How and what to do?!

[Guest Israel]

Hello everyone. Seems I somehow find my way through to this site (via Clarkhoward.com). Not really sure where I am, but this site seems pretty good so thought I would see what happens.

So....here is the story:

I am a 28 year old married man. Got married a year ago and my wife and I just had our first baby 6 weeks ago (yeah!). We have zero credit card debt, no car payments, school loans, or other loans. I just built our own house and did most of the labor myself so I have a new house with market value of around $175K that has a mortgage of $105K. The only payments I make every month are my new mortgage and utilities/food. Despite my traveling before getting married, I saved a lot when I worked so we have savings. We live on one income (mine) and I make $48K a year. I work for a non-profit so no retirement benefits or 401(k) or 403(B). I at least have a car and insurance provided though! I am a home builder by trade and now do residential land development- taking raw land and doing the subdivisions, etc. Besides my own home I own two other building lots that are appreciated nicely (and looking for more).

We are looking at starting a ROTH IRA but I have no clue about investing in this manner. I am good at real estate and part of me says to just stick with what I know best, but I want to diversify so that when the real estate market tanks and interest rates rise I have something else working for our future and for the family. So I went to Vanguard.com thinking I could just get a nice simple "Roth IRA" and that there was only one kind of Roth IRA. HA! Simpleton me had a nice little surprise! How on earth do I decide how to invest in an IRA? How do I choose? How do I make this happen? Most importantly, how do I research this so that I know I am making the best decision? I see the % drop in all the IRA's and look at how my few real estate deals are doing and well...makes me think twice. But I want something long term and it seems like now might be a good time to buy into a ROTH IRA since they are down and isn't that better than buying when it is expensive? Obviously I have a lot of educating of myself on this type of investing before I proceed!

Anyone have some good advice? Sorry if this post is extremely basic (not to mention long) and I know I should take the time to read through the archives b/c I am sure I am not the first to pose this question. But, 6 week old babies, at least ours, are not known for giving adults lots of free time!

Thanks to all.

-"Israel" (Gensis 32:28)

[John G]

You are doing a lot of good things financially, like no bad debt and using your skills to build home equity. I would suggest that you talk with your non-profit and see if they can take the next step towards a retirement fund. In some areas, the non-profits have a collective program... many small non-profits using the same system and keeping overhead minimal. You also should be building a cash reserve for the unexpected.

ROTH IRA: Yes, this is a very valid option for you if you want to set aside up to $6k a year, half for you half for your wife in separate accounts. Initially, you do not need to spend a lot of time focusing on investment decisions if you elect an broad based index fund. Vanguard is a very good choice since their annual expenses are extremely low. The S&P500 version would give you general market performance and you would not have to spend a lot of time thinking about investment choices. Perhaps 5+ years down the road when your assets grow you may want to tinker with your choices, but that could be even put off for 10+ years. Since you are a busy guy, saving time should be worth something. An index fund will mirror the unlying market on which it is based. You therefore should get standard market performance... and over the long haul, that is perfectly adequate. The Roth would add some diversification to your growing assets. You do not have to put the full amount in each year, perhaps you should consider an automatic withdrawal program to put a set amount each month from your checking account into a Roth.

REAL ESTATE GAMES: Something else to think about. If you build your own home with some sweat equity and live in it for two years, you can then sell the home and keep the capital gains. Then start over and do it again. Your wife might get irritated with the frequent moving, but you do get to live in a new house all the time. No ssn, no income taxes. There is a fellow in Denver who is doing this making over 100k each year and paying no taxes. Given your background in home construction, this is another option for you. The "gain" is not subsequently tax sheltered, but the recent tax law changes on home sales gives you some options that just where not there a few years back.

[Guest Israel]

ok, so how do I make this happen? How does one go about starting a ROTH IRA? Just go to the vanguard website and click to the SNP 500 Roth IRA option and click on "Buy me now"?? How are the fees assessed and paid? If I put in 6K for both my wife and I, is a portion of that then taken out for the fee, or do I pay above and beyond what I deposit as ROTH IRA for the fee? Basically I don't understand how the fee schedule works and who it is paid to and why they are paid it.

Thanks for the help!

[Guest Israel]

Do you recommend putting the max in every year? I don't know that I can do that every single year, but right now I should be able to do that. Is the ROTH IRA set up so that I am basically buying a certain amount of "stocks" in the IRA, or does the IRA just act as an account that invests in individual stocks such as in the SNP 500 index stocks? If the market continues to go down, would it be better to wait for lower prices, or go ahead and invest now?

