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Keep It Simple is a convenient way to obtain the broadest diversification in a single fund. Investing in a Total World Stock Index Fund is a convenient way to obtain the broadest diversification in a single fund . . . like one-stop shopping. Well-diversified portfolios should have holdings of bonds as well as stocks. Again, we believe that index funds provide the most efficient vehicle for individual investors to hold bonds. On the opposite page, we list three bond index funds that are suitable investments. We believe that the funds listed here provide suitable exposure to the stock and bond markets. They can easily be purchased by calling the toll-free numbers listed or by visiting the web sites. Some investors will find that exchange traded funds, or ETFs, will be useful investment instruments. ETFs—most are based on index funds—trade like individual stocks. The two most popular ETFs are the QQQQs (or “cubes”) that track the NASDAQ 100 index and the “Spyders” (ticker SPY, which explains the peculiar spelling) that track the Standard & Poor’s 500 stock index. Neither of these ETFs is as broad as we would like, but fortunately, new ones are 121 c05.indd 121 11/3/09 10:16:22 AM The Elements of Investing now available that track total stock market indexes in the United States and in the world. The table on the opposite page shows the menu of ETFs that we recommend. ETFs tend to have very low expense ratios, and they can be more tax efficient than mutual funds because they are able to sell holdings without generating a taxable event. This could be an advantage for taxable investors. However, brokerage commissions are charged on the purchase of ETFs, and for small and moderate purchases these commissions can overwhelm those other advantages. No-load indexed mutual funds typically have no purchase fees. However, if you are investing a lump sum (as, for example, when rolling over an established plan such as an IRA), an ETF may be an optimal choice. The Vanguard Total World ETF (ticker VT) will give you all the diversification you need, over both domestic and all international markets, with one-stop shopping. 122 c05.indd 122 11/3/09 10:16:22 AM Keep It Simple Exchange Traded Funds (ETFs) Total U.S. Stock Market iShares Russell 3000 Vanguard Total Stock Market Total World Ex-U.S. Vanguard FTSE All World SPDR MSCI ACWI Total World Including U.S. Vanguard Total World iShares MSCI ACWI Total Bond Market U.S. Vanguard Total Bond Market iShares Barclays Aggregate Ticker Expense Ratio IWV VTI 0.20% 0.07% VEU CWI 0.20% 0.34% VT ACWI 0.29% 0.35% BND 0.11% AGG 0.20% 123 c05.indd 123 11/3/09 10:16:22 AM c05.indd 124 11/3/09 10:16:22 AM A SUPER SIMPLE SUMMARY: KISS INVESTING The steps to a comfortable care-free retirement are really simple, but they require discipline and emotional fortitude. 1. Save regularly and start early. 2. Use company- and government-sponsored retirement plans to supercharge your savings and minimize your taxes. 125 both1.indd 125 10/31/09 1:33:40 PM The Elements of Investing 3. Diversify broadly over different securities with low-cost “total market” index funds and different asset types. 4. Rebalance annually to the asset mix that’s right for you. 5. Stay the course and ignore market fluctuations; they are likely to lead to serious and costly investing mistakes. Focus on the long term. KISS investing—Keep It Simple, Sweetheart—is the best and easiest and lowest cost and worry-free way to invest for retirement security. Go for it! Speaking of sweethearts, all wives and all husbands should be sure they both know all the facts about their investments. And because we are each different in our emotions about investments, markets, and money, families should strive again and again to share their thoughts and feelings so they can understand each other and make decisions together. 126 both1.indd 126 10/31/09 1:33:40 PM APPENDIX: SAVE ON TAXES LEGALLY Because the U.S. government wants to encourage us to save more, a variety of retirement plans are available that allow individual taxpayers to deduct from their federal taxes every dollar they save. Moreover, these plans allow the earnings and gains from these savings plans to compound over time tax free. Here we describe the details of these tax-advantaged plans. This section is, by necessity, more detailed and dryer than most readers would like. You can skip it if you 127 bapp.indd 127 10/31/09 1:32:47 PM Appendix: Save on Taxes Legally wish. Just make sure you are taking full advantage of at least one of these plans. They not only permit you to save more but also let the earnings from your savings compound at a faster rate. INDIVIDUAL RETIREMENT ACCOUNTS (IRAS) The simplest form of savings and retirement plan available to everyone is the individual retirement account. All people with earnings from employment can take $5,000 a year ($6,000 if you are over 50 years of age) and invest it in a mutual fund or other investment vehicle.* If your income is moderate, you can deduct the entire $5,000 from your taxable income. Thus, if you are in the 28 percent tax bracket, the $5,000 contribution really costs you only $3,600 because your tax bill will go down by $1,400. Moreover, all the earnings from that $5,000 investment will accrue tax free. Wealthier individuals cannot get the same initial tax deduction, but they do enjoy the benefits of the tax deferral *These are the rules as of 2009; the dollar limits may well be raised in subsequent years. 128 bapp.indd 128 10/31/09 1:32:48 PM Appendix: Save on Taxes Legally from the investment earnings on their IRA investment account. The result is that the government subsidizes your savings. Now suppose that you have entered the workforce at age 23 and that you invest $5,000 each year over a 45-year period. Let’s further assume that you invest in a broadly diversified mutual fund earning 8 percent per year. No taxes are paid on those earnings until you withdraw the money during retirement. A person who followed such a program of IRA savings would have a final value of over $2 million. The same savings without the IRA benefit (with all earnings taxed at a 28 percent rate) total only about $750,000. Even after paying taxes at a 28 percent rate when you withdraw your IRA contribution, you would end up with almost $1.5 million, and you might be in a lower tax bracket during retirement. The figure on page 130 shows the dramatic advantage of investing through a taxadvantaged plan. You don’t have to win the lottery to be a millionaire. Anyone with the will power to save regularly and start early can become a millionaire. 129 bapp.indd 129 10/31/09 1:32:48 PM Appendix: Save on Taxes Legally $2,087,130 $2,000,000 Tax-Deferred Investing Taxable Investing $1,000,000 $755,512 $0 1 5 9 13 17 21 25 Years 29 33 37 41 45 How Tax-Deferred Investing Grows Faster Than Taxable Investing ($5,000 Invested per Year Earning 8 percent) ROTH IRAS A type of IRA, called a Roth IRA, is available to savers whose income is below certain levels. (Any mutual fund company can tell you if you qualify.) The traditional IRA lets you deduct your contribution from your taxes immediately—in effect, giving you “jam today.” The money gets taxed at retirement when you take 130 bapp.indd 130 10/31/09 1:32:48 PM