How to Invest for Retirement: A Diversified Investment Portfolio

       If you’ve figured out how much you should be saving for retirement, your next step is to actually start investing the money. Vanguard offers the widest range of low cost index funds available to individual investors. This calculator will help you invest in a diversified portfolio of index funds.


*Note: Click the ‘Click to Edit’ button to use the calculator with your own numbers.

       The dollar amount you should invest is in column E, which you won’t see unless you scroll over. You can use the full screen view or download it as an Excel spreadsheet.

       Depending on your age and the amount you have to invest, you might not be able to use this calculator. If you’re still young, there’s no problem using a 100% stock portfolio until you’re within 25 years of retirement. (That’s my plan. The 120 – your age rule is just a guideline.) You can force the calculator to use a 100% stock portfolio by entering an age of 20 or lower.

       Otherwise, follow the directions the calculator provides. If you have less than $1,000, you should continue saving in a high-yield savings account (like ING Direct’s Orange Savings Account). Until you have more than $3,000, you should use Vanguard’s STAR Fund (#0056). If you have more than $3,000 but not enough to use this calculator, you should use Vanguard’s Target Retirement Funds. Vanguard’s website can help you determine which target retirement fund would be best for you.

Questions about the Portfolio Allocation

       I’ve compiled some responses to typical questions about the portfolio allocation used in this calculator.

       Why so little in U.S. stocks/so much in international stocks? Most investment advisers recommend a large portion of your portfolio be allocated to U.S. companies. Why is this? As far as I can tell, it’s because they have more faith in American companies. The truth is that American companies only make up about 40% of the total world stock market. If you put 80% or more of the stock portion of your portfolio in American companies, you’re basically putting all your eggs in one basket. By diversifying into foreign countries, you mitigate the risk that any one country’s dilemmas will adversely affect the value of your portfolio. Even though foreign stocks tend to move like U.S. stocks in hard times (like right now), they will move quite differently in the long run. This reduces your volatility (risk) and increases your return. (Though I can’t guarantee that, obviously.)

       Why add value stocks? Historically speaking, value stocks have outperformed growth stocks. In some ways, this makes sense logically. Because you’re buying companies that are “undervalued”, you’re getting them at a discount. Once these stocks return to their true values and continue to grow, you end up with a higher return than if you had bought the stock at a fair or high price. Not all Value stocks actually recover and many do go bankrupt or out of business. However, the ones that do recover come back very strong and more than make up for the losers. This is why you would buy a value index fund – you’ll own thousands of companies, so no one company will have a huge effect on your portfolio.

       The bonds don’t seem very diversified to me. What about long-term bonds, global or foreign bonds, high-yield bonds, or government bonds? The bond portion of a portfolio should be there to serve as a safety net. It’s designed to offset the risk you’re taking on by investing in stocks. You shouldn’t use the bond portion of your portfolio to seek extremely high returns, so that rules out high-yield bonds. Long-term bonds give you slightly higher returns than intermediate-term or short-term bonds, but they do so at much higher risk. It’s actually so much more risk that it doesn’t make sense to invest in long-term bonds for the safer portion of your portfolio. Global/foreign bonds and government bonds are not listed separately because they are included in the bond funds I’ve recommended. The two funds both invest in a mix of U.S. and international bonds and government and corporate bonds.

Other Questions

       If you have more questions about the recommendations or investing at Vanguard, feel free to leave a comment below. I’ll be happy to answer your questions.