Wednesday, April 06, 2005

Why I bought a raft of index funds

My wife recently opened her first IRA (tax time you know), and I opened a 529 plan for Joshua. Since we didn't have much to invest, we were somewhat limited to a handful of options. Commissions would eat up too much of the investments if we tried to buy individual stocks and most mutual funds require $3000 initial deposit.

For Joy's IRA, we opened an account at USAA, which is where I have my IRA account. The best choice was USAA Extended Market Index Fund which tracks the companies that trade on US stock exchanges that are not part of the S&P 500 index. It's top holding is Berkshire Hathaway, which owns The Pampered Chef (and Dairy Queen and Gieko and Sees Candy and ...)

For Joshua's 529, I opened an account with the New York program. It has the advantage of low fees and a relationship with Upromise. California's plan has higher fees and no extra tax advantage. I've spread the investment evenly between the Vanguard Total Stock Market, Growth, Value, Mid-Cap, and Small-Cap Index funds.

I'm not as happy about the group of index funds as I would have been a few years ago because I think we are in the beginnings of a bear market when holding the market in general won't work as well as it did in the 1990s. (Read Thoughts from the Frontline for some reasons why this might be true.) But there are some very powerful advantages to indexing: low fees of course, but also low turnover. John Bogle, father of indexing, points out that high turnover costs more in taxable accounts and that commissions are a hidden fee paid by the funds shareholders. This is why I use turnover and fees when I pick actively managed funds.

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