Yesterday we talked about where to put your money. The number one question has been – “How do I open a Roth IRA?” We are going to try to keep this one simple because it seems like the biggest barrier to actually doing this is the complexity. There are 3 steps to getting your IRA open, funded, and invest.
- Open. The first step is to simply open your Roth IRA. When I was researching where to open my Roth IRA, two companies stood out as solid choices. Vanguard was the one I went with because they focus on simplicity, keeping costs low, and great customer service. I already have needed help a few times and it was easy to get someone on the phone. The other great option is Charles Schwab because they try to make it easy to invest your money in a hands-off fashion. Both companies have a $1,000 minimum for investing (which is considered low), however Schwab waives this minimum if you set up a minimum automatic monthly deposit of at least $100 and open a checking account with them.
- Fund. After you open the account you need to simply put some money in it. Since you need $1,000 to buy most funds, start putting money into your account until you pass that 1K mark. It may take you some time to save up to that amount and that is OK! Continue to put money into it each month so you get it out of your bank account and don’t spend it. When you fund your account the money is put into a settlement account. Think of it as a holding area for your money – it is out of your bank account but it is not yet invested in anything to work for you.
- Invest. The last step is to invest your money. This is where your money works for you over time. It is important to think of this as a long term investment, in the short term your money will fluctuate up and down. However, in the long term you will gain around 8% on your money (10% minus inflation). This average has stayed consistent for a remarkable long time – go check out a chart of the stock market over time if you would like. When you are picking your investments you have two options.
The first is to select a target retirement date fund. This is one fund that you can invest in that is spread out among a large amount of different investments based on how close you are to taking the money out. The pros to this fund is that it automatically re-balances your fund if some things out perform others and will re-balance based on how close you are to retirement. This option is definitely more hands-off. I have seen some people say this option has lower returns than the second option but I have not found any information to back that up. It seems people may be referencing the initial target date funds which had higher fees attached to them.
The second option is to buy a handful of different funds and create your own asset allocation. If you want to spend time learning more about different stocks, bonds, international and domestics, and be hands on with your money then this is the option for you. One thing to remember though, even the best investors struggle to beat the market year after year. That is why you should be focusing on this as a long-term investment and not trying to beat the market on the short term. There are a few cons to this option – each fund will have at least a $1K minimum so it will take you some time to build up enough money to buy multiple funds and actually reach your asset allocation. Also, over time your allocation will become skewed as some funds outperform others and you will have to take time to re-balance your portfolio about once a year.
One important thing to look at when you are choosing which funds to invest in is the operating expenses. This is basically money you are giving up for them to manage your account and funds. You want this fee to be under .2%. When I was looking around on Vanguard the retirement date funds were around .15% and if you were doing your own asset allocation they were between .08 and .12%. By keeping your fee under .2% you are just putting more of the money you make through growth in your pocket.
For full disclosure, I chose to open mine with Vanguard and use the retirement target date fund. It gets me putting money away and investing it for now and if I ever want to take the time to switch over to doing the allocation myself then I can make that change in the future. If you do one thing from these emails, open up your Roth IRA now. Even if you only put in a few dollars a month, it will start the 5 year timer for when you can take out money (for emergencies only!) and get you to start saving and investing.