What to Do With $2,500

What to Do With $2,500: Advice for Young Investors

After a few years in the workforce we may find ourselves with a little extra cash. Maybe it's a delightfully large tax refund or an apartment deposit you finally got back, but it's the first significant sum of money you've had that doesn't need to be spent paying back loans or furnishing an empty apartment. For the first time, you want to save or invest that money, instead of spoiling yourself with a spray-on-tan.

I spoke with five financial advisers about what a young investor should do with a small windfall: $2,500. I created a profile of a twentysomething novice investor who doesn't have debts and is diligently paying into a 401(k). Investor X doesn't necessarily want to lock up this money until retirement. He or she may want to buy a house, fund a year off or have something socked away in case of a car crash or other emergency.

After each planner made a recommendation, I asked for numbers on the performance of their picks from the beginning of 2002 until this May.

Set up a Roth IRA
Charles Buck, a financial planner in Woodbury, Minn., recommends that you set up a Roth IRA, as he did for his 27-year-old son. The nifty thing about the Roth is that we don't have to pay taxes when we finally withdraw the money after age 59 ½. We don't get a tax refund now on our contributions, but it's likely that we'll enter a higher tax bracket by retirement and will thus save the difference in taxes. In special cases, like when buying a home for the first time, all of the money in a Roth IRA can be tapped pre-retirement without penalties. We can also withdraw our contributions -- but not returns -- early without penalties. Keep in mind Roths are only for singles who make less than $110k or marrieds who make less than $160k.

Mr. Buck advises that the twentysomething investor's Roth IRA include shares in a diversified mutual fund targeted for retirement withdrawal in 2045. "Target-date funds are good for young people," he says: "Pick a fund, forget about it and it takes care of itself." Mr. Buck's fund pick is the T. Rowe Price Retirement 2045 Fund1. It charges a fee of 0.76%. T.Rowe Price has reported returns of 17.01% from the fund's inception on May 31, 2005 to April 30, 2007.

Put Something Aside First
Richard Rosso, a Charles Schwab financial planner in Houston, recommends setting your $2,500 aside in an emergency reserve for six months of living expenses. "Keep $1,000 in a CD that matures in 6 months, $1,000 in another that matures in 12 months, and put $500 in a savings account in case you need to change your tires or replace an air conditioner," he says. (For more info on CDs, see WSJ.com's savings center2 from Bankrate.com)

If you already have a reserve, Mr. Rosso says you should use the money for living expenses and increase your salary deferral to your 401(k) to benefit from employers' matching contributions.

"If all this is done," says Mr. Rosso, "I would contribute to the Roth IRA…invest in a way that's fully diversified." The mutual fund Mr. Rosso recommends is the Schwab Total Stock Market Index Fund, which contains a large amount of U.S. stocks and charges a fee of 0.53%. Schwab reports a five-year annualized return of 7.43% for the fund. Setting up a Roth or traditional IRA through the brokerage's Web site is free. The other large financial services firms I mention in this column also offer free Roth IRA enrollment.

ETFs, ETFs, ETFs
For the young person who is eager to learn about securities and actively manage his or her own portfolio, exchange-traded funds are an option. An ETF tracks an individual stock index such as the S&P 500 or a specific asset class such as real estate, currencies or gold. Unlike mutual funds, ETFs trade on a stock exchange or in an electronic market. Expenses tend to be lower, and ETFs that track a multitude of securities may not be as much of a gamble as an individual stock.
Kim Arthur, an investment adviser in San Francisco, doesn't invest on behalf of people with less than $1 million dollars, but if he were your mom's best friend he might tell you, over lunch, that you should build a diversified ETF portfolio and rebalance it every year. His firm, Main Management, only manages ETF portfolios. He likes their transparency, tax efficiency and low expenses. The goal: "10%-type returns with lower volatility than the stock market."

