Where to Invest my Roth IRA

[Guest collegekid]

I am a 21 year old college kid that knows very little about investing and finances (except what I've learned in class), and I am a little intemmidated. I opened a Roth IRA account last year with my mom's small-town bank. I did this so that I could already be earning interest until I decided where I wanted to invest my money more permanently, later. I am currently earning 6.7% interest, and I would like to be able to earn more. I was wondering which type of fund or bank I should transfer my money to in order to get a higher rate of return on my investment with a low amount of risk (no stocks) and no annual fees. I would appreciate your advise.

Thanks,

Paige

[John G]

I am a great believer in young folks investing for the long run in growth stocks, typically via NO LOAD MUTUAL FUNDS while they build their IRA assets.

But if you are still in school, I would suggest that you focus on the academics and just keep contributing what you can to the bank IRA and earning 6.7%. That is not a bad rate while you finish school. I suspect that you will have a more time to brush up on investing basics after you are out of college. At that point, I would either transfer the bank IRA account (when the CD becomes due to avoid any penalties) to either a mutual fund family {Vanguard, T Rowe, Janus, or any broad based growth fund} or an internet based brokerage {like Etrade, Schwab, Ameritrade, etc} where you also have access to a wide range of mutual funds.

NO LOAD means a fund that does not have a front end or back end commission. They still have annual expenses, and you should select something below 1% annual expenses. Read Kiplinger Finance or the March issue of Consumer Reports for ideas. They ussually list dozens of funds with long term track records.

If you are invested in equities (aka stocks) or equity based mutual funds, you normally look for a return in the 10 to 12% range. On the high end are the all equity, growth funds with higher volatility and risk. On the lower end are the blue chip and bond blend funds.

Lesson One: the "Rule of 72" says that you divide 72 by the annual percent gain to determine the double period. Therefore, if you get just a hair over 10% your assets double in 7 years. 2k becomes 4k when you are 28, then 8k, 16k, 32k, 64k.... and finally 128,000 when you are 64! You don't need to bet on long shots, penny stocks, options, etc. to amass a small fortune in a tax sheltered IRA. This example is the growth of just one year of max IRA contributions. Yes, you need to reduce the "pile" to account for inflation, but if you fund your IRA every year (and hopefully your spouse will as well) you should be very pleased with the result.

Sure hope you started with a ROTH IRA, since all withdrawals are tax free in later years.

Post another question, if you need more info. Investing is a big topic. If you spend 1 or 2 hours reading about it (and acting) each month, you will be miles ahead of most of your classmates.

You are wise to start early. Good luck.

[Guest collegekid]

Thanks for the advise.

I did invest in a Roth IRA account because of tax reasons, it just made more sense to me. I also found out that I have another 2 years before I can transfer my funds to another bank, anyway. At least this gives me some time to think over my options, learn a little more about investing (my risk management class is teaching me a lot), and how much risk I am willing to take with my investment.

I just don't like the idea of having to pay someone to hold my funds. Also, I am unsure about investing in a huge company like Janus or Vangard because I don't know much about how they work and how they invest their funds (stocks-high risk or bonds).

I guess my main question is - What will happen if I invested in a mutual fund that invested in stocks (because they offer the most return) and the stocks' return decreased? Would the interest on my IRA decrease as well, or are you guarenteed a minimum rate of return with the possibility of more if the stocks do well?

Thanks,

Paige

[John G]

From your second post, it is clear you are at square 1 on investing. Briefly... all investments have risk, ALL. Even CDs that are insured have risk: the risk of inflexibility for the CD term, the possibility that inflation will erode the value, etc. Stocks also have risk: prices flucuate, some firms die, technology changes, business trends change, etc. In a crude way, the level of risk is often inversely related to the likely reward.

But, over the long haul, equities (stocks) have offered better returns then the IOU investments like CDs and bonds. With stocks, you get both years with gains and years with declines. However, up years out number bad years between 5:1 to 8:1 and the up years typically go up a higher percent then the worse years drop... which all nets out to better long term performance of stocks when you are thinking 20+ years.

There has never been any 20 year period where stocks ended up lower than they started, but you can get back to back single year stinkers. But, there is no guarentee of performance with stocks. You are investing in capitalism and the USA economy. Sort of like backing the Yankees. You are picking the long run winning team.

Mutual funds: when you invest in a mutual fund you are buying the performance of a very large cluster of investments. For example, the Vanguard 500 holds positions in the 500 largest companies that make up the S&P500 index. While some mutual funds will only hold 30 stocks, most have hundreds. This gives you diversity. Since you own a portfolio of stocks, one bad apple does not hurt you. You can also start mutual funds conveniently at low $$ levels for a fixed amount.

One way or another you always pay someone for holding your funds. The amount charged can vary as well as how "visible" are the charges. Annual IRA fees are just one type of charge. When you talk about bank IRAs, one of the hidden charges is the lower rate of return offered.

NO LOAD mutual funds, especially index type funds have the lowest expenses or the funds. An index fund picks stocks from a list (like 100 largest Nasdaq firms, or Standard and Poors 500 industrials) rather than having analysts review the company performance and visit the firm. Index funds outperform many analyst based mutual funds because their expenses are lower.

Maybe you can find a class on investing basics. I teach this for junior/seniors at some local high schools via the JA program. If your college doesn't offer any classes, your first option is to teach yourself by reading. You may also want to ask around to see if there are any investment clubs you could join. They vary in quality. The best are great learning tools.

[Guest collegekid]

Thank you so much. You really helped me understand a lot, especially about the hidden charges. I plan on doing more research on my own, now that I have a good base knowledge of how investments work. I didn't realize before how ignorant I am about investing, which motivates me to do more research.

Thanks,

Paige