Roth IRA investment strategies?

[Guest IRAnewbie]

To start with the topic: I'm curious as to what my Roth IRA should be invested in?

But first, I would like to thank you everyone who responded to my post a few weeks ago about Roth investments. I've read up a lot and now feel a little more secure about my financial future.

To remind those reading THIS post, I'm an 18 year old high school graduate, who is looking forward to college in the fall. For years, I've loved the market, but due to recent underminings (poor stock choices) I no longer want to be in the game. Too much fluctuation. But two years ago, I heard of Roth IRAs and how tax-free money for your retirement was the way to go. Now I've saved money very well, allowing me to have "emergency" money, "play" money, and now "retirement" money.

My business teachers explained to me that I must immediately begin my Roth IRA for time is ON MY SIDE. I am aware there is a $3000 limit/year and because I'm going to college on several scholarships, I need not worry about not making the payment. So basically, I want to invest as much as I can, into a fund that will give me the greatest return in my retirement. This way I'll not only have my military pension (planning on joining the air force after college), but a nice retirement portfolio.

So in closing, I'm just a little unsure of in whom to invest in? I already know about a few things. For instance, banks nowadays have very poor returns, stocks are doing bad and probably will continue to do so, but index funds allow for the "dollar-averaging" scheme to take place. So now its really a matter of what index fund and what broker. Does it have to be a broker? I mean, who else does Roth IRA/Index Fund investments? Do they charge a commission? I just want to do things right. I do have some time however because I just turned 18 about 4 days ago, LOL. Thank you for reading this...and any help in this matter would be GREATLY appreciated. Thanks again. Look forward to your replies

[John G]

My business teachers explained to me that I must immediately begin my Roth IRA for time is ON MY SIDE.

The only thing "magical" about starting earlier is that your funds will compound within the tax shelter for a longer time and you are likely to have significantly more assets later. For example, if you average 10% a year, the "rule of 72" (at 10% your assets double in 7.2 years) says that starting at 18 is likely to produce a 100% larger nest egg in later years compared to starting 7 years later at age 25.

I am aware there is a $3000 limit/year and because I'm going to college on several scholarships, I need not worry about not making the payment.

Remember, you must have earned income equal or greater than your contribution, up to the annual ceiling of $3,000. You can remove contributions anytime without penalty, so in that sense a Roth can be considered emergency funds.

"stocks are doing bad and probably will continue to do so"

?? There are lots of stocks doing just find. For example, I took a position in FRO (the largest independent VLCC and Suezmax tanker company) about 10 months ago and it is up somewhere around 300% when you include regular dividends, special dividends and a spinoff of part of the original firm. In any market, there are always stocks moving up and down. For a while, the Atkins related stocks were there own form of dot.com "gold rush". Generalizations about any market are often very wrong. I love the evening commentary "there was a lack of buyers" - everytime something is sold, there IS a buyer, by definition.

"Index funds allow for the "dollar-averaging" scheme to take place. So now its really a matter of what index fund and what broker. Does it have to be a broker?"

The main choices for custodian are brokers, banks and mutual funds. Among the hundreds of choices are hi vs low cost, limited investments vs huge array, and various levels of service or convenience. You can find names in any financial magazine (all those ads DH complains about), sponsoring public radio financial shows, on network TV, populating CNBC commercials, etc. I did a quick Google search for "index mutual funds no load" and had 190,000 hits ! NO LOAD is the key word for mutual funds if you want to eliminate commissions. The second issue is annual expenses - which are always labeled in the prospectus. Index funds have lower annual expenses and are simple to track. I have no problem with you also choosing a broadly based actively managed fund, but be wary of making a choice based upon recent performance. What worked last year often changes by the second year. If you go the actively managed route, then next year pick a different actively managed fund and the third year a completely different type of actively managed fund. You will learn a lot from watching how they perform. The final cost issue is the annual fee the custodian charges. Some charge none, under $20 is acceptable, but be aware that the more hand holding or special services, the higher this fee can go some brokers (including one I occasionally use) charge $100.

Post again if you have other questions. Remember, the best return you will get from your initial investing experiences will be the knowledge of how to invest. You need to learn both from your mistakes and the things you do well.

[Guest IRAnewbie]

So what would be an ideal Roth IRA investment? I mean, where do I go? Who do I talk to? I live in a very rural place, so I can't say there is much happening, as far as stocks and banks go, but we do have a few. Any suggestions?

[John G]

A rural location is not much of a handicap in the modern era of communications.

Go to the library first. Grab the March issue of Consumer Reports, or recent issues of Money or Kiplinger Financial magazines. They should all have articles about Roths - and because of their general audiances, the sidebars will give you most of the ABCs. Read some of the advertisements - especially in the Feb through April issues when IRA money is being actively courted by the industry.

Next step, try looking on the internet for various mutual funds or brokerges. There are hundreds of brokerages and thousands of mutual funds. You only need to find one for the next few years. You might try Vanguard or Fidelity for mutual funds. Some of the major brokers are Schwab, Etrade, Scott, TD Waterhouse and Ameritrade. I won't give you a pick... these are the kinds of decisions you need to make.

