Supplemental Roth IRA - need help getting started

[Guest Spicoli]

Hello, I am 31 years of age. I currently contribute 10% of my pre-tax salary into my company's 401K. This does not meet the $15,500 year max allowed by law. I have additional monthly funds to invest, and thought that instead of increasing the 10% 401K contribution, I would start up a Roth IRA. I would contribute $300-$500 monthly.

First, is this a good idea, or should I increase the 401K? Second, if Roth is the way to go, then I admit, I'm a little clueless as to where and how to get this going. I'm not really interested in paying a finacial advisor. I'd rather manage/learn this process myself.

Thanks.

[JanetM]

I have to assume you already have an emergency fund that would provide up to 6 months living expense. So now that you are ready for today you are thinking about tomorrow. If you don't have this yet, I would not advising tying the funds up in a Roth now.

Roth is great idea but it doesn't exist in a vacuum. Your entire financial situation must be assessed to decide if it the right thing at the present time.

If you want to learn how to manage/invest your funds you either have to read a lot of material (read this as large time investment) or spend a little money to get someone point you in the right direction. There are financial planners/advisors who will look at what you have & your goals and then give you differnent options of how to get there. After that you are on your own.

[Belgarath]

How can you afford a Roth-IRA? I thought you blew the reward money hiring Van Halen to play your birthday party? (Spicoli is one of my fovorite characters - I had a roomate in college who was a clone - he was more like a mascot or a pet, but always amusing)

That aside, I'm not an investment counselor, but I'd just observe that with regard to the Roth contributions - the contributions themselves can always be withdrawn with no taxation, as they are after-tax anyway. So unless your chosen investment has a big surrender charge, I don't see why Roth contributions can't be considered part of your "emergency fund" if so desired.

Other than that, I'd just second what Janet said.

[K2retire]

Be very careful about hiring and adviser. Many of them have an interest in selling you what pays them the best commission rather than what is the best investment for your situation. With that in mind, you really need to invest the time to understand investment options, even if you hire an adviser.

[masteff]

Websites like Bloombergs and Motley Fool can be great places for general learning about investing. Many of the major financial firms (Fidelity, etc) also have free educational resources online.

[John G]

I think starting a Roth with a monthly contribution is a sound idea for many reasons: (1) you are planning ahead, (2) the Roth itself can be part of your emergency plan since you can withdraw contributions without penalty or tax in dire emergencies, (3) monthly process eases you into investing - you will see this refered to as "dollar cost averaging", and (4) I support the concept of folks learning how to invest instead of abdicating responsibilities to an "advisor". I am assuming that you are contributing to any employee program that offers a initial "match".

Here is what you need to get started. Go to your local library and look at a couple of different sources of information. First, read the spring edition of Consumer Reports (I think it is either April or March) that covers investing/retirement planning. Second, spend and hour each with Money and Kiplinger Financial magazines which cover this topic and more. I highly recommend that you subscribe to one of these which gives you a monthly reminder via US mail to spend a modest amount of time reading/thinking about your financial affairs. Third, look in the book section for readable recently published books on investing or financial planning.

Next big step is to find a "custodian" - banks, mutual funds and stock brokers are common choices. Convenience, range of investment options, and fees are some of the criteria. Most of your choices will have websites you can explore.

Short term, I think you want to keep your financial choices simple. I suggest that you look for a custodian that offers a few NO LOAD mutual funds and choose one of those for your initial Roth contributions.

You can search this message board for keywords like: beginner, Index, noload, mutual, custodian...etc. and find a lot of posts on this process. Put up another question if you need additional guidance.

[Guest Spicoli]

Thanks for the great advice. I have a follow up question. First off, I am just about to set up a Roth IRA account, where I will make monthly contributions. At the same time, my wife and I are going to do a Rollover from her 403B (she changed jobs to teaching). We're going to roll her 403B into a Traditional IRA. I've done some research and have decided to invest with T Rowe. I like their Retirement Funds, specifically the 2040 Retirement Fund would be the right one for me, considering my age of 31. Good historical performance, good diversification, no load fund, etc.

