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Assuming same expense ratio and zero commission, ETF or index fund to start an IRA?

I am a single father, earning $70K at a stable job (11+ years). I did not start planning for retirement until now – age 42 due to 1) no 401K plan at work (a very small company with$500k annual gross revenues, 1 owner and two employee environmental consulting company), 2) paying off credit card debt and car loan and 3) cost of divorce (paid off my ex-wife’s car and credit card debt, too). Also, due to market conditions which scared me, I used savings to pay off additional principal of my mortgage (moved the initially 30-year term first to 15 years, and then the 15 year end date from 2018 to 2014.) My son is 13 (14 in the summer), he is in 8th grade. In 5 years, he will be in college. I have no college savings for him, either. But I have no debt (no credit card balance, car loans, etc.) except the remaining mortgage of approx. $70K in my home worth about $200K. I plan to finally start my retirement savings, with a traditional IRA (to take tax deductions otherwise I owe $800 more to IRS). I would like to put $5000 lump sum now from my cash savings for the 2011 contribution before April 17th, and another $5000 by the end of the year or next spring for 2012. Or maybe $400/month depending on investment type. Can you compare ETFs and index funds as categories, assuming both low expense and zero-commission (such as Scottrade, Vanguard, Schwab, Ameritrade or Fidelity buying within the broker’s own funds)? For example, on a market crash situation, are ETFs more volatile than mutual funds due to being easier to buy and sell? Do both loose and recover in a same way in such instant crashes? For this kind of scenario (small investment amount, just starting, ETFs or index funds, and no daily trading), which online broker would be most suited? I also do not understand how the dividends become a tax burden in mutual funds? Isn’t it good to get dividends?

Feb 24, 2012 by AYHAN from Plano, TX in  |  Flag
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Ayhan - My perspective is different than Barry's. All else equal, I would give index mutual funds a slight edge. While ETFs do offer the flexibility to trade throughout the day, this feature is a red herring for most investors. ETFs can trade above or below net asset value (NAV), and individual investors tend to wind up on the wrong side of the bid/ask spread more often than not. If you buy an ETF above NAV, it's like paying $1.01 for a 100 pennies. With mutual funds you are guaranteed the ability to transact at NAV each day, so there is no execution risk.

For your specific scenario, I believe your needs would be well-served by a Vanguard mutual fund account. Fees are low, minimums are low, systematic contributions are supported, and their broad lineup of funds will allow you to create a well-diversified portfolio. In my advisory practice, when we produce a financial plan for someone who wishes to manage their own investments on a self-directed basis, we usually direct them to Vanguard for implementation.

Comment   |  Flag   |  Feb 24, 2012 from San Francisco, CA

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Barry Rabinowitz Level 19

hi: Since you are getting started: I would recommend ETF index funds rather then mutual funds. Unlike mutual funds- ETFs trade like a stock and can be bought and sold all day. Mutual funds price after 4pm. You have more flexability with ETFs. The only negative is thst dividends cannot be reinvested in ETFs. The dividend would accumulate in a cash account- until you decide to reinvest some or all of it.

Comment   |  Flag   |  Feb 24, 2012 from Fort Lauderdale, FL

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I would go ETF if expense ratios are lower...VTI, VEU, DND make an inexpensive and diversified portfolio.

Comment   |  Flag   |  Feb 25, 2012 from Boston, MA

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