Wednesday, 15 July 2020

How To Invest In A Roth IRA For Beginners

Do you want to know how much money I plan to have in my Roth IRA in 30 years?. over $500,000, it is not because I am smarter than you or anything like that. The only reason is that I actually invest in my Roth IRA every single year. But don't worry, because I want you to have as much money as I will, or hopefully, even more. In this article, I am going to pull back the currents to go over what you need to know, and the things you need to think through before you start investing in a Roth IRA. If you don't think about these things now, then you will just end up opening a Roth IRA account and possibly wasting money investing in something just because you did not know. 

Let's get into the article

  • Quick Disclaimer: I am Not giving you investment advice at all. These are my thoughts, my opinions. This is for informational purposes only. Please contact a professional, if you have any further questions.

1. Who Can Invest In A Roth IRA

You need to know that anyone who has a job, that has an earned income that is taxed, is able to invest in a Roth IRA. Yes, This even means a 16-year-old can invest in a Roth IRA as long as he or she has a job. This also means that you can and in my opinion should invest in an IRA. Even if you have a 401k through your current job.

2. Your Investment Options

What most people get stuck on is what in the heck should they be investing in now? I agree that this can be a little bit overwhelming, there are so many options that we get decision fatigue and end up not investing in a Roth IRA at all. I am not going to tell you exactly what to invest, but I will lay out some of the more popular options and give you my personal opinion on the ones that I prefer. Once again. I am not telling you what to do with your money, do any additional research that you need, to make a decision that aligns with your situation 

In a Roth IRA, You can invest in things from

  • Real estate investment trusts (REITs)
  • Single stock
  • Target-date funds (TDF)
  • Index funds
  • Mutual fund
  • Bonds

Single Stock Investing 

This is one you are probably more familiar with because it is where you buy a share of a single company. While you can't make money investing in one company, You are at a higher risk of losing money, since you are putting all of your money into one company. It is like having a bag with one egg in it, then dropping that bag on the ground. There is a higher likelihood