Roth IRA: My ETF Portfolio

One of the biggest barriers to the beginning investor is the mistaken impression that investing is complicated. One glance at CNBC at midday is enough to make your head spin. It would be very easy to give up on the idea of investing in the stock market altogether and run to a more conservative and less risky place to store your pennies. It was partly this and partly sheer laziness that kept me from investing in the market until recently. But now that I have taken the proverbial plunge, I see that many of the fears and misconceptions I had about investing were just that: misconceptions. I have found investing in the market to be quite easy after a very modest amount of research into what investments would suit my situation as a twenty-something investor with 30+ years for the investments to grow.

One of the first lessons I learned was that if you have this many years until your retirement, you want your investments to be mainly in stocks rather than bonds. Although bonds are less risky than stocks, the average return on stocks is much greater than that of bonds in the long term. Over thirty years, you have enough time to ride out the ebbs and flows of normal market swings. Even a major recession can be successfully dealt with as long as you are persistent enough to ride out the rough periods in the market. So the first decision I made was to have a portfolio that consisted entirely of stocks, given that I would not likely be retiring this side of the year 2040.

The next lesson I learned was that I needed to pay attention to how my portfolio was diversified. I had in mind a complicated process of wading through stock reports and prospectuses, trying to find the perfect mix that would assure me decent returns while at the same time minimizing risk. Enter the ETF (Exchange Traded Fund). An ETF is a fund that consists of holdings of various stocks, which is then broken into shares and traded on the stock exchange. Usually ETFs are tied to stock indices such as the S&P 500 Index, which means that most ETFs are already diversified due to the variety in stocks that make up the fund. The long and short of this is that by buying shares of an ETF, you are buying securities that are inherently diversified without all that complicated research I was initially worried about. So I decided upon a portfolio that would be comprised mainly or entirely of ETFs. The only question remaining was: which ETFs do I choose to buy and in what proportions?

Rather than quibble over which ratios would be best for my new Roth IRA, I decided that it was most important for me to get into the habit of saving and investing regularly so I could finally end this paycheck-to-paycheck nightmare in which I have been living for a decade. With that in mind, I wanted a simple and easy portfolio that may not be what my fellow Blogger Ramit would call "Sexy," but would do the job of building our nest egg for retirement. What I discovered was that a very basic portfolio would have decent exposure to at least three areas: a broad market large cap index such as the S&P 500 Index (larger more reliable companies with steady growth), a small cap index such as the Russell 2000 Index (smaller companies with more room for growth), and some foreign stock exposure (due to the increasing globalization of the economy and the resulting higher chance for growth). While doing my research, I found many, many sample portfolios consisting mainly of these three areas, with the only differences being how to properly allocate between them.

Of course, there were more complicated portfolios out there; but I wanted to keep things simple and boring rather than complicated and sexy. So I decided to take the simplest route I could think of, which was to weight each of these three areas equally in my portfolio. That way whenever I wanted to make a contribution to my IRA, all I had to do was divide the contribution into thirds and buy the three funds accordingly. So here is the portfolio I ended up with (along with my current holdings):

SPY (S&P 500 Index ETF): 2.3042 shares @ $143.39/share = $330.40
IWM (Russell 2000 Index ETF): 4.1689 shares @ $80.24/share = $334.51
EFA (International Stock Index): 4.4271 shares @ $76.50/share = $338.67

Not bad considering I have only been at this about two months! This portfolio should return somewhere between 7 and 10 percent annually, which makes for significant growth over 30 years! I have made a commitment to myself to contribute at least 10% of my income to this retirement account, so I will be keeping this blog updated with monthly or semi monthly progress reports so I can track my progress. After playing around with a compound interest calculator, I calculated that I could end up with $1.3 million by the time I retire if I continue to invest at the present rate and assuming an average return of 10% annually (which should be no problem given the stock market's historical performance). If you haven't already done so, try playing around with the compound interest calculator. Most people have a vague idea about compounding and the power it has to grow your money, but it is another thing altogether to play with the numbers and visualize yourself with a huge amount of capital that is entirely within your grasp if you start early and invest consistently for the long term. Go ahead and play with the link above; it completely changed the way I think about money and hopefully will for you as well.

8 comments:

moneymonk said...

If you are going to go international EFA is your best choice. EFA is a very well performing ETF

Living Almost Large said...

ETFs are a terrible way to invest for someone like you. They are great for people with a lot of money. The carrying costs of ETFs, where you have to pay like a stock purchase basically eats into any gains you make.

You made 3 purchases for how much per purchase? For what $1k? I'm not knocking the savings but you are better off using an index fund.

So every time you contribute you will pay how much per transaction for each of your 3 funds. Bad idea.

Keep saving though.

Jon said...

I set up a very similar IRA -- the sole difference being DVY instead of SPY. DVY focuses on the top dividend paying stocks within the S&P 500.

One tip to keep expenses down is to only invest in one security each month (or whatever period you use), rather than dividing your investments into thirds each time. Doing that will save you 2/3 of the commission.

Donald said...

Yep, don't spread your commissions too thin. I chose one ETF per month to add my contributions to, thus keeping my commissions down to a minimum.

Jessie B. R. said...

You make this sound easy but it makes my head spin at rapid speed. I have been sending money to a Scottrade account for a few months and have not even chosen an investment yet. The money's just sitting there. Completely overwhelmed by the whole thing!

Donald Family said...

Most of the comments regarding ETF commissions are outdated. Most of the discount brokers, following the lead of Vanguard funds charge ZERO commission when purchasing their own ETF products. So you can now invest in an ETF as you would have a mutual fund, by making periodic, incremental contributions. The advantage is that ETF's typically have lower, often much lower, operating costs than actively managed mutual funds. So ETF investing now IS the best tool for most small investors. If you are still paying commissions on ETF trades, you're with the wrong brokerage.

Donald Family said...

Most of the comments regarding ETF commissions are outdated. Most of the discount brokers, following the lead of Vanguard funds charge ZERO commission when purchasing their own ETF products. So you can now invest in an ETF as you would have a mutual fund, by making periodic, incremental contributions. The advantage is that ETF's typically have lower, often much lower, operating costs than actively managed mutual funds. So ETF investing now IS the best tool for most small investors. If you are still paying commissions on ETF trades, you're with the wrong brokerage.

Oliver said...

Yes but as you say firms like Vanguard and Schwab only have zero fees on their own products, not (all) ETFs in general.

Having said that the fees are fairly low (I pay $8.95 at Schwab) but the OP is probably doing the right thing by only increasing his holding in one of the three each on a monthly rotating basis.