How to Use Schwab Index Funds to Build Simple, Diversified Investment Portfolios
Building an investment portfolio may not be the easiest financial task.
There are many investments available and many ways to put together a portfolio.
Undoubtedly, you've heard of Schwab, one of the biggest mutual fund companies in the world.
It offers a wide selection of options, among which are some very low-cost index funds.
The best part:
You can use just 3 of these funds to build a very comprehensive and diversified portfolio that you can stick to -- without ridiculous management fees.
If you’re looking for a place to start investing, Charles Schwab is a good option to consider.
Why Charles Schwab?
Charles Schwab offers a wide variety of investment options.
Many of their investment options come with low fees. This helps you keep as much of your investment earnings as possible.
While they do have some funds that have high expense ratios, they’re easy to avoid. You just have to pay attention to what you’re investing in.
When it comes to purchasing investments, Charles Schwab offers the following options:
- Online stock trades are available for $4.95 per trade.
- Online Schwab ETF OneSource trades are free.
- Other ETFs can be purchased online for $4.95 per trade.
- Mutual Fund OneSource service funds and other No Transaction Fee funds offer $0 online trades.
- All other mutual funds cost up to $76 to buy and $0 to sell.
If you want to buy a fund that isn’t part of their Mutual Fund OneSource service or their No Transaction Fee funds list, you may want to invest somewhere that charges lower fees.
Schwab Intelligent Advisory
If you aren’t comfortable investing on your own, Schwab offers an Intelligent Advisory service that charges 0.28% advisory fee on the non-cash assets in your account.
The fee is capped at $900 per quarter but a $25,000 minimum investment is required to use this service.
The service allows you to set goals and build a plan.
After you complete this step, you schedule an appointment with a virtual consultant that works with you.
Next, you meet with your consultant.
Finally, they put your plan into action.
After you activate your plan, their software will rebalance your portfolio, as necessary. If you have over $50,000 in assets, you’ll be eligible for tax-loss harvesting, too.
Why Charles Schwab Index Funds?
Charles Schwab has over $167 billion assets under management in Schwab Index Mutual Funds and Schwab ETFs. They’re the third largest provider of index mutual funds. They also have over 25 years experience managing index assets.
So why should you use Charles Schwab index funds for your investments?
First, they claim to have the lowest costs in the industry on market cap index funds and ETFs. In addition, they have no minimums to invest.
Unlike some other brokerages, everyone pays the same expense ratio for their index funds whether they have $5 or $5,000,000 invested in a fund. This is a great selling point for beginner investors that don’t have a lot of money to invest right away.
For instance, Vanguard offers different classes of index funds.
The index funds with lower minimum investments come with higher expense ratios. If you’re able to meet the higher minimum investment, you could get lower expense ratios.
Why Expense Ratios Are Important
How important is it to have a low expense ratio on an index fund?
While a difference between a 1.06% expense ratio and a 0.06% expense ratio may not seem like a huge deal, it is.
Over time, that extra 1.00% adds up to quite a bit of money due to the power of compounding.
Here’s a quick example.
Let’s say two people each invest $5,000 per year for 40 years.
Person A invests in an index fund with a 1.06% expense ratio.
Person B invests in an index fund with a 0.06% expense ratio.
After expenses, Person A earns a 6.94% annual return while Personal B earns a 7.94% annual return.
After 40 years, Person A would have $1,051,089 while Person B would have $1,376,242, an astounding $325,153 more than Person A.
3 Schwab Index Funds That Could Build Your Portfolio
A portfolio is essentially the combination of all of your investments.
While you could hold a portfolio with just one stock, one bond or one mutual fund, it’s best to have a diversified portfolio with many different investments.
By having multiple investments, you spread out the risk of investing across each of the investments.
While one investment may end up going to $0, another investment may take off.
In the end, a diversified portfolio allows you to reduce the risk of losing everything while still earning a decent return.