In regards to flipping houses every 2 years, I pretty much plan on doing that. I think I know the answer to this next question (No?), but for properties that are vacant land that does not contain my primary residence, does it matter whether I hold them for 2 years or not? It is my understanding that these would be subject to capital gains no matter how long I hold them since they are not used for my primary residence. Is that correct?

[John G]

How do you get started? I suggest that you select three potential custodians. Ask them for their basic "getting started" materials including application forms, "how to invest", summaries of the key funds/options. Evaluate what you get and make a choice. Talk to the firm, ask them your basic questions. If you are satisfied, open your accounts.

Note, you will have two separate accounts. One for yourself, and one for your wife. They are "individual" accounts.

Each custodian has different rules governing annual fees. Many custodians charge none, especially if you have other business with them or if your accounts grow above a set amount. Some custodians do not charge an annual fee if you subscribe to a monthly contribution plan. In addition, you can often ask for them to waive the annual fee. If you are dealing with a custodian that does charge a fee, you may be able to pay the fee with an outside check.

After you put money into your Roth IRA, you often must make a second decision on where the funds should be invested. I would recommend that given your long likely hold period that you invest in equities (stocks). No one can tell you if the current stocks prices are high or low, nor can anyone I have ever met tell you when the market is about to change direction. Don't get overly concerned about the "snapshot". You are investing for multiple decades and over such a long hold period, stocks will tend to outperform CDs and bonds. I have suggested a broadly based index mutual fund because this gives you diversification - you are not picking a single stock but a broad cluster.

Should you put in the max? Well, if you are flushed with money that has no other home, then why not. The Roth is a wonderful tax shelter. But remember, as a new father you want to be sure to have a significant number of "protections" in place. For example, I would suggest 3-6 months cash reserves. I would also recommend that you get a TERM life insurance policy, perhaps for a 1/2 million. You should also consider if you need disability insurance. If you have satisfied all these areas, you are in a good position to put money into a Roth. Remember, this is money you are not expecting to tap for decades.

On Housing: The tax free retention of gains is only for houses that you occupy for at least two years and then sell. All other construction that is built and sold will create income... and your accountant will suggest how it should be handled, including if the time period makes a difference. You clearly do not have to hold a house for two years before you can sell it. The two year period only refers to the tax status if you occupied the house as your primary residence.

[Guest Vinny]

I can say that I know exactly how you feel. I have done some reading online at the IRA and Roth sites, and felt pretty comfortable about involving myself.

After meeting with a superior of mine who actually has a Roth, I felt I was right back where I started; absolutely confused. I was also under the impression that an IRA was just a simple account you put money into monthly. I had no idea of the different options of diversification for the IRAs. I can't imagine "picking" what arenas I want my money to play in.

I have been tip-toeing for months over this IRA account. I'm a SSgt in our Air Force, and as you might imagine, the money isn't always quite there. As of late, I purchased another car to get my wife to the university she attends, so any money I plan to save with such a long term commitment I want it to count.

John, you mentioned that Vanguard is pretty acceptable with its involvement in the SnP; wide diversification. I'm curious, who you chose as your "broker" will determine what options are available to you? I figured any institution that caters to IRA's would have the same access as the next company? Am I wrong to believe that?

Vinny

[John G]

Originally posted by Vinny

Vanguard is pretty acceptable with its involvement in the SnP; wide diversification.  I'm curious, who you chose as your "broker" will determine what options are available to you?  I figured any institution that caters to IRA's would have the same access as the next company?  Am I wrong to believe that?

The main choices for custodian of an IRA are banks, brokerages and mutual funds. Yes, the types of investments that are offered vary by custodian although it seems like the trend is for a growing overlap in options. Even within a broad class of custodians you will find a range of investments options.

Banks: they may offer just CDs (common for example at a small thrift) or they may have in-house mutual funds or even some kind of brokerage tie. Banks generally offer the more conservative investment options. They are local and offer counter service, but a lot of banks lag in "modern" services like internet access and may not offer a complete range of investment options.

Brokerages: traditionally brokerages started with an emphasis on advisor-makes-the-picks style investing, but this has involved into self directed stock picking, discount services and finally internet pick-by-click. Brokerages also used to sell LOADED funds, but this has evolved to brokerages offering hundreds of LOADED and NO LOAD mutual funds (like Schwab and Etrade). Today, most brokerages offer a range of services (with a range of costs) that run from do it yourself intenet to full service hand holding. The later is ussually a much more expensive option. Brokerage access to mutual funds start with their in-house funds, but access to the funds of other firms depends upon the deals they have struck with those firms. Some mutual funds do not want to participate in the cost share and choose to be independent or brokerages. Others like the "recruiting" that the brokerages do for building their asset base.

