News Analysis date published New: 
Wednesday, August 1, 2012 - 12:30
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Wednesday, August 1, 2012 - 14:31
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Wednesday, August 1, 2012 - 12:30

The Best Investment for Beginners I've Ever Seen

Wednesday, August 1, 2012 - 12:30pm

Newcomers to the world of investing have much to consider: How much volatility they can handle, what asset mix to use, what securities to select, or how to keep tabs on their portfolio. Many times, though, the first thing on their mind is "Do I even have enough money to get started?" It's an especially big question for those who are self-employed but haven't yet set up a savings plan and for employees of companies that don't offer such a plan.

But I may have the perfect trade for these and other fledgling investors.

For those who are just starting out in the stock market and currently have very little money to invest, there's no better choice than this $14.3-billion mutual fund. The fund has everything a beginner could want -- a strong performance history, convenience and low costs. Plus, it follows an investment strategy that helps keep risk at bay. In fact, this is exactly the kind of strategy Amy Calistri uses in her Daily Paycheck newsletter.

I'm talking about Vanguard STAR (Nasdaq: VGSTX). Vanguard STAR has a low initial investment minimum of $1,000 for IRAs and regular taxable accounts. For both types of accounts, the minimum for each additional investment is only $100. The fund also has a rock-bottom expense ratio -- the percentage of assets used to pay investment advisory fees, administrative costs and other costs of running the fund -- of 0.3%. This is far lower than the average expense ratio of 1.1% for other similar mutual funds.

Vanguard STAR is in the moderate allocation category, meaning assets are split between stocks and bonds, not devoted entirely to one or the other like most mutual funds. The fund typically maintains a mix of about 60% stocks and 40% bonds, making it a fine choice for investors who are seeking long-term growth but would prefer much less volatility than they'd get with an all-stock investment.

You can tell the fund is a lot less volatile by looking at the standard deviation, the amount of variation in the price of a fund during a specific time period.

Vanguard STAR has a three-year standard deviation of 11.4, for example, meaning the fund's price typically fluctuated up or down by as much as 11.4% during the past three years. This is a much smoother ride than you'd get with a portfolio invested entirely in stocks like, say, the Vanguard 500 Index (Nasdaq: VFINX), which is designed to mirror the overall stock market and has a three-year standard deviation of 16.1. Vanguard STAR's price behavior should be similar going forward since it's sticking close to the usual 60/40 ratio of stocks to bonds.

Although we see in the table above that Vanguard 500 has outperformed Vanguard STAR slightly, the latter comprises of 40% bonds, so it's substantially less volatile (and it actually has outperformed the Vanguard 500 during the past 5- and 10-year periods). Vanguard STAR is convenient in that it provides instant and broad diversification. It accomplishes this simply by holding a basket of nine Vanguard funds, all with solid performance histories and low costs. Of these, three invest mainly in domestic stocks, two focus primarily on foreign stocks and four hold U.S. government and/or high-quality U.S. corporate bonds. The fund has no exposure to foreign bond markets.

Taken together, the equity portion of Vanguard STAR is 78% large-cap stocks, 18% mid-cap stocks and 4% small-cap stocks.

About 34% of equity holdings are foreign stocks, including those of emerging markets like Brazil, China and India. I consider this an advantage even though foreign stocks are out of favor right now. With Europe beginning to take meaningful steps toward resolution of its debt crisis and emerging markets being the last places on Earth with fast growth, I think high exposure to foreign equities could be beneficial in the long-term.

Risks to consider: Vanguard STAR's investment approach significantly dampens volatility. But the fund can still take a hit because of its 60% allocation to equities. For instance, it posted a 25% loss in 2008, when the recession was at its worst.

Action to Take -->
If you're new to investing and wondering where to put your money, then take a look at Vanguard STAR for the reasons I've just described.

Consider, too, the fund's history of competitive returns. Since its March 3, 1985, inception, Vanguard STAR has delivered 9.5% a year. When you consider Vanguard STAR is less risky, this compares favorably with the roughly 10.5% a year the overall stock market has typically returned.

Because of the current economy, though, it would be wise to temper your expectations about future investment returns. These days, I think something in the 6%-a-year range is probably more realistic for the S&P 500 Index. As such, Vanguard STAR might come in at roughly 5%-5.5% a year.

In any event, beginning investors might want to contribute to the fund until they've built up enough money for very precise asset allocation with 8 - 10 different mutual funds or a combination of funds and individual stocks. Or, they may find they're perfectly happy with Vanguard STAR and decide not to change a thing until they get close to retirement age and need to reduce their exposure to equities.

P.S. -- Amy Calistri has developed a portfolio of dividend stocks like these that holds up remarkably well in down markets. For example, in the sell off last year the S&P 500 lost 5.3% in August alone. Despite all the turmoil, Amy's Daily Paycheck portfolio fell just 1.0% during the month. To learn more about Amy's strategy -- including a few more high-yield picks she likes -- you can visit this link to read more.

Tim Begany does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC does not hold positions in any securities mentioned in this article.