help starting a roth at 18?

[Guest katie927]

Hi,

I'm 18, and I'm very lucky to be in a situation right now where I don't have to pay for college, so I'd like to invest my earnings in a Roth. I have a few questions about that.

1--are there different kinds of Roths? Do I have the option of setting it up through different banks, etc.? If so, will some places charge different fees than others?

2--I made about $1000 in 'legitimate' paychecks this summer, jobs where I was actually on a payroll. However, I made another $1000 'under the table'--housesitting, babysitting, etc. Am I only able to deposit the $1000 from my "real jobs," or if I claim the other $1000 on my income tax forms, can I add that money to a Roth as well?

Thanks so much.

[John G]

A "Roth" is a general term used to describe a custodian account that your set up in your name. The "Roth" was created by legislation written by the former Senator Roth of Delaware.

The primary choices for custodians include banks, mutual funds, and brokerages. That means you have thousands of potential custodians. Yes, they vary in terms of the minimum opening balance, types of services, internet access, types of investments offered, and annual fees. Fees range from zero to over $100. Frankly, I prefer zero, but I actually have some IRAs that have higher fees because of the services the firm offers.

Your Roth contributions are limited to your earned income (assuming that you are not married and your spouse has income), which could include baby sitting, lawn mowing, etc. if you claimed this income. You are just a few months away from 2006 which may give you additional chances to contribute based upon 2006 income.

Are there different kinds of Roths? No and yes. Generally, a custodian is a custodian, with minor variations in fees and services. The biggest differences come in terms of the types of investments allowed. Banks often have limited choices and focus on reduced risk options (in other words, low annual return investments for folks fearful of investing), while a mutual fund will often only offer some of the funds in their family.

You might want to consider the lower cost internet options. For example, some firms offer zero fee custodial Roth accounts if you elect to use the email notification for statements and confirmations. Etrade (an internet brokerage) is one of these firms... but you can probably find many via a Google search. Vanguard (home of many low expense index funds) has low annual fees. No recommendations of these firms, there are many choices of custodian.

[Guest katie927]

Thanks so much for your reply! It was really helpful.

To clarify, is it correct banks tend to be lower-risk and thus lower annual returns, while mutual funds will typically offer higher annual returns? Or is that too much of a generalization?

If this is the case, I think I'd prefer to invest my money in a mutual fund...

Also, since I'm assuming internet custodians are a relatively new phenomenon, do you think there is any risk in setting up with an online service rather than a bank or a mutual fund? Are they as reliable? Also, are there advantages?

Thanks again for your help.

[John G]

It is my impression that banks cater to older, more risk adverse types of folks and therefore slant their products towards interest/dividend types of earnings. There is however a lot of overlap. Think of this as a slight bias. You will find a wide range of investment styles in each catagory: bank, brokerage, mutual fund.

All of the big names (Vanguard, Schwab, Fidelity, T Rowe, Janus, etc.) have been around a long time. Mutual funds are a regulated industry. Bad behavior with mutual funds, companies and banks is relatively rare. Yes, you still get an Enron or Worldcom once in a while.... but it is rare.

All of these are generalizations. You can not know in advance what choice will perform best. Some years its stodgy bonds, or value funds, or international corporations. Remember you are investing for a very long time.... way beyond your normal planning horizon. Think decades. Don't sweat the first choice - you will learn a lot by watching the process.

When my niece got started in the 90s, she had a string of 20% or better years. She thought I was nuts to say that getting 10% a year over the long term would be just fine. Ten years later, she has learned a lot. Her assets have climbed and falled a few times. BUT, she now sits on about 50k in a Roth and absolutely none of her closest friends have anything near that. She started in her 20s. You have her beat by 7 years. Good luck with your investments.