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2. To answer this question, you need to understand a little more about fund fees. In short, some funds carry a 12b-1 fee, which is basically a commission paid to the seller of a fund. This fee is built into the overall expense ratio that you pay to own the fund. Funds with 12b-1 fees can usually be bought through a broker, including online brokers, with no special fee charged to you, because the broker is already getting paid through the 12b-1 fee which is built in to the fund. For funds that do not carry a 12b-1 fee, you typically have to pay some amount in order to buy through a broker, just like you do with stocks. Those fees can be avoided entirely, however, if you just go straight to the fund company. For instance, if I was going to go the index route, I would probably just open up an account with Vanguard (generally regarded as the low-cost leader in index funds) and buy fund shares directly from them, skipping the broker entirely. If you’re buying funds from many different companies, or some have 12b-1 fees and some don’t, it might make sense to use an online brokerage or a regular broker just so you can conveniently manage everything in one place. Just be aware of the fees your broker is charging so you can minimize them.

Given your lack of interest in stocks, if you were going to manage your own investments, indexing would be the clear choice. Since you’re going through a broker, hopefully the money you’re paying the broker is generating market-beating (or at least market-matching, after you subtract the costs) returns. If you’re that interested in real estate, then you probably are much better at real estate investing than the average person and can get better returns from that anyway. You’re using stocks to diversify away some of your risk in the real estate market, which is perfectly valid.

Before you do anything on E*Trade, I recommend you go straight to Morningstar’s Investing Classroom and click on the Stocks Curriculum: http://www.morningstar.com/Cover/Classroom.html. That’s the best introduction to stock investing that I’ve found online. Once you’ve done that, you’ll be very well-prepared to start that E*Trade account. Experimenting with the stock market can be very educational, but if you really don’t enjoy it, I’d stick with indexing or using a broker for your stocks, and put your own time and energy into what you know and love – real estate.

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1. Is an Index Fund really just one type of Mutual Fund?
I really don’t know the answer. My broker has me in mutual funds, but I have no idea the specifics (it’s all there on the statement but I just look at the gain each month and rarely anything else).

2. Do you use a broker or do you just buy these through an online brokerage account like Schwab or ETrade?

Your article makes me think because for the most part on all three topics: Index Funds, Actively Managed Funds, or Individual Stocks – I’ve taken the approach of “I don’t know and I don’t care”. I’ve never researched the funds that my broker has put me in. It’s just not interesting to me or worth my time – isn’t that her job?

My attitude is why I’ve never attempted buying stocks on my own and probably why I’ve allocated a portion of my portfolio to real estate. I search and buy rental properties with the same enthusiasm that you have with the market. I’ve just never put any emphasis on learning.

Funny, but one of our financial goals this year was to open an ETrade account by starting small. We’ve yet to do this and it’s November. I guess that goal will be on the rollover list for 2008. Losing ten pounds is in the same category. Oh well.

Any suggestions? Not on my weight loss, but on dipping my toe in the market without my broker.

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Regarding actively managed funds, the top fund managers don’t constantly change, unless you’re focusing (wrongly) on short-term returns. My point was that when it comes to active funds, you’re investing in managers – and if management changes you should reconsider the fund. You should follow the manager, not the fund, because there are managers who are able to beat the market repeatedly for long periods of time. For example, one study (http://goizueta.emory.edu/faculty/KlaasBaks/Documents/baks_metrick_wachter_000.pdf) used Bayesian analysis to prove this point.

For individual stocks, don’t underestimate the power of having no expense ratio and no capital gains. That gives you a huge advantage over actively managed funds and makes it much easier to get index-matching returns. You don’t need to beat the top 5%, or even the top 25%, to get index-matching returns with your own stocks, specifically because you’re not hobbled by having 1% or more sliced right off the top of your return. I may revisit this point in a future article if I can dig up some good data.

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Same goes with selecting an actively managed fund – you are basically saying that you are able to determine who the top 5% of financial gurus are AT ANY GIVEN TIME. Like you said yourself, these will constantly change, so just like the stocks, you would need to pick the “right” ones consistently. Good luck with that.

Finally, the only argument you provide against index funds is the possibility that they would inflate as the market starts chasing another bubble. However, this is exactly what asset allocation is for. As soon as the index starts to balloon in your portfolio, you sell some of it to maintain your target allocation.

Dima

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