ROTH IRA ?'s (NEWBIE INVESTOR)

[Guest jkriv03]

Ok I have been studying up on the Roth IRA. Have been doing my research on the net for awhile now. I have been thinking about looking into setting up a ROTH IRA thru vanguard. They seem to have the lowest rates. As far as I go I am a 21 year old college student going for Business. I realize not many of us know what the future will bring. I also realize that by the time i am old enough to college social security I wont even be able too. OK to the point. I am looking at starting with a balance of 3000 in my roth ira thru vanguard. I will make annual contributions of 4000 or the maximum allowed each yr. (I will set money aside each week just to make it easier and so I dont get behing). I have seen many roth ira calculators out there and would like to have a nice nest egg when i retire and I know the sooner i get started the more money i will have. My question for all of you is what is the expected return on roth iras? I've seen the average anywhere from 8-10% a year. Is this correct? What is the average? Thanks, Jason

[John G]

Good question.

First, annual performance is very likely to flucuate, even if you choose a bond fund. Second, a down year is possible in any investment (even bonds), but good years will generally out number bad years, perhaps by 5:1. When we talk performance stats, we are normally talking about the long term average over decades rather than any specific year.

I agree with most financial planners suggest that the single biggest factor that effects long term performance is asset allocation -- the percent composition of various investment catagories. For some very general financial planning, I would use the following for historical performance of the major catagories:

2-8% Money market funds and CDs

6-9% Bonds

8-10% Conservative stocks (more blue chip, utilities and dividend stocks)

10-12% Stocks (aka equities), but biased towards growth companies

The lower performing catagoies are essential forms of IOUs. The higher performing catagories are tied to capitalism, production and growth.

You likely result would be a function of the asset allocation mix you choose. For example, if you were 1/3 bonds and 2/3 blue chip stocks, you might average around 8-9%. But, if you were 100% growth stocks, you would expect to be slightly higher, perhaps 10-12%.

These are VERY general guidelines. In any given year, you could wildly diverge from the average. It is often said that performance is inversely related to risk, especially when you are considering shorter holding periods. But over many decades, this tends to wash out.

You are wise to us the Roth vehicle. Getting started is good. Early is good. All things being equal, lower annual expenses is good. SSN may be around in some form, but if you follow your plan you won't be relying upon it.

[Guest FLMaster]

The average Mutual fund investor from 1984-2002 received 2.6%. The S&P during the same time averaged 12.2% chose an S&P fund (index) and forget about trying to beat the market. Go for the long term and concenate on additing to the IRA rather then investment performance. Hope this is helpful.

[John G]

2.6% ??

Please check you numbers - looks like you have a typo. Also, please indicate a source.

I agree that "beating the market" is not the goal. First, we can't all be above average. Second, average performance will work out just fine for many long term investors as retirement accounts compound over decades and an annual 8% or 10% often will produce a substantial Roth nest egg.

Reasons to consider an S&P500 index fund: broadly diversified, very low annual expense, easy to understand, requires less analysis/selection time, easy to track, and gives the S&P version of market performance. (Outside of an IRA/Roth there are also the benefits of lower portfolio turnover.)

These are especially strong positives to novice investors. Many folks do just fine with Index funds. But, there are other mutual fund choice strategies that also work. For example, some make an argument for using the total market index rather than the large cap S&P500. In my view, very young investors would be better served by a portfolio slanted towards growth stocks.

I don't believe in one solution for all people. Investors differ in their ages, long term objective, education, risk tolerance, available time, etc.

[Guest jkriv03]

2.6% ??

Please check you numbers - looks like you have a typo. Also, please indicate a source.

I agree that "beating the market" is not the goal. First, we can't all be above average. Second, average performance will work out just fine for many long term investors as retirement accounts compound over decades and an annual 8% or 10% often will produce a substantial Roth nest egg.

Reasons to consider an S&P500 index fund: broadly diversified, very low annual expense, easy to understand, requires less analysis/selection time, easy to track, and gives the S&P version of market performance. (Outside of an IRA/Roth there are also the benefits of lower portfolio turnover.)

These are especially strong positives to novice investors. Many folks do just find with Index funds. But, there are other mutual fund choice strategies that also work. For example, some folks make an argument for using the total market index rather than the large cap biased S$P500. In my view, very young investors would be better served by a portfolio slanted towards growth stocks.