Here's my main question. Would it be a good idea to invest both the Traditional IRA (from my wife's 403B) and our Roth IRA (from our monthly contributions) in the T Rowe 2040 Retirement Fund? Or should I only do that fund for my Roth and pick another for the Rollover, such as Vanguard or even a different mutual fund through T Rowe? The Rollover will amount to about $10,000 and I'm planning to max the Roth at the $5000 annually. Thanks.

I think starting a Roth with a monthly contribution is a sound idea for many reasons: (1) you are planning ahead, (2) the Roth itself can be part of your emergency plan since you can withdraw contributions without penalty or tax in dire emergencies, (3) monthly process eases you into investing - you will see this refered to as "dollar cost averaging", and (4) I support the concept of folks learning how to invest instead of abdicating responsibilities to an "advisor". I am assuming that you are contributing to any employee program that offers a initial "match".

Here is what you need to get started. Go to your local library and look at a couple of different sources of information. First, read the spring edition of Consumer Reports (I think it is either April or March) that covers investing/retirement planning. Second, spend and hour each with Money and Kiplinger Financial magazines which cover this topic and more. I highly recommend that you subscribe to one of these which gives you a monthly reminder via US mail to spend a modest amount of time reading/thinking about your financial affairs. Third, look in the book section for readable recently published books on investing or financial planning.

Next big step is to find a "custodian" - banks, mutual funds and stock brokers are common choices. Convenience, range of investment options, and fees are some of the criteria. Most of your choices will have websites you can explore.

Short term, I think you want to keep your financial choices simple. I suggest that you look for a custodian that offers a few NO LOAD mutual funds and choose one of those for your initial Roth contributions.

You can search this message board for keywords like: beginner, Index, noload, mutual, custodian...etc. and find a lot of posts on this process. Put up another question if you need additional guidance.

[masteff]

Here's my main question. Would it be a good idea to invest both the Traditional IRA (from my wife's 403B) and our Roth IRA (from our monthly contributions) in the T Rowe 2040 Retirement Fund? Or should I only do that fund for my Roth and pick another for the Rollover, such as Vanguard or even a different mutual fund through T Rowe? The Rollover will amount to about $10,000 and I'm planning to max the Roth at the $5000 annually. Thanks.

There is no reason to use multiple trustees. And the point of a target date fund such as the TR 2040 is that you CAN put it all in that one fund and know that it's reasonably diversified. So using it for both accounts is not problematic.

As you become more educated about investing, you might choose to develop your own diversified fund portfolio and replace the TR 2040 fund with your own mix of funds. But for a good place to start that will have an appropriate long-term investment perspective, that target fund is a good way to start.

[Guest Spicoli]

Thanks, that answered my question. I agree, as I become more educated, and build a larger net worth, I will look to develop my own portfolio. However, as of right now, I'm pretty much a beginner so I felt like the mentioned retirement fund would be a good starting point.

Based on your post, it appears that you agree. Thanks again.

As you become more educated about investing, you might choose to develop your own diversified fund portfolio and replace the TR 2040 fund with your own mix of funds. But for a good place to start that will have an appropriate long-term investment perspective, that target fund is a good way to start.

[Belgarath]

Here's one other thing to possibly consider. And I cannot caveat enough that I'm not an investment advisor!! Depending upon risk tolerance, overall portfolio, etc., I know that some people are putting the more speculative PORTION of their portfolio into the Roth. The theory apparently being that if you hit a home run on your long term investment earnings, then the tax-free aspect becomes particularly attractive. Since there's always a downside to everything, I suppose that if you lose your investment you've paid income tax on that money and gotten nothing out of it!

If you just stay poor, you won't need to worry about these various investment philosophies.

