Interest earned after retirement on Roth?

[Guest smatts]

Hi,

I'm looking into starting up a Roth account and am 27. My question is, when you retire and start withdrawling from the Roth does it still earn an annual return? OR, when you start withdrawling, does interest stop?

-Matt

[John G]

I can tell from your question that you are very new to investing. Welcome to the new age of taking charge of your future! You are a decade ahead of many folks who will only start thinking about building the proverbial nest egg in their 30s.

I urge you to look at many of the posts at this message board by using the search function on keywords like "starting", "newbie", "basics". There are hundreds of posts on these topics and they spin off in many directions.

In a nutshell:

Roth contributions need to be invested to grow both now and after you start drawing down funds in retirement.

You really want to think beyond "interest". Interest is associated with IOUs like savings accounts, money market accounts, and CDs. Frankly, that is like running a long distance race and carrying a few snow tires over your shoulder. If you put 4,000 into a Roth each year for 40 years and collect 5% "interest" you will have about 483,000 at age 67. But investments that average 8% annually will boost that nest egg to over $1 million. And.... at 10% your contributions would grow to around $1.8 MILLION, or almost 4x the "interest" example. Its all about compound growth - something you can do with a spreadsheet or an HP 12c calculator.

Since you are investing for many decades, you should be looking initially at mutual funds that have a substantial component in stocks (also know as equities). "Mutual Funds", "choosing", "no load" and "index" are three more key words that will get you a ton of material on this site.

My best advice: don't make any snap decisions right now. Spend a couple of hours reading material here. Check Kiplinger Financial magazine at your library (they cover a lot of topics relevant to someone in their 20s) and also look for the March issue (any year) of Consumer Reports which has good laymens articles on Roths and mutual funds. Like on this message board, these articles will talk about "asset allocation" which is the mix of different broad types of investments like bonds, stocks, and money markets. They will also talk about that really scary thing called - risk. The long term better performing investments have various types of risk.... for example many investments often go down in some years. But, another element of risk is that long term risk related to not keeping ahead of inflation.

Another major step you are going to need to take is to contact a few companies that can serve as your "custodian". All Roths are administrated by custodians. Custodians vary in what kinds of materials they offer beginners, but almost all have some general brochures about how to get started. (some are now on DVDs!) You can also scan the internet for the companies you see referenced in Kiplinger or CR. Contact three companies, be up front and tell them you are a beginner and ask for materials. Don't fall for the first sales pitch, but compare what you get.

Custodian examples (no recommendations)

-- Your local banks - some offer mutual funds but bewary of LOADED funds that charge front end commissions, as banks have been slow to catch up with the next two catagories.

-- Stock brokers (full service, discount, internet) - Charles Schwab, Scott Trade, Etrade, Fidelity... there are hundreds, and most offer mutual fund options.

-- Mutual funds or fund families - Fidelity, Vanguard, T Rowe Price... there are thousands

You are not going to understand everything that you first read. But plug away and than post your questions here. In the long run, you are a key person in managing your own money. Over many years you will lean a lot. Sometimes you will make mistakes (think of it like paying tuition), we all do. But, that you are even thinking of investing for the future means you have taken the first steps down the right path.

[Guest smatts]

Thanks for the info. I called it interest because it is a percentage that you earn annually .... whether it fluctuates or not, correct? What is the correct term?

-Matt

[John G]

There are many terms like annual return on investment or annual yield. Some folks will use "gain" or "performance" to refer to the same thing. Note, there is a big difference between to total percent gain on a investment and the annualized gain - which converts variable holding periods to 1 year rate.

Interest mostly refers to IOUs. Dividends are like interest but generally refer to cash payments to those who own stocks. Bonds have yields, often refered to as the "coupon rate" from the days when you clipped a stamp like coupon that had to be presented to get your cash dispursement.

Many investments have no interest, dividend or coupon but work because of capital gains which means refers to the increase value from the time you bought something to when you sell. For example, when you buy a home no one is sending your money for holding the investment. Quite to the contrary you have expenses such as mortgage payments, repair and property taxes. But, after a few years, the house often has appreciated in value and when you sell you have a capital gain (for most folks this is not a taxable event now).