Financial Advice for the Younger Daughter - Part 3

Smith Island cake

OK... for the past two days I've looked through the Fidelity booklet explaining 401k choices available for my younger daughter's company's retirement plan. She needs help - she's a 23-year-old pastry chef starting a new job. Her expertise is making creme brulees and Smith Island cake - not in picking mutual funds.

We looked at the available fund choices  and stressed the importance of fees over performance. Hopefully the point got through. College graduates as well as many others will be going through a similar exercise  (April non-farm payroll +244,000)  in the coming months. The crucial point:

Over the long run,  index funds with lower expenses have performed better historically on average than higher expense actively managed funds and past performance of actively managed funds has  not been indicative of future performance.

Thus, using the low-cost index criteria, we selected from the available domestic equity choices the following:

• Spartan 500 Index - Investor Class (as guessed by MoneyCone)  - ticker FUSEX

• Spartan Extended Market Index Fund - ticker FSEMX

Using the same approach, we go back to the booklet and find:

• Spartan International Index Fund - Investor Class - ticker FSIIX

This latter fund has an expense ratio of 0.2% - very low for an international stock fund.

On the bond side, we use the same criteria. We are looking for a low-fee index fund. The choice I recommend is:

• Fidelity U.S. Bond Index Fund -ticker FBIDX

(Note:  this fund had a large tracking error a couple of years ago - sometimes that happens!) with expense ratio 0.22%.

Asset Allocation

With the funds picked out, the next order of business (and actually the most important)  is to decide on asset allocation. At 23 years old, she should participate heavily in the stock market. She can stand the ups and downs. Furthermore, a declining market would help her take advantage of dollar cost averaging - buying more shares at lower prices with a given amount of money. So, I recommend 80% stocks, 20% bonds.

In the stock sector, I would recommend 30% in large caps with FUSEX, 30% in the extended index FSMEX, and 20% in international index FSIIX. These percentages are in terms of her overall contributions out of each paycheck. The remaining 20% goes into FBDIX as the bond allocation. FBDIX is indexed against the Barclay's Aggregate Bond Index which is representative of the whole bond market.

As a matter of information, the extended market index is a completion index. In essence, it includes the entire stock market except for the Dow Jones 30. Thus, it includes small and medium cap value and growth stocks etc.

Nobody knows what will happen in the future; but if the stock market should hit an air pocket and drop 10% or more over the next 6 months, I would suggest that she increase both balances and contributions by 5% to FUSEX (big cap stocks) out of the bond portion  (FBDIX) and continue if stocks continue to drop.

Additional Considerations

At the same time she is building up her 401k, she needs to scrounge and build up an emergency fund. She is getting extra pay for working overtime, so this is a source for these funds. We need to check out her disability insurance - when it kicks in and how much she gets. Many workers over the course of a 35 - 40 year work period will experience disability. At that time, it will be the most important consideration in her financial life.

If she has funds above and beyond her living expenses and 401k contributions, a Roth IRA would be worth considering.

The bottom line is that, if she follows these simple steps and goes on a mission to be the best pastry chef she can be, she will one day wake up to a 55- or 60-year-old birthday party and have a lot of paths she can take involving pretty much whatever she wants to do with the rest of her life.

Some people may think that the Fidelity reps would help her with all of this. As our president is fond of saying, "Let's be absolutely clear."  Fidelity reps are brokers. As such, they are not fiduciaries. The interest of clients is not their primary concern. Registered investment advisors are fiduciaries. By law, they have to disclose conflicts of interest and how they are compensated. For fun, I will ask her to ask the Fidelity rep how he or she is compensated. This crucial distinction is lost on the investing public and surely on budding pastry chefs. Some Fidelity reps are great and some not so much. Some will confuse 401k participants to the point of tears. Others will steer them in the right direction.

Disclosure:  This post is intended for educational purposes only. Individuals should do their own research or consult a professional before making investment decisions.