Mutual funds: a mutual fund in its simplest form is a company that offers participation in a cluster of investments (called a portfolio, could be stocks, bonds or other investment options) where the citizen gets ownership in a diversified package. There are thousands of mutual funds, often clustered in "families" like Vanguard, Fidelity, T Rowe Price, Scudder, etc. They key issues with mutual funds include:

FUND FOCUS: like Baskin Robbins ice cream, mutual funds come in many flavors with a key distinction being what is the allowed investments or fund focus. There are also structural issues such as LOADED vs NO LOAD. LOADED mutual fund refers to any fund that has built in commissions either on the front end or back end. NO LOAD funds have been slowly displacing LOADED funds as modern marketing and economies of scale take over. The NO LOAD fund has annual expenses, but no percent commission. In theory, a LOADED fund has a commission to pay the "salesperson" and these commissions used to be 5-7% up front. Market pressure has forced many LOADED funds to trim those costs, or hide them as back end fees (when the account assets are larger!) or dangle the phased out fee system (commission drops if you stay with the fund for many years). An INDEX fund is a fund based upon a list (like the Wilshire 5000 stocks or S&P 500) and therefore no analysts, no company visits, no hotels/meals/flights, etc. which are reflected in significantly lower annual expenses.

As a person just getting started, you need to avoid getting confused by the thousands of choices. A beginner IRA owner needs just one or two good investment vehicles. If you are young, I highly recommend starting with a broad based equity (aka stock) fund that is NO LOAD. The Vanguard Index funds are reasonable examples of this, but many mutual funds and brokerages offer similiar funds. I recommend a NO LOAD fund because you are not stuck with fees if the fund performs poorly. I recommend equities because the stock market over many decades reflects the growth and success of capitalism and gives a better return than IOU based investments like bonds and CDs. I recommend starting with one fund for perhaps 5 to 10 years because a fund gives you diversification, removes you from single stock picking, and is relatively low maintenance. You have a life to live, and when you IRA assets are relatively modest, why spend hours thinking about investments. It just isn't neccessary. It may seem crazy, but people who spend a lot of time thinking about investments are not likely to out perform an index fund. The reason is because the extremely low annual expenses drains off very little of your assets, while frequent switching often increases annual expenses and folks have a nasty habit of selling low (in panic, like right now) and buying high (in euphoria like the late 1990s). Smart investors stay detached from market emotion and do just the opposite: buy low and sell high.... or atleast they try to, it is just not very easy to figure out what is high and what is low.

You do not need to put the maximum annual ammount into an IRA to get started. You can do a monthly fixed amount, or a single lump, or periodic small investments...the choice is yours. The Roth is an excellant tax shelter for building wealth. I suggest that you ignor the daily/weekly/monthly investment "news" and commit yourself to the big picture of building a retirement nest egg over the long haul. I have friends who have built IRA accounts to hundreds of thousands and even millions of dollars and in many cases spent less than four hours a year thinking about "choices". Getting started is more important that what specific investment choice you make. Over time you will learn more about investing and be more comfortable with the decision process. You can't get there if you don't get started.

Post again if you have additional questions.

[Guest Israel]

Glad to see I am not the only one that gets bogged down and confused about a little IRA. One new question:

I ahve heard that if you buy into an IRA at the end of the year that this is not good, that it is better to buy right at the begining of the fiscal year. Is this true? Why is this? Is better to wait until after the holidays, etc. to start an IRA?

[John G]

You may be confusing what was said about buying mutual funds at the year end in a taxable account.... this does not apply to IRAs. It is all related to capital gains distributions that often occur at year end.

With IRAs and Roths, all things being equal, you want to put the money into the account early in the year. Early contributions will typically give you a larger nest egg. The reason is because your funds will be sheltered longer. However, dollar cost averaging or making contributions when you know that you qualify are other valid reasons for different contribution schedules.

One reason for not waiting to the end of the year is that IRA departments get jammed in December. Same with April.

I would totally ignor the stock market conditions in making decisions about when to make contributions. Life is short, don't spend too much time thinking about the timing of contributions.

[Guest Vinny]

John, thanks for the advice. I guess I better get on the ball starting this thing if December is busy. I get a nice raise come Jan 1st, so I'm going to divert most of that raise to the IRA. I think it's a good place to start, and I won't ever see the money to miss it.