It’s important to realize :
Index funds don’t invest in just one stock or one bond. Instead, they invest in many different stocks or bonds as their prospectus states.
Technically, you could own one mutual fund and be diversified based on all the different holdings the fund invests in.
That said, you have to know which index funds to invest in to get the diversification you want.
Read a fund’s prospectus to see what they invest in and whether it meets your diversification goals.
In addition to diversifying between investments within an asset class, such as stocks, it also makes sense to diversify between asset classes.
For instance, most people will want at least some exposure to stocks, bonds and international stocks. That way, if one of the classes of assets has a bad year, the other classes may have a good year to offset a potential loss.
Here are three Schwab index funds that could take care of your diversification needs.
Schwab Total Stock Market Index Fund
The Schwab Total Stock Market Index Fund (SWTSX) uses the Dow Jones U.S. Total Stock Market Index as its index.
It offers an amazing 0.03% expense ratio and has no minimum initial investment.
This index fund aims to match the returns of the total U.S. stock market before fees and expenses.
However, it does not include some of the smallest U.S. stocks or some illiquid U.S. stocks.
Schwab U.S. Aggregate Bond Index Fund
The Schwab U.S. Aggregate Bond Index Fund (SWAGX) uses the Bloomberg Barclays US Aggregate Bond Index as its index.
It offers a very low 0.04% expense ratio and has no minimum initial investment.
The index fund aims to match the return of the total U.S. investment-grade bond market before fees and expenses.
It does not include Treasury Inflation-Protected Securities or municipal bonds due to tax issues.
Schwab International Index Fund
The Schwab International Index Fund (SWISX) uses the MSCI EAFE Index (Net) as its index.
It offers an expense ratio of just 0.06% with no minimum initial investment.
The index fund aims to provide returns, before fees and expenses, that match the total return of large, publicly traded non-U.S. companies from countries with developed equity markets outside of the U.S.
It does not include Canadian companies but does include companies from countries in Europe, the Middle East and the Pacific.
Three Portfolios for Different Situations
Below are three example portfolios.
These portfolios are simply examples and may or may not be a good fit for your specific investment goals and risk tolerance.
Seek advice from a financial advisor before making any investment decisions.
A conservative portfolio makes sense when you’re looking to earn a small return on your money but you cannot withstand a major drop in portfolio value.
However, even conservative portfolios can decrease in value.
If you’ll need the money in a short time frame, cash is best.
That said, if you’re willing to delay your goal should your portfolio decrease, a conservative portfolio may work for you.
- Schwab Total Stock Market Index Fund (SWTSX) - 14%
- Schwab U.S. Aggregate Bond Index Fund (SWAGX) - 80%
- Schwab International Index Fund (SWISX) - 6%
A balanced portfolio is a bit more aggressive and looks to earn a modest return on your money.
These typically match up well with people that have a mid-range goal.
A balanced portfolio will have a higher risk of loss of value than a conservative portfolio, but would likely decrease less than an aggressive portfolio in a down market.
- Schwab Total Stock Market Index Fund (SWTSX) - 42%
- Schwab U.S. Aggregate Bond Index Fund (SWAGX) - 40%
- Schwab International Index Fund (SWISX) - 18%
An aggressive portfolio is built to maximize your gains at the risk of sustaining large losses in down markets.
Aggressive portfolios work best when you can hold the investments for decades without selling.
This way, you can wait for down markets to turn into good markets again before selling.
- Schwab Total Stock Market Index Fund (SWTSX) - 63%
- Schwab U.S. Aggregate Bond Index Fund (SWAGX) - 10%
- Schwab International Index Fund (SWISX) - 27%
Charles Schwab Has Even More Options
Besides the funds and portfolios discussed above, Charles Schwab has many other low fee investment options.
Additionally, their no minimum initial investment funds offer new investors a great place to start investing.
When you consider the low expense ratios many of these funds offer, it’s easy to see why many investors choose to invest with Charles Schwab.