The blend Mr. Arthur recommends, and calls "all asset lite," contains five different ETFs weighted at different percentages. For stocks: 30% Vanguard Total Market and 30% State Street Developed and Emerging Market. For bonds: 20% iShares 3-7 year Treasury. For commodities and real estate: 10% PowerShares DB G10 Currency Harvest Fund and 10% State Street International REIT. "It's diversification at a low price," he says, "there are over 2,000 stocks in this blend." Though many of these ETFs didn't exist five years ago, Mr. Arthur calculates that based on their underlying indexes, an investment of $2,500 would have returned an annual average of 12.91% between 2002 and now.

The expenses of an ETF are twofold: Those charged by the fund -- an average of 0.29% for all of Mr. Arthur's recommendations -- and broker trading fees. At TradeKing.com5, for example, you will pay $4.95 per trade. Re-balancing your portfolio back to the original asset weightings every year will cost $25. Mr. Arthur says these ETFs have a lot of assets and thus won't suddenly shut down, as some ETFs with lower net assets have recently done. (Read more about ETFs here6.)

Be Aggressive
If you expect to sell your shares ten years from now to purchase a house or pay a smidgen of your graduate-school tuition, financial planner Kathy Hankard says you want to be pretty aggressive and should invest in a mutual fund that is comprised mostly of stocks, with some short-term bonds. "You don't want to risk not making enough money and inflation eroding the value," says Ms. Hankard, whose firm is based in Verona, Wis.

She suggests the Vanguard Star Fund, for its low fees: 0.35%. It is the only fund that Vanguard offers for investors with less than $3,000. Made up of 11 mutual funds, the "fund of funds" invests 62% in stocks, 25% in bonds, and 13% in short-term bonds. Vanguard's Fran Kinniry, a principal of investment counseling and research, says it's good for investors with a five-20 year horizon, and gives broad diversification. Vanguard lists the fund's annualized five-year return as 8.26%.

Take the Bond Route
One planner recommended bonds for young people who don't know how their financial needs will flesh out.

"So many things are going to change in your twenties that it's possible you're going to need some of this money," says Christine Fahlund, a senior financial planner at T. Rowe Price in Baltimore. When Ms. Fahlund's son inherited some money and stashed it away in a conservative money market account, she thought that was correct. "You don't want to be in stocks with this money, and you have a lot of issues on your mind right now." Ms. Fahlund remembers telling him, "you might use it next year." She recommends using $2,000 of your $2,500 on a mutual fund that's heavy in bonds, the T. Rowe Price Spectrum Income Fund (with fees of 0.70%), and putting the other $500 in a conservative money market fund, her company's Prime Reserve fund (0.60% fees).

T. Rowe reports a five-year annualized return of 8.16% for the Spectrum fund and 2.21% for the Prime Reserve fund.

When many of us get a bit of extra cash, we consult a list to choose between a new laptop or a trip to some hot place with scuba diving. Perhaps we shy away from saving or investing because we're intimidated. Don't be.

The risks of stocks are serious – you can lose your money -- and should be considered whenever a mutual fund is heavily weighted in stocks. Intermediate government bonds, a more conservative option, will yield negative returns extremely rarely, but they will not likely return more than 8% per year, according to charts going back to 1966 by Morningstar Inc. High-yield bonds, on the other hand, are loans to companies that might default and never return your cash -- but if they do, your return will be a percentage that's typically higher than that of government bonds. The Merrill Lynch High Yield Master II Index, a benchmark, has average five-year returns of 10.36%.

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investments, young investors, financial plan, savings, ETFs, mutual funds

Checking Out China Funds

Checking Out China Funds
Managers still see solid opportunities away from Shanghai's frenzy. Here are five savvy playsby David Bogoslaw

Alan Greenspan may have warned of a possible "dramatic contraction" in Chinese equities in a May 23 speech, but investors appear so far to be unfazed. Despite the bubble talk, many fund pros are still focused on opportunities in the Middle Kingdom.

When investors think of opportunities to make money in China, companies riding the wave of huge exports are typically the first to spring to mind. But fund managers have begun to pay attention to stocks whose fortunes are tied more to growth in the domestic market, as the sizzling Chinese economy creates a widening population of eager consumers.

