Invest and prosper

I think that most beginning investors should start by investing in an index fund. There are several reasons for this:

1. Diversification - it is not easy to assemble a well-diversified portfolio by collecting individual stocks. An index fund, on the other hand, is already extremely diversified. For instance, Vanguard 500 Index fund (VFINX) tracks the persormance of the S&P 500 index, which includes - you guessed it - 500 stocks. Standard & Poor has already done the job of picking 500 excellent large US companies, so you wouldn’t have to.
2. Tax efficiency - index funds very rarely sell stock; companies do not get kicked out of S&P 500 too often. Therefore, the chance that an index fund will distribute capital gains to you is very small. On the other hand, some actively managed mutual funds will sell stock often; if they sell stocks at a profit, the capital gains will be distributed to you, sticking you with a tax bill.
3. Ease of administration - this one is easy. Watching an index fund is not as labor-intensive as watching a portfolio of 10 different stocks. In addition, you do not have to follow an index fund as closely. The net result is that you save time, effort and possibly money that your occasional lapses in attention could cost you.
4. Low transaction costs - if you buy a number of shares of an index fund, you pay one commission charge. If you buy 10 different stocks, you pay 10 commission charges. Enough said.
5. Returns - Only one in three actively managed stock funds in operation since 1976 has beaten the Vanguard 500. You can be in the top third of the returns of all professional money managers by simply owning an S&P 500 index fund!
6. Low volatility - an index fund is extremely unlikely to plummet in value with the same speed than any individual stock or even a 5-10 stock portfolio. Sure, it can’t increase in value with the same speed either - but to most people, losing money quickly is of more concern than missing out on making even more money.

Short answer: stocks. Here’s why.

Over the long run, stocks massively outperform real estate. To see a chart of the performance of S&P 500 vs. the real estate market in 10 largest US metropolitan areas, from 1980 to 2005, on Forbes.com, click here.

Performance is not the only reason why stocks are a much better long term investment than real estate. Stocks (and ETFs and mutual funds) are much less expensive to buy, sell and own (discount brokers now charge very low commissions without any annual or inactivity fees). In addition, a stock portfolio can be diversified; real estate, since it represents a single asset class, lacks diversification. The time and effort one needs to expend to own real estate can be tremendous - think finding, inspecting, negotiating for and buying the property, maintenance and repairs, dealing with tenants if a property is a rental, as well as the hassle of selling it.

References (which are also suggested reading):

1. Stocks vs. Real Estate, CNNMoney.com
2. Real Estate Vs. Stocks, Forbes.com

So you’ve opened a retirement account, moved some money into it and resolved to contribute to it regularly. Now what?

Before you invest your money, you need to know in what securities to invest it. A good retirement portfolio takes into account your age and your risk tolerance. There is an excellent, highly visual investment allocation calculator at Fulcrum Inquiry. Just put in your age, your risk tolerance (there is a worksheet to help you estimate this) and - voila! - you see what I think is an excellent model for a retirement portfolio.

The best place, in my opinion, to keep your taxable investment account, is with a discount broker.

Both IRA and taxable investment accounts may be opened with a discount broker. Banks, premium brokers and full-service brokers are likely to charge significantly higher commissions on security purchases and sales, known as transactions. These fees can add up to significant amounts of money. it is important to research the discount broker prior to investing with one; here is a good discount broker comparison chart.

I personally like Tradeking - they have been rated #1 discount broker by Smart Money magazine 2 years in a row, in 2006 and 2007. They have also been top-rated by Barrons. Their commissions on stock and ETF (exchange-traded fund) trades are $4.95, which is very low. They do not have an IRA custodial fee.

Zecco offers 10 free stock and ETF trades per month to users with accounts valued over $2,500, otherwise trades are $4.50. This is hard to beat for a taxable account. However, they have an annual $30 IRA custodial fee.

Scottrade offers $7 stock and ETF trades, which is not bad; it also offers over 1150 NTF (No Transaction Fee) mutual funds, meaning you can buy and sell them free.