If you don't want to go that route, you can look into what your local bank offers. Some have decent options, some very conservative CDs only.

I usually suggest that you pick 3 different custodians and call for information. Tell them you are a novice and ask for the "getting started" package. Some have very good materials for the beginner.

The Ideal investment? Sorry, there is no such thing. No one can tell you what will work the best. This would be like using Lance Armstrong's great Tour de France as a guideline to say that his son will win the Tour in twenty years. The good news for you is that you can get great results without finding the ideal investment or custodian. There are lots of good custodians and solid investment options that will get the job done. My experience suggests that just an average mutual fund is very likely to make you a wealthy person over the long haul.

You are going to need to dedicate some time to learning the ropes. Don't expect to watch your investments like you might ESPN... asset growth is slower than watching a garden grow. Keep your approach relatively simple - that is one of huge advantages of index funds. You don't want to devote too much time to studying your IRA investments.... especially at age 18.

[Guest IRAnewbie]

I recently spoke with a representative from Edward Jones' Investments. He agreed that 18 is a profitable age to begin a Roth IRA. He told me that it would probably be best to diversify my portfolio by investing in several funds from the same company. I asked about Vanguard, which he said was a good growing fund, BUT if I were to invest my Roth IRA with them 1% of my money with be towards broker compensation. So instead, he said that American Funds, the largest fund-holding company and strongest today, compensates him directly, without me having to pay any fees. Anyway, I just wanted to post this to see what you thought. I checked out the bank: its only a 5% return as of right now. And so really I'm just trying to decide whether to do it myself through Ameritrade or through a financial advisor, most likely from Edward Jones.

[Bird]

IRANewbie-

I'm a registered representative, and am posting my name and investment firm at the bottom because I think I have to disclose that whenever I even think about investments, but let me make it clear I am not soliciting business, just sharing information.

What your broker said is at least partially accurate, but misleading...at best.

You can buy a Vanguard fund through him, and you'll probably pay 1% per year. But that's a charge that he (his firm) assesses against your account, not Vanguard. You can call Vanguard directly and open a mutual fund account directly with them and pay no commission whatsoever; that's there reason for being (no sales charges). (As an aside, you will always pay some expenses when you buy any mutual fund, these are basic operating and management expenses, and they can vary widely. Vanguard is known for having low expense ratios, especially with their index funds.)

I happen to like the American Funds, a lot, and I use them almost exclusively. They are also known for having low operating expenses. However, you will pay something (extra) to get into their funds, either directly (an up-front commission of probably 5.75% if you buy A shares) or indirectly (higher annual expenses of about .75% per year for 8 years.

If you want to buy Vanguard funds you don't need a broker or Ameritrade; you just deal directly with Vanguard. If you feel like you don't need a broker then that's probably the way to go.

Ed Snyder

Investments offered through Univest Investments, Inc.

[Guest IRAnewbie]

What are some of the +'s and -'s of NOT having to do your Roth IRA through a broker. I mean obviously, no compensation has to be paid AND you are in control of your assets. But I'm sure there are other reasons.

[John G]

You have hit on the key reasons.

Many folks will not use a broker is because they don't want to insert a middleman who will syphon off a percent of the funds. Opening a Roth account at most institutions takes only a few minutes. There are folks at each institution willing to help newbies. Info you will need: name, address, SSN, and birthdate. You will be asked a few questions about your level of experience in investing. You will be asked to designate a beneficiary(s) in case of your death. It is probably easier to open a Roth than to get a driver's license, purchase a car, or register for college.

Do not assume that because you are paying someone a fee that the advice or service you will receive will very good. While there are excellant financial advisors, there are also plenty that have little experience, minimal insight and are not especially good at listening to their clients concerns.

If you are comfortable with posting on a message board, you probably have the basic skills to visit the websites of various custodians, brokers and mutual funds. Most have good materials for beginners, including FAQs and fund profiles.

I believe that YOU are the best person to be in charge of your own finances. It is your money, and I believe you should decide on you tolerance for risk and what you understand about investing. Not everyone agrees with this philosophy. But, from my viewpoint, it is not rocket science or brain surgery to learn basic investment concepts. There are a lot of folks who never went to college but have mastered the basics of investing. I assume that you are willing to put some time into reading about investing - say one or two hours a month. (Some folks spend more time than that deciding on what electronics or cars to buy.) You won't learn it all in a month, year or decade... things change and there is always something to learn.

I don't see many pluses in the average person using a broker to "handle" these basic matters. Theoretically, some brokers can offer advice... but for something this basic I am not sure that applies. The negatives include: extra cost, possibility of mistakes, extra layer in the decision process, and may foster a reliance of the decisions of others rather than the tax payer.

[Guest IRAnewbie]

Thank you so much for your insight John G.

Your advice has been intuitive and very practical. I appreciate all the assistance you have given me. And hope to utilize the expertise I've learned here and that of investopedia.com in upcoming years. Live Long and Prosper