What’s the best way to transition from stocks to index funds and ETFs?

I have read Paul Merriman’s book, Live It Up Without Outliving Your Money and watched some of Paul’s videos and listened to his podcasts. I have a question that hasn’t been addressed: What’s the best way to transition a portfolio from individual stocks to index funds and ETFs?

I would like to make the change quickly, but I’m worried that my timing might turn out to be all wrong. Should I do it all at once, or gradually over a period of time?


We believe that the move you are describing is a good way to reduce your risk and potentially improve your return, because index funds and ETFs will give you much greater diversification. I recommend you follow the recommendations that you’ll find in Paul Merriman’s article “The Ultimate Buy and Hold Strategy.”

Once you have made this decision, I cannot see any good reason to spread it out. If you do it all at once, you will get it over with quickly so you can focus on other things. I recommend you sell all the stocks in a single day. Stock trades typically take three business days to settle, so there will be a short delay before you can reinvest the proceeds.

During that brief period while your money is in cash, the market may go up or it may go down – or it could remain largely unchanged. You can’t control that, so you will have to accept it as an unknown price you’ll have to pay (if you must reinvest at higher prices) or an unknown bonus you receive (if you reinvest at lower prices). Either way, make the change and get it over with.

If you try to control this, you’ll have to predict or guess future stock prices, and that’s likely to lead to second-guessing your plan and not getting it accomplished.

There’s an exception to that advice. If the stocks you own are in a taxable account, it’s important that you consult your tax advisor before you move forward. Tax consequences in some cases should dictate the timing of your sales.

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401(k)s have mostly missed the boat on index funds

For over 28 years I have been chastising 401(k) plans for not offering some of the best funds in the industry. The investment offerings  that have been most obviously missing  from plans are index funds. What’s not to like about low costs, broad diversification and low turnover? Sometimes trustees will throw employees a bone by offering an S&P 500 index fund, but the long list of index funds we have been recommending for 15 years are rarely included.

Ron Lieber writes the Your Money column each Saturday in the New York Times.  He recently wrote a terrific article entitled, “Why 401(k)’s Should Offer Index Funds.” If you have a trustee who is dragging his or her feet in adding index funds, I suggest you put a copy of this article on their desk with a little note, “Wouldn’t you like to quit paying the extra fees and keep those profits in your account? The rest of us would. Signed, A Prudent Investor”

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What is an Index Fund?

An index fund is a mutual fund that is constructed to mirror the components of an index such as the S&P 500 (large companies).  Other indexes include the Russell 2000 (small companies), MSCI EAFE (foreign stocks in Europe, Australia, and the Far East), and the Lehman Aggregate Bond Index (total bond index).  By nature index funds encompass a passive investment style.  There is no active stock picking.  Stocks are deleted when they no longer are part of the index.  If, for example, a company grew from a small cap stock to one of the largest 500 companies in the US it would move out of the Russell 2000 index and into the S&P 500 Index.  Index funds are usually less expensive to own and more tax efficient than actively managed funds.

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Why are you such big fans of index funds?

If you compare the Fidelity Low Price Stock Fund to Vanguard’s small-cap and mid-cap index funds, you will see Fidelity’s three-year, five-year and 10-year performance leaves the index funds in the dust. Fidelity’s fund is a small to midcap blend fund. If it’s so easy to find funds that do much better than index funds, why do you recommend index funds? If actively managed funds make you more money in the end, you’d be better off rather than worrying so much about expense ratios and turnover. Please answer my question. I am getting different answers from every advisor.


The debate between active and passive management has been going on for decades and will probably continue to do so. In the end, you must decide for yourself what to believe and what to do. I’ll give you my perspective plus some resources that show you why we believe in passive management.

What you have done is very easy. You have looked at the past and determined what you should have invested in, at least in this category of assets. If investing were that simple, everybody would do it, and we’d all be wealthy. The problem is you cannot invest in any past track record. (more…)

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Part 3: Investing Smart

Editors Note:
Burt Mayer, a senior at Lakeside High School in Seattle, WA interned at Merriman this summer with the intention of creating educational material for young investors.  This three part series is perfect for those investors who are looking to get started but need to know the basics first
.

If I’ve already convinced you to begin investing your money towards your future, give me a pat on the back.

But you’re not out of the woods yet. There’s a big difference between investing and investing intelligently. In this article I’ll try to figure out what it is, and then pass it along to you. (more…)

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