I don't believe in one solution for all people. Investors differ in their ages, long term objective, education, risk tolerance, available time, etc.

Ok well i appreciate all the input and am sure welcoming more. I know its obvious that I am completely new to investing. But, I know that the sooner i get started... the better off I will be. Like you stated I am not looking to beat the market I am just looking to have a nice nest egg. A fairly nice one haha. Umm yeah alot of the things you told me are helpful and I'm sure alot went way over my head. Since I posted this article Ive been looking into fidelity also. Sounds like you prefer investing in the S&P. Guys.. dont take me as stupid but I am not even familiar with that. I'm sorry. Anymore information would be greatly appreciated.

[John G]

You can search on keywords such as "index" or "beginner" or "starting" to find lots of posts that may be useful. Feel free to post specific questions... its easier to answer something narrow than a very broad question.

S&P500 index fund - a mutual fund (typically no load) that invests based upon a list of stocks such as the Standard and Poors list of 500 large companies. Index funds tend to have very low annual expenses - minimal staff, no field trips!

NO LOAD fund - a fund that has no front end or back end commission schedule. All funds originally were sold by agents who received a commission. No loads were created later - based upon more efficient operations (pre internet!) and a marketing desire to attract money away from funds based upon commissions. The pressure was so great that some of the industry created: "low load" using about 1/2 the normal commission, and declining back end loads (example, 6% back end commission year 1 but dropping 1% each year until after a 7 year hold there is no commission).

There are many successful strategies for investing using mutual funds. Index funds have some strong positives, but you can find equally strong arguments for the better no load funds.

Summary was good: early start is better than later, no loads over loaded funds, greater returns likely if you bias your long term investments towards equities (stocks).

Second in importance to getting started is adopting an attitude that the initial emphasis on learning is more important than annual results! You might want to catch the March retirement investing articles in Consumer Reports. You will also get a huge amount of information from Kiplinger's Finacial magazine - not just investing, but also credit, insurance, home ownership, car buying.... and I think it is under $20 for a 1 year subscription. If you don't save that much from the advice in KF - send me the bill!

[Guest FLMaster]

My source is Dalbar research who stated the average mutual fund investor earned 2.6% from 1984-2002 wheere the S&P returned 12.2%. Hope this is helpful. For low feees try Vanguard index fund.

[John G]

FL, I don't think your 2.6% holds up to any reasonable level of scrutiny.

The S&P500 makes up a huge part of the total market capitalization... I seem to recall it is more than 1/2. Now, how can half of the market be up an average of 12.2% annually but mutual fund investors are somehow up only 2.6%? Any cash component over that time span would surely be higher than 2.6%, and ditto for bonds.

Lets look at a few examples of what was happening in equities.

Since Jan 1 1984 - my quick calcs indicate:

DOW INDUSTRIALS - rose from 1,253 to 10,798 or about 10.8% a year compounded, not counting any dividends

NAZDAQ - rose from 277 to 2,258 or about 10.5% per year compounded, again not counting dividends

Fidelity Contra Fund - NAV plus non-reinvested dividends rose over 10.4% annually {one of the few funds were I could quickly grab historic data for almost 20 years}

I visited the Dalbar website and searched for 2.6 and found a single reference in an article as clear as mud. As these folks sell reports for high fees, I was not able to track the statistic back to its source. But, they may have been talking about market timing investors who move in and out of mutual funds. The statistic was not labelled or qualified very well.

From every angle that I have looked at, the 2.6% gain number looks like just bad data.

[Guest FLMaster]

Thanks for the reply. The 2.6% is not my number it is Dalbar's number. I have seen research studies from them and other money managers that show individual investors do not perform up to the level of the S&P 500. Other studies published in investor magazine's such as Investment Advisor and Financial Planning magazine as well as institutional managers (such as Rogers Casey) reflect the same (they state a 4.6% return). Why? Individual investors tend to buy high and sell low. For example many individual investors entered the securities market in 1999-2000 took a hit and got out. Many are now going into real estate (after the boom). They tend to follow yesturday's story. There have also been published studies where the average mutual fund, and in some cases 80% of the mutual fund managers do not beat the S&P 500. It does seem counterintutitive to return 2.6% where the S&P does 12.2%.If you buy on the high and sell on the low it can happen. Remember when the market crashed in 1987-many individual investors removed themselves from the market and missed the 87-99 upswing. These same investors entered in 1999 and took a dive in 2000-2001. Hope this is helpful.