With China's economy growing at around 11% a year, investors are looking for ways to grab a piece of the action. Although the current Year of the Pig may excite investors with visions of becoming fat, happy, and prosperous, a note of caution is in order: Investors should be wary of gorging themselves amid what appears to be a stock-market bubble to many economists (see BusinessWeek.com, 5/18/07, "China Tries to Turn Down the Heat").

Consider the relatively new Shanghai Stock Exchange, whose composite index has jumped 50% since the beginning of the year. Some fund managers are steering clear of the index, warning that its sharp and sudden gains reflect a torrential inflow of domestic money with nowhere else to go at the moment. That's bound to change as the government's Qualified Domestic Institutional Investor (QDII) plan, which would allow a greater portion of domestic funds to be invested in other markets, gains traction, albeit ever so slowly. The government quota on how much money can be invested outside the country is a paltry $15 billion to $17 billion, chump change compared with China's $2.6 trillion economy.

With an eye toward prudence, some portfolio managers who wish to play China are sticking to stocks that list in Hong Kong, where transparency and corporate governance are far better than on the mainland. While economic growth is expected to moderate in 2007 due to slowing U.S. export demand, the continued rise in property prices is likely to support local investor sentiment in the months ahead, according to a May research note from Aberdeen Asset Management.

Obviously, investing in China carries notable risks. Investors who want some exposure to one of the world's most dynamic economies may want to do some homework first. With that in mind, this week's Five for the Money looks at a few funds with sizable exposure to China that remain open to new investors.

1. Guinness Atkinson China & Hong Kong Fund (ICHKX)
This $172 million fund has been making money by focusing on companies staking a claim in the infrastructure boom. That includes energy companies with ADRs trading on U.S. exchanges such as CNOOC (CEO), PetroChina (PTR), and Yangzhou Coal, and industrials such as Angang Steel and Dongfang Electrical Machinery.

Dongfang is one of the two largest domestic manufacturers of electrical turbines, which are in great demand in "a country installing the equivalent of the U.K. national grid every year," says Edmund Harriss, who has co-managed the fund since 1998.

He prefers Dongfang to its competitor Harbin Power, which he faults for over-diversifying, and points to Dongfang's slimmer balance sheet; cleaner, more straightforward business focus; and superior returns on investment.

In the auto industry, Harriss has been a buyer of Denway Motors, which, through a joint venture with Honda Motor (HMC), makes the Honda Accord and Odyssey for the Chinese market. There has been a general upgrade in the car models available to Chinese consumers; they're now as good as anything being sold in the U.S. or Europe, he says.

Harriss advises investors interested in China to avoid getting caught up in the vaunted huge growth story and instead to drill down into particular market niches, with the aim of finding those companies that have genuinely been generating high growth, beating their competitors, and capturing higher margins. The fund has a 70% weight in Hong Kong-listed stocks, with the other 30% invested in Hong Kong-based companies doing business in other parts of Asia.

2. Oberweis China Opportunities Fund (OBCHX)
Managed by James Oberweis since its launch in October, 2005, the China Opportunities Fund is taking cues from the explosion in consumer buying power on the mainland. Looking beyond the 20 largest companies favored by most institutional investors, Oberweis is buying up shares of second-tier companies that have strong retail potential.

"This is a country where the biggest consuming class in the world is likely to develop over the next 20 years, and it's already happening," he says. That creates an opportunity for retailers to develop brands—and they stand to profit nicely by doing it sooner rather than later.

Li Ning (LNNGF), which makes athletic shoes, is an obvious choice, since domestic sports-apparel manufacturers are well-positioned to go up against international rivals like Nike (NKE) in catering to domestic Chinese demand with their lower prices. But an equally savvy way to play the surge in consuming power is the advertising market, Oberweis says.

