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In the last article, Diversification Through Mutual Funds, I wrote about investing in the stock market using mutual funds. I described two kinds of mutual funds: active funds and passive funds.

Based on the kinds of securities that are held, there are three main categories of mutual funds:

1. Stock Mutual Funds, which invest only in stocks
2. Bond Mutual Funds, which invest only in fixed income securities
3. Balanced Mutual Funds, which invest in a mix of stocks and bonds

You can find the complete list of Vanguards stock, balanced and bond mutual funds on Vanguard’s website where you can Research All Vanguard Funds.

Stock Funds & Bond Funds
Stock funds invest 100% in stocks. An example is the Vanguard Total Stock Market Index Fund (VTSMX) which invests in the entire U.S. Stock Market. VTSMX has an expense ratio of 0.18% and the minimum initial investment in VTSMX is $3,000.

For International stocks, there is the Vanguard Total International Stock Index Fund (VGTSX) which invests in stocks in Europe, Asia and Emerging Markets. The expense ratio is .34% and the minimum initial investment is $3,000.

Bond funds invest 100% fixed income. An example is the Vanguard Total Bond Market Index Fund (VBMFX) which invest in many kinds of bonds including U.S. Treasuries, Corporate bonds, government agency bonds and mortgage bonds. VBMFX has an expense ratio of 0.22% and the minimum initial investment in VBMFX is $3,000.

Balanced Funds
Balanced Funds maintain a constant ratio mix of stocks/bonds. Two examples of balanced funds are Wellesley Income Fund (VWINX) and Wellington Fund (VWELX). Wellesley holds 35/65 and Wellington holds 65/35. Both are actively managed funds. Expense ratios are 0.31% for Wellesley and 0.35% for Wellington. The minimum initial investment in each is $3,000.

If you prefer index funds to active funds, Vanguard has some balanced funds that are passive index funds. These are the Vanguard Target Retirement Funds. Each has a target date for you retirement and holds a different mix of stocks/bonds. The idea is that you choose the fund that matches your retirement year. The fund automatically adjusts the stock/bond mix as the retirement date approaches.

There are a few other balanced funds offered by Vanguard. Here is a list of some of the Vanguard balanced funds, sorted by risk level (E.R. stands for expense ratio):

One caveat with the Target Retirement funds is that they hold a high percentage of stocks–more risk than many people want to take. A lot of people learned the hard way during the last bear market when the stock market dropped nearly 60%. My suggestion is to ignore the target date and base your investment decision on the level of risk and the amount of stocks you want to hold.

For instance, if you are 25 and plan to retire at age 65, that would be the year 2050. But suppose you are only comfortable with a moderate level of risk. You may opt instead to hold the Target Retirement 2005 fund. Yeah, the target dates really don’t make much sense. It is just the way Vanguard chooses to market its products.

Have You Decided On Your Risk Level?
In a previous article, Where To Invest Your IRA Contribution, I wrote about choosing a level of risk that you are comfortable. More stocks are higher risk level; more bonds are lower risk level. I suggested keeping your $5000 IRA contribution in a money market mutual fund until you have decided on the level of risk you are willing to take. Here is the table again, only expanded for more levels:

For any mix of stocks/bonds you could divide your money between VTSMX and VBMFX. The only problem is that there is a $3,000 minimum initial investment so you need at least $6,000 to invest in two funds.

An alternative would be to use one of the balanced funds. That way you need to invest in a single fund.

Suppose your are willing to accept a moderate level of risk with 35% in stocks. You can put the whole $5,000 sum into Wellesley Income. Or suppose you are willing to accept a high level of risk with 65% stocks. Then you can put the whole $5,000 into Wellington.

Longer Term Parking
What if you absolutely can’t decide how much risk you are willing to take? So far you have been parking your money in a money market mutual fund. Right now, these mmmf’s are paying about zero percent interest.

If you need more time to decide on your asset allocation, I would suggest putting your money into a 6-month Certificate of Deposit, or CD. Right now this pays a little more interest than money market funds. Then you can spend more time thinking about how much risk you want to take and decide on your asset allocation. You can purchase brokered CDs through Vanguard Brokerage Services.

Start Off Less Risky
To make it easier for you, I am going to make a suggestion and give you three options.

If you have never invested in stocks before, I suggest starting at a low or moderate risk level. As you get used to the idea of stock investing and watch the balance in your portfolio fluctuate you can increase you risk level later.

Option 1 is to put 100% into Wellesley Income Fund (VWINX). You will be 35% stocks and 65% fixed income, which is a moderate level of risk. Wellesley is an actively managed fund.

Option 2 is to put 100% into the Target Retirement Income Fund (VTINX). You will be 30% stocks and 70% fixed income, which is also a moderate level of risk. This fund uses a passive indexing approach.

Option 3 would be to put 100% in Vanguard Total Bond Market Index (VBMFX). Next year when you have more money to invest, you can put money into Vanguard Total Stock Market Index Fund (VTSMX). Starting off with 0% in stocks is a low risk beginning. Just be aware that while they are low risk, bond funds will fluctuate in value. Although it is unusual, bond funds can go down as much as 10 or 15 percent. This is rare, but if you absolutely cannot tolerate seeing you balance go down, the only choice is a Certificate of Deposit.

After one year of investing, you should have a better understanding of your risk tolerance. Then you can adjust you asset allocation to a tolerable level of risk.

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