Q. I am writing for my son, who is a first lieutenant in the U.S. Army. He just turned 24 and is ready to start his retirement investing. His car is paid for. He has no credit card or college debt. He has about $6,000 in savings with plans to increase it to $10,000. He is planning to invest the maximum for 2009 in a Roth IRA, but has no idea where to put it. Can you please offer suggestions for a simple way for a young person to start saving for retirement? Even if he makes a career of the military and has a government pension, he wants to have other sources of retirement income. ---S. P., by email

A. The most basic thing to do is to put the money in a single fund and forget about it. As you probably know, I prefer index funds and look for the lowest possible cost to manage investments. Here are three good funds that would fill the bill:

  • Fidelity Four-in-One Index fund (ticker: FFNOX). This fund has a current expense ratio of 0.08 percent and is a relatively aggressive mix of domestic and international equities, with about 20 percent fixed-income.
  • iShares S&P Growth Allocation fund (ticker: AOR) is a more diversified alternative. This new exchange-traded fund has an expense ratio of 0.33 percent and will require paying a brokerage commission (about $12 at most discount firms), but it will get him a portfolio that is 70 percent equities. Some of the equities are international.
  • Vanguard Balanced Index fund (ticker: VBINX). It will require a minimum investment of $3,000, has no commission cost, has expenses of only 0.19 percent a year, and has done better than 75 percent of its managed competitors over most time periods. The limitation of this fund is its lack of international diversification. It is 60 percent domestic equities.

Q. I was a little confused by a recent column about 401(k) investing and how you came up with the costs if I use exchange-traded funds (ETFs). I put money into my 401(k) every payday. My company buys my mutual funds either every payday or monthly, along with their matching funds. From what you said in your article, my understanding is that there is a transaction cost each time I buy or sell an ETF. Wouldn't this make the cost of purchasing ETFs in a 401(k) plan extremely high?

From your column, it appears that you were talking about buying each of the ETFs once per year and rebalancing as needed. If so, doesn't this take away the advantage of dollar-cost averaging? I would like clarification on how to keep the costs at 0.75 percent, or less, by using ETFs. ----N. J., by email

A. Yes, ETFs are expensive for relatively small accounts. But the greater the account value, the lower the burden of commissions as a percent of assets in the account. Suppose, for instance, that your account is worth $10,000 at the beginning of the year and you can do transactions at $12.50 each. Then you can do 4 transactions a year--- one a quarter--- and commissions will absorb only 0.5 percent of account assets.

That means you can buy exchange-traded index funds that cost an average of 0.25 percent and still keep your costs to 0.75 percent. That's well below typical industry figures.

As your account value rises, you can have more and more transactions and remain within a total transaction cost of 0.5 percent of assets. A $20,000 account can have 8 transactions--- two a quarter. A $40,000 account can have 16 transactions. By the time you get to the heavy saving years--- the late 40s and 50s--- the cost of transactions as a percentage of account value will inevitably decline.

Does this mean ETFs are what everyone should be investing in? No. Traditional index mutual funds are the most efficient vehicles for younger people with relatively small accounts. The reason I started to write about ETFs in 401(k) plans is that the combination of ETFs and a 401(k) plan with a "brokerage window" was a good way to do an end run on the choice and expense limitations of typical plans. You can read more about this on my website.

On the web:

Earlier columns in this series:

Part 1: They Don’t Call Them 201(k) s for Nothing

Part 2:: It’s Time for Plan B

Part 3: Building Inflation Tilt Into Your Retirement

Part 4: How to Build a Low Cost Inflation Hedged Retirement Portfolio

Part 5: The Payoff for Low-Cost Index Investing