He points to the focused approach Focus Media (FMCN) is taking, targeting affluent consumers by placing flat-panel display screens in the lobbies of large office buildings in China's biggest cities. With a 95% market share in this area, Focus Media nearly tripled its sales in 2006 from the prior year, with sales expected to nearly double this year. Focus Media is a Chinese-owned company based in Shanghai, but its shares trade only as ADRs on the NASDAQ exchange.

Oberweis is also leery of shares trading on the Shanghai Stock Exchange and says the bulk of his portfolio is in H shares of Chinese companies, or those listed on the Hong Kong Stock Exchange, which can be bought for half the cost of Shanghai-listed A shares. Once the government's QDII scheme takes hold and is expanded beyond the initial quota of $17 billion, he expects prices of H shares to rise and prices of A shares to drop, as investors take advantage of arbitrage opportunities between the two markets.

"We're not buying for the arbitrage opportunities. We're buying because we think they're good companies. And [buying H shares] is the cheapest way for us to invest in those companies," he says. Oberweis has $825 million in assets under management.

3. U.S. Global Investors China Region Opportunities Fund (USCOX)
For 2007, this $90 million fund is pushing the theme of "asset-injection" plays as an easy concept for investors to wrap their minds around. Romeo Dator, who has co-managed the fund for the past five years, is betting on Hong Kong-listed names that are buying assets at hefty discounts to market prices from their government-controlled parent companies on the mainland. "It's a way for the parent company to realize the benefits of getting these assets off their books, and the government getting out of the business of owning some of these companies," Dator says.

The bonus is that this is happening mainly to resource companies at a time when the massive infrastructure buildup in China has stoked demand for these products. The stock price of China's premier copper producer, Jiangxi Copper, is up at least 50% since it bought cheap copper mines from its parent earlier this year. And coal producers China Coal Energy and China Shenhua Energy should see comparable gains after their asset injections, Dator predicts.

The China Region Opportunities Fund also favors health-care suppliers such as Shandong Weigao, a manufacturer of female sanitary napkins and other health-care-related products. Dator says he believes these stocks will benefit from the emphasis the Chinese government has placed on health-care spending in its latest five-year economic plan.

The fund's turnover rate was 200% in 2006, the result of the managers' decision to prune their holdings and take profits following dramatic runups in stock prices across the board.

4. Eaton Vance Greater China Growth A Fund (EVCGX)
Portfolio manager Pamela Chan is also a great believer in the profit potential of branding. She likes high-end department stores such as Ports Design, Peace Mark, and Parksons that have come to dominate the market thanks to strong brand recognition.

With the infrastructure development in China showing no sign of abating, she's also a fan of building-materials manufacturers such as Anhui Conch and China National Building Materials. These companies are benefiting from ongoing consolidation within the cement industry, which has been aided by government policy stressing sustainable growth. That has driven out highly polluting kilns, which had been a source of excess supply and low pricing in recent years.
Chan thinks the property sector is another attractive bet amid rising income levels and the ability of developers to increase their land-banks, she wrote in an e-mail message.

5. Dreyfus Premier Greater China A Fund (DPCAX)
Don Martin, president of Mayflower Capital, a California-based financial adviser, recommends this fund, which invests in midcap growth stocks. With 20% of its portfolio allocated to consumer-discretionary names, 17% to industrials, and 15% to financial companies, he sees Dreyfus' China fund as a safer bet than some other options that are too heavily weighted in financials and more vulnerable should the volatile China market crash.

To avoid the potential for capital-gains taxes of around 30%, which would be triggered if portfolio managers started selling off shares of stocks, Martin advises new investors who haven't benefited from the stock gains to buy through a fee-only planner that can get the load fee waived on these funds.

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china, foreign investment, mutual funds

Index vs. managed funds -- one size doesn't fit all

Index vs. managed funds -- one size doesn't fit all

In the battle between index funds and managed funds, it was the passive investing style of the index funds that triumphed in 2006. But that doesn't mean index funds are for everyone. "Indexing is a long-term strategy, and it may on occasion test the patience of investors," according to Sonya Morris, an analyst with Morningstar.

Read the articles.