[John G]

Sorry FL, after futher research I conclude the Dalbar 2.6% is completely bogus and further suggest that you are misusing the number to support a cynical world view.

Valid statistics about "performance" of household investments are very hard to obtain. Making universal claims based theoretical behavior seriously misrepresents what many persons achieved. The time period you selected represents one of the long sustained bull markets in US history. The Dalbar study apparently was looking at market timers.

(see a critique of the Dalbar study by a Kiplinger reporter at http://redesign.kiplinger.com/personalfina...ory.php?pid=859 , this rebuttal is not exactly clear but suggests some of the issues with Dalbar's paper. I will also note that Dalbar sells products to investment advisors and financial planners, so they have a commercial interest in promoting the theory that individual investors make poor investment decisions.)

Consider the data available from the Investment Company Institute (the primary association for mutual funds, especially the 2005 Fact Book , see http://www.ici.org/factbook/ ) which compiles statistics of member companies... that represent 95% of all the assets in mutual funds. In 1984, only 11.9% of all households owned mutual fund shares. By 2004, 53 million households owned shares in mutual funds, nearly 1/2 of all families. In 1984, the ICI data show 1,243 funds holding 8 billion in assets. By 2004, there were over 8 thousand funds holding 8,106 billion in assets. IRA assets in mutual funds in 2004 were 3,475 billion, representing 43% of all IRA assets, slightly ahead of assets held in individual stocks/bonds. There was only one year since 1984 when the mutual fund industry did not see positive net cash flows, and that was 1988, not during the dot com crash. The most significant trends in the past 20 years is greater participation in mutual funds, a significant climb in IRA accounts and assets, and a high participation in stock mutual funds. Today 78% of all mutal fund IRA assets are in equity funds, 10% in money market and 12% in bond funds. There is very little data to suggest that massive numbers of households swing in and out of stocks - if this was true, you would see it in the net cash inflow statistics. To the contrary, the 20 year trend suggests that folks were getting good results and increased their participation.

Very few studies have been conducted of individual investor behavior, such as how individuals change assets allocations. But in one study noted by ICI staff, the University of Chicago researcher found a tendancy for mutual fund investors to migrate to: lower fees, lower expenses and better performance. Adam Smith would understand that concept.

When all market indicies were going better than 10% a year over the 84-04 period (see my prior post)...

When many big mutual funds were obtaining the similiar performance....

When money market accounts averaged around 6% a year for just cash....

When bonds averaged in the high single digits....

What kind of tortured investor behavior could lead to a conclusion that mutual fund investors averaged only 2.6% annual appreciation.

Could there be a few people who achieved such miserable results? Sure. And there were likely some folks that even LOST money during this time period. But, they would have had to work awfully hard to obtain such miserable results. It is ludicrous to suggest that the average mutual fund investor did so poorly.

I have access to and track 46 accounts related to 18 individuals with each have over 25k in assets and where I have over 10 years of data (the oldest six accounts are over three decades). These accounts include a mix of bonds, stocks, and mutual funds. They include Roth, IRA, 403B, non-profit endowment and taxable accounts. Only eight of these accounts have long term annualized returns under 8 percent, and none below 5%. All of the lower performing accounts have very large bond or money market components and represent the "withdrawal" life phase. Every single account beats your 2.6%. If your number was credible, then this must be miraculous performance. A win record of 46 - 0. I don't view this as extraordinary, just a little above average and rationally related to the asset mix of each account.

Yes, there are valid points about the problems with market timers. Yes, some folks panic in a stock market sell off. Yes, there are some folks who invest erradically - getting buy low and sell high confused. But, please don't use the bogus Dalbar number to suggest that all mutual funds investors obtained such poor results. It's just not a realistic portrayal.

[Guest Pensions in Paradise]

John G - in case you were not aware, FLMaster is a 412(i) salesperson. You may not want to waste too much of your time discussing reality with him.

[Belgarath]

JohnG - as someone who knows very little about investing and investments, I always find your posts very informative. (And believe me, you've convinced me) I do have one question that I'd like confirmed about your post. "There was only one year since 1984 when the mutual fund industry did not see positive net cash flows,..."

Does a positive net cash flow mean that the funds (collectively) actually posted a gain, or does it mean that the net inflow of new money could produce a positive cash flow even in a down year?

Thanks in advance!

