Questions about Roth IRA's

[Guest LisaRose]

I have a couple questions about Roth Iras that I hope someone can help me on.

I am 21 and want to start saving for retirement but I dont want to go to a financial planner or on-line broker. I'm going to try and see if I can research everything by myself. So where can I set up an Roth IRA on my own? Also, for 1999, I was a full-time student and didnt have any "taxed income" but I do have some money saved up over the years that I want to contribute before 4/15 for the 1999 IRA. Can I do that even though I had no taxed income. I had heard that you can only contribute the same or above ($2000) the amount of taxed income you had that year.

I'm planning to buy buy 1-2 Mutual Funds to put in my IRA and many people have told me that Vanguard is the best. Specifically Vanguard Total Stock Market Fund and Vanguard Growth and Income. But I had read that Vanguard mostly deals with index funds and I had wanted to stay away from those because I feel at my age I can be a little more aggressive and index funds arent managed very much. Are the above Funds index funds?

Well, thanks for listening!

Lisa

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"Does they leave it there during the game?"-Bill Lee on the Green Monster

[John G]

Wonderful 21, and thinking about investments! wow

Here are some of your answers:

1. you can readily learn the basics from mags like Kiplinger Financial Mag, Money, Worth, etc. I think Kiplinger might be the best for a 21 yr old since it covers lots of topics including credit, major purchases and careers besides decent coverage on investing. A very short summary that might be a good start can be found in the March issue of Consumer Reports.

2. You can only have an IRA if you have earned income. You apparently do not for 1999 so no IRA for 1999.

3. You can invest in an IRA for 2000 if you will be working this year. You can put the max ($2000) if you eventually will make that much this year, even if it is later. Nothing magic about $2000, you can start with a smaller amount. Many custodians will open an IRA with just $500.

4. You can still invest, even if you will not be working this year either. As long as you do not expect to be using those funds for a few years, you can get started. Vanguard is one of many mutual fund families which might be helpful for you. They feature lots of very low cost index funds, check their web site for specific details. There is not a lot of portfolio turnover in index funds so your taxable capital gains each year should be very low. Index funds have performed very well the past decade relative to stock picker funds, partly because of much lower expenses.

4. I agree that you might want a more aggressive fund since you are so young, but do not buy into all the hype about some of the hot sectors such as internet stocks. Hot investing areas come and go. There are dozen of great growth funds that might meet your need for speed. Try Janus Mercury or American Century International, but hey, there are probably hundreds of funds that might qualify. You would want to find a NO LOAD fund with the right minimum, annual fees, etc.

Remember, in a down market, hot funds can go down a lot in a very short time. Reward is typically comensurate with risk. You should only be investing funds you don't need for years.

What do you think should be your annual expected rate of return? It is not uncommon for someone new to investing to say 80% or even 200%. Realistically, think more in terms of 10, 12 or 14% annual over the long haul. The last five years have been abnormally positive, a very rare combination. Expect some years to be net losers too. Good luck.

[This message has been edited by John G (edited 03-05-2000).]

[Guest LisaRose]

Thanks for all the advice John. Actually, I was thinking my annual rate of return would be as low as 8%. You said that capital gains would be taxed each year, but I had thought that if you kept those gains within the Ira, you wouldnt be taxed. Maybe you were speaking in general terms and wasnt assuming the index funds would be in an IRA.

Well, thanks again!

Lisa

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"Does they leave it there during the game?"-Bill Lee on the Green Monster

[John G]

Capital gains: only apply to mutual fund holdings outside of retirement accounts. Most mutual funds have gains and dividends that are distributed often near year end. With a taxable account, you can get a surprise tax liability depending upon the turnover and performance of the fund. Tax liability is lower at tax managed funds and index funds.

On target annual return: 8% over the long term probably represents an IRA that has a blend of cash, bonds and equities. It is wise not to overestimate results before they happen. If you have a string of good years, you can adjust your targets. The "Rule of 72" says that at 8% annual, your assets will double (without additional deposits) every 9 years (72/8 = 9 yrs). At a 10% return, assets double about every 7 years.

In any given year, the annual return can swing rather dramatically. For example, lets look at the long term track record of the ICA fund. Over 66 years (since 1934) the fund's best three years were +83%, 56% and 45% and the worse years were -38% [ouch, ouch!], -18% and -17%. Big swings for a blue chip fund. Twice the fund had back to back down years, but UP years out numbered down years 56 to 10, and the average annual compound rate of return was just under 14%. There was no 10 year period when the fund was down.

Note, ICA is a loaded fund and I do not recommend it, but 66 years makes for a good long term example. I use it for my Junior Achievement classes on the stock market to address risk and "time is your friend" aspect of investing.