[John G]

Target Funds: You can search and find more comments on these on this message board. Basically, Target funds are a marketing gimic of the mutual fund industry. Something new that addresses the vague apprehensions of initial investors. They may work out for you. If they are no load and low annual expense (not all target funds are) then they meet two key criteria. But, don't buy into the idea that T Rowes notion of asset allocation (stocks vs bonds, domestic vs international) best matches your specific needs. Think of Target funds as sort of men's socks - one size fits all.

Hitting Home Runs in a Roth: Belgrath? I am curious about how you know in advance which assets are going to be your big winners? If you could sort them out in advance, then why invest in the others? While having your max gains in a Roth is wonderful from an academic tax perspective, I don't think I would try to manipulate/sort your investments in this fashion. There are just too many unknowns with investing. I also don't think investors should be focused on making long shot bets. If they have that compulsion, then spend $2 on lottery tickets and get it out of your system. Beginning investors don't need to "hit home runs", they can reach there goals by lots of walks, bunts and singles. Success in investing is heavily connected with asset allocation (the balance or mix between equities, bonds, etc.) and holding time (retirement investments are very long term investing and time is an investors friend). You are investing in capitalism -- that tomorrow is going to be better than today because of economic profit -- a portfolio of companies that strive to market new products, operate efficiently and reward their stock holders based upon their long term performance.

Accounts in One Place: You are investing in a mutual fund package that is diversified. Each fund family or brokerage offers enough choices that you can easily find different types of funds for each account (note there will often be substantial overlaps in portfolios because lots of funds hold Microsoft and Exxon). You may find it convenient to have all the accounts at one location, or prefer different locations to clearly segregate His/Hers. Its really up to what you want to do and what works for you...there is minimal investing issues. You may find some custodians will waive fees if the cluster of your accounts exceeds some number like 10 or 20k, but fees tend to be modest at the financial houses you mentioned.

[GMK]

Spicoli,

John G's advice about investments vs. the lottery is right on target. Read it carefully.

Belgrath is correct, too. He did not say he knows what will win (quite the opposite). And he is not equating "speculative" with home runs (if only that were true). Riskier investments (say stocks) are expected on average to give bigger returns than safer investments (say Treasury bonds). The bigger potential return is the reward for taking the bigger risk, but the risk also means that you could lose more.

The real question with investing in a Roth is whether or not it is likely to provide more net income in retirement than a 401(k) or other tax-deferred plan would.

Before retirement, you have an amount of money for investing each paycheck. With a 401(k), the whole amount goes into your account, because it's pre-tax, and the miracle of compound interest grows it for many years. With a Roth, you don't have as much money to invest, because some of that money goes to pay the taxes now. Compounding grows your contributions, but your Roth account balance is less (and therefore your earnings are less) than in a 401(k), assuming the same investments in both.

At retirement, the money you put into the 401(k) and the earnings are all taxed when you take them out (at whatever the tax rates are then), which reduces your net retirement income (maybe a little, maybe a lot). In contrast, you get all the money you put into the Roth and the earnings; no tax.

Which one comes out ahead depends on your personal circumstances. Retirement calculators help give you a range of possible outcomes, which can depend significantly on the actual returns from your investments, future tax rates, and other things you can't predict with certainty.

And some simply say, "I'll take my chances paying the taxes now rather than later," while others prefer to put off the taxes for as long as possible.

[K2retire]

The real question with investing in a Roth is whether or not it is likely to provide more net income in retirement than a 401(k) or other tax-deferred plan would.

Before retirement, you have an amount of money for investing each paycheck. With a 401(k), the whole amount goes into your account, because it's pre-tax, and the miracle of compound interest grows it for many years. With a Roth, you don't have as much money to invest, because some of that money goes to pay the taxes now. Compounding grows your contributions, but your Roth account balance is less (and therefore your earnings are less) than in a 401(k), assuming the same investments in both.

To further confuse the issue, some 401(k)s now permit Roth contributions. So you cannot make the blanket assumption that 401(k) contributions are all pre-tax any longer.