a financial makeover done for me through Medical Economics magazine,” says Mabry, 30. “A lot of them focus on what doctors making six figures a year should do with their money, but I wanted to know what residents and fellows making $30,000 a year should do.”
Mabry’s first step was to stash an emergency fund equal to four months’ worth of living expenses in a money market account. This month, she’ll begin funding an IRA, “just to get into the habit of investing and to learn about the process. I’m interested in mutual funds because I don’t think I’m going to have a lot of time to spend picking [individual securities].” Aside from paying off her medical school debt, she wants to beef up her emergency fund and begin building a retirement nest egg.
The financial planner that did Mabry’s make over, Chris Parr of Columbia, Maryland, says that she definitely should focus on stock funds to get started. “Young people have many years to build up their portfolio,” says Parr. “Over the long term, stocks proved to be excellent investments throughout the 20th century, and that probably will be the case for the 21st century, too.” In fact, over the past 20 years, the average annual return for the S&P 500-stock index was 17.99%.
For Mabry, Parr recommends an index fund that tracks the broad stock market. Index funds have low expense ratios (that is, management fees eat up a smaller portion of your return than those of actively managed funds, usually a difference of more tha
n 1%) because the manager merely tries to match a certain index; no stock-picking efforts are required. These funds also assure investors of participating in major market moves.
“Among the funds I’d suggest for her is the Vanguard Total Stock Market Index Fund,” Parr says. This fund holds thousands of stocks in an attempt to match the Wilshire 5000 Index, one of the broadest measures of the U.S. equity market. Recently, about 20% of the fund’s holdings were in technology stocks, while sizable amounts were in communications and bank stocks. Thus, investors will be in a position to profit whether stocks continue to surge or if interest rates fall and bank stocks bounce back.
According to Parr, novice investors with $10,000 to invest might want to put their first $8,000 or so into this type of core fund. “Next,” he says, “I’d put $2,000 into an international fund because there are some excellent companies outside the U.S.”
While an index fund may be appropriate for a beginner such as Mabry, such funds aren’t only for novices-they can be one pillar of a well-allocated portfolio. Index funds have performed well (Vanguard 500 Index Fund, for example, has returned over 18% per year for the past 10 years), attracting approval from sophisticated analysts. “We recommend a 50-50 split between domestic index and domestic actively managed funds,” says Sheldon Jacobs, publisher and editor-in-chief of The No-Load Fund Investor, published in Irvington-on-Hudson, New York. “Transaction costs are lower in index funds. Over