by Archie M. Richards, Jr., CFP^®
August 9, 2004

Al writes, "At 35, I want to start preparing for retirement. What's your opinion of the ShareBuilder.com website?"

It's not bad, Al. ShareBuilder is a brokerage firm that encourages the withdrawal of money on a regular basis from client bank and savings accounts. Automatic investing is the key to retirement wealth. If your employer pays twice a month, for example, direct twice-monthly withdrawals. As soon as the money comes in, some of it goes out again before it can be spent.

The firm accepts orders for individual stocks, exchange-traded funds, and closed-end bond funds, but not mutual funds.

ShareBuilder commissions for purchase orders are only $4. This is low (although higher than that of no-load funds, which cost nothing). Purchase orders are accepted in terms of the number of dollars for each security, not the number of shares.

The buy orders are pooled and executed once a week. If some of ShareBuilder's one million customers, for example, want to buy Diamonds (an exchange-traded fund that tracks the Dow Industrials), ShareBuilder combines all of the amounts for the week and executes a single order in the market, allocating partial shares of Diamonds to each customer.

Sales are executed immediately and cost $15.95. The firm charges nothing for inactivity.

I think commissions should amount to no more than 2 percent of the amount invested. If you invest $50 each time, the $4 commission comes to 8 percent, which is too high. If you acquire two different issues with the $50, the cost is 16 percent, which is ridiculous.

If you can invest only small amounts, arrange for the automatic investing to take place less frequently, bringing the commissions down to 2 percent.

Later on, when you can invest, say, $1,000 each time, utilize a different commission arrangement also offered by ShareBuilder. For $20 a month, you can make 20 commission-free purchases a month. The money can then be spread among various investment sectors, cutting the risk.

Restrict purchases to exchange-traded funds, not to individual securities. Individual securities present two kinds of risk: firm risk, whereby the entire market may rise but the particular company you own falters, and industry risk, whereby the entire market may rise but the industry of which your stock is a member falters. By buying just a few stocks, you suffer both of these risks but receive no corresponding rewards. Instead, use exchange-traded funds to participate in hundreds of stocks from dozens of industries.

Studies show that holding a single stock instead of a well-diversified portfolio increases the annual volatility by about 30 percent. (Volatility means the average amount by which a portfolio's return differs from that of the long-term market.) Let's say the market's average volatility is 15 percent. The single-stock investor would suffer volatility of 45 percent (15 + 30).

Rising and falling almost 50 percent a year? Too much of a roller coaster!

Owning 25 stocks cuts diversifiable risk by about 80 percent. 100 stocks cut diversifiable risk about 90 percent. 400 stocks cut it about 95 percent.

But why bother with even 400 stocks when you can do away with diversifiable risk altogether by buying, for example, iShares Russell 3000 Index Fund? For $4, you'll own tiny amounts of 3000 U.S. stocks.

A third kind of risk is market risk. This can't be avoided altogether, but you can reduce it by buying exchange-traded funds of different types. With U.S. stocks, for example, buy ETFs representing big growth, big value, small growth, and small value. Other exchange-traded funds track foreign stocks of different regions, real estate investment trusts, and bonds.

The up and down movements of these various sectors don't coincide. One offsets another, reducing the volatility. You're left with some risk, but as long as you stay invested for the long pull, you're well rewarded.

To achieve retirement wealth, you need automatic investing, which ShareBuilder provides. You need wide diversification, which ShareBuilder provides. You need low costs, which ShareBuilder provides pretty well, although not as well as no-load index funds.

But forget about individual stocks. Exchange-traded funds are safer. Better yet, invest in several of them.