[Guest FLMaster]

Thank you for your reply John G. I have no bias to Dalbar or C. Rogers Casey who produce data which may be inaccurate, which in your opinion it is inaccurate. I would be interested in their response. The market in many cases has be oversold by investment advisors just like 412(i) is oversold by insurance agents. I have recently received data from a major brokerage firm who stated that there have been many periods that the market did not move. For example from January 1966 until August 1982 a period of 16 years and 8 months, the DJIA achieve a 0% return. The same report states from January 2000 until October 2005 the DJIA went down 10%.

Many mutual funds will take funds that have performed and tount them and ignore the funds that have not performed. For example, the ads may show the real estate REIT returns over the last 5 years and ignore the large caps. This form of misrepresentation goes on quite often. Perhaps in the events I attended Dalbar and C . Rogers Casey were misrepresenting the performance of individual investors, then again perhaps not. I generally counsel clients who are not astute in money management to use a trust company as they have a fiduciary relationship with the client where brokers do not. In fact the conflicts are evident. I spent too many years in court battling brokers to get back funds that were lost. For example the Jupiter fund. The fund managers churned the account and then left the country. In Naples Florida, Elliot securities told clients they could invest in Repos and earn 12% until the SEC shut them down as it was a Ponzi scheme-$60 Million lost. (SPIC did not protect them as the REPO took the account out of SPIC). In one instance I had to litigate against a broker who held bearer bonds for the benefit of the client and when the client did not die he claimed them as his own. We were sucessful in recovering the funds by receving a court order to freeze the account.

From what I have seen an individual inestor with no expierence who wants to be in the market should be in an S&P 500 fund with lost cost like Vanguard and forget about the razzle dazzle asset allocation models developed by Markowitz, Scholes, Fama and others from the University of Chicago, the gentlemen who took Long Term Capital management down.(Mainly by missing an emperical observation taht the Russian bonds may default). (See "When Genius failed-the story of Long Term Capital Management). Hope this is helpful.

[John G]

Reply to Belgrath -

Net inflow of cash to IRA/Roths - this statistic shows only if money is flowing into or exiting from the mutual fund industry. There is usually a small amount of money exiting every year for folks in retirement. To have a positive net cash inflow, more money must be arriving then exiting. While there is variation in the year to year statistics, with one exception, more money was arriving then exiting in the past 20 years. Note, this statistic has no connection to the performance of the assets in the funds.

FL implied that people were switching in and out of investments. The aggregate annual statistics demonstrate that money has very consistently been added to IRAs and mutual funds. If you believed that folks were massively exiting the stock market when it was down and flowing back in at its peak, then you would expect to see positive and negative cash flows.

Overall mutual fund performance varies by year, and within funds by type of fund. There are up and down years although positive years significantly outnumber negative years.

[John G]

FLMaster

When you post on this message board in answer to a question, you should speak from some level of authority and experience. Responses should stay on point and not wander off into anecdotal stories. When you provide data a source should be cited and perhaps a website reference. You should understand the statisitics you select, and they should be relevant to the discussion and used appropriately.

You just posted "The same report states from January 2000 until October 2005 the DJIA went down 10%. "

As one of the moderators of this message board, let me point out some things you are doing wrong. First, no source cited. Second, the statistic is not directly relevant to the issues in the thread. Third, you are using a selective "snapshot" of specific start and end points with no apparent reason other than to show a result. Fourth, the pure statistic, while technically correct, is in a bigger sense misleading. The DJIA is an index value, not a stock. The industrial average represents 30 large companies whose composition has changed. What is missing is that during this five year the DJIA stocks provided annual dividends between 1.6 and 2.3%. So, although the index was down 10% during that time period, actual investors in the DOW 30 industrials would be showing a slight gain from compounded dividend yield. What was the point for saying the DJIA was down 10% during some "snapshot"?

FLMaster, your posts are not sharply focused and include misleading material. This message board aims to answer the questions of many novices. They deserve accurate information, clearly presented. If you post again, please try focus on what you know rather than what others have told you.

As moderator, I am closing this thread. It has gotten too long and drifted away from JKR wanted to understand. The topic of "performance" is useful and can be addressed again if raised by another viewer.

See:

www.djindexes.com/mdsidx/index.cfm?event=showAverages

www.djindexes.com/mdsidx/downloads/xlspages/DJIA_Hist_Perf.xls is a spreadsheet covering these years and note DIVs column