Your financial advisor is terrible!

Investing
financialadvisor

Hi Joanna,

I am 21 years old and pay my financial advisor a fee. When I asked why not any Vanguard funds he became angry at me and said those fees are how I’m paid. He went on to say Vanguard are not managed closely by anyone and the funds I have now are the best. I’m just getting started so I am not 100% sure about investing. Are there any books I should read ? And which broker do you suggest I go through ? Scotttrade?

-LP

Hi LP,

Wow. That’s a terrible response. I would recommend that you leave that financial advisor immediately. His job is to help you, not to maximize how much he gets paid. It’s outrageous that he would put his needs ahead of yours. Since you are new to investing, your financial advisor should be patiently explaining to you not only what you should do, but why. If he can’t do that, then it’s time to move on. Going forward, try to only choose financial advisors who are fee-based meaning you pay a flat fee and they recommend what they think is best, not what pays them the most.

As for Vanguard funds, I think they’re a great choice for a lot of people and certainly a well respected fund family that has been around for many years. Since you don’t know much about investing yet, I wouldn’t recommend you try to trade stocks. Instead, I would suggest you put your money in low cost index funds and leave it there for the long run. Vanguard offers a great selection of funds for this. Saying that they aren’t managed closely by anyone is a lie. There is a difference between being managed and being actively managed and all mutual funds are managed, including Vanguard funds, just not actively managed, which I think is actually a good thing. There are two types of funds: active and passive (index). Active funds are when the manager chooses the stocks themselves. Passive funds (or index funds) are when the manager invests in the entire market (or a particular subset depending on the type of fund). In both cases the money is watched very carefully. The only difference is that an active fund is trying to beat the market while a passive fund is trying to match the market. Overwhelming evidence shows that active managers do not beat the market by enough to justify their higher fees. I would recommend you invest in passive index funds like Vanguard Funds.

Below are a suggestion of a low-cost stock index fund and a low-cost bond index fund:

Stocks: VTSMX – Vanguard Total Stock Market Index – 0.17% expense ratio (low), $3,000 minimum
Bonds: VBMFX – Vanguard Total Bond Market Index – 0.20% expense ratio (low), $3,000 minimum

If you want to choose another fund family like Fidelity, go ahead. Just be sure not to pay an expense ratio higher than 0.25%. That means they will take $2.50 each year as a management fee for every $1,000 you have invested. This is much lower than most actively managed funds charge. Since index funds just invest in the index, there is no reason to ever pay a high expense ratio.

So how much should you invest in the stock fund and how much in the bond fund? A general rule of thumb is to invest 100 minus your age in stocks and the rest in bonds. So at age 21 you should invest about 79% in a stock fund like VTSMX and 21% in a bond fund like VBMFX and then adjust over time (80/20 or anything in the ballpark is fine). As your portfolio grows, you may want to consider adding an international fund or an alternative investment fund like a REIT.

But isn’t investing in only one or two funds a bad idea? Don’t you need diversification? Actually, you already have it. The beauty of investing in a fund, as opposed to an individual stock, is that the fund invests in hundreds or thousands of stocks so even if you only buy a single market index fund, you are already adequately diversified.

As for books to get started with investing, I would recommend A Random Walk Down Wall Street by Burton Malkiel. It’s very easy to read and provides a great overview and big picture perspective on investing.

As for brokers, you don’t really need one.  If you’re just going to purchase index funds I would recommend you go directly to Vanguard’s website so you don’t get charged any purchase fees. If you want to eventually trade stocks as well, then your suggestion of Scottrade is a decent choice. They offer stock trades for $7 per trade and access to many mutual fund families. Just try to avoid paying fund purchase fees.

About the Author

Joanna D. Pratt, CFA is an experienced institutional investor.  She holds a bachelor’s degree in economics and certificate in finance from Princeton and an MBA from Stanford.

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