is ridiculous. It is apparent you do not know much about the historic development of index funds at Vanguard and the ruthless cost cutting instituted by John Bogle to achieve ultra low annual expenses that have become an industry standard.

[dh003i]

John, you ignore almost all of the important issues in my post, and continue to -- from what I can see -- insist that individuals cannot intelligently manage investments, so should just put their money in an index fund. You claim to simply be sharing facts, yet it seems to me like you are discouraging individuals from bothering to look for well-performing portfolios or invest in stocks, on the rationale that index-funds outperform 80% of all other funds (over the long-run) and there's no way to make an intelligent prediction on which funds will outperform the index', or which stocks will. To me, that sounds like the same kind of scare-tactic that you accuse Fidelity, M. Lynch, and others of using.

[John G]

DH - I have focues on correcting inaccurate comments your have made about investment fundamentals (now edited out from some of your prior posts). If you will look at the original post... this thread was about a 19 something college student starting a Roth. The first person asked basic questions about where to invest and how to get started. A second student joined the thread and asked "Where do I enroll?" I stand by my original responses as being directed to the questions raised. A simple approach for someone just getting started.

I have never said that individuals "cannot intelligently manage their investments", the words you want to put into my replies. What I have insisted is that their is no simple solution to success. There is no single way that always beats the average and works all the time. Go back and read your prior posts. You have alluded to a number of simplistic solutions - like just select value funds, or just pick the top 20% performing funds. No one can tell in advance what will be the most successful region, industry, sector or fund manager in the coming year. To suggest otherwise is to mislead a starting investor. Lower Manhatten is littered with investment methods that stopped working - like the Nifty Fifty, Dogs of the Dow, Cashflow momentum, etc. A current theory is that the best stock pickers now all work for hedge funds because they are more highly compensated there... but isn't that off topic for beginner college students. I write not to discourage individuals but to give them a realistic view of some investment approaches, the work required, and what they may be able to achieve. For a beginning investor who is still in college, an index fund is an outstanding way to start because it is diversified, simple and easy to initiate.

While the private investor has some advantages that can be used to chisel a successful portfolio - this takes a lot of work, an ability to analize accounting data and a sense for competitive advances. I know this from personal experience, I spend a large part of each year investigating stocks. I read annual reports, 10Qs, press releases, brokerage analyst document, company websites and four financial newspaper/magazines... every week. I have been doing this for 20+ years, and I typically make about 200+ buy/sell decisions every year involving over 50 stocks. I make my living though these decisions and am not an average investor. I do not assume that many other people are likely to take this path, especially not a 19 something college student. They don't need rambling theories about "irrationalities" on Wall Street, but practical advice of how to get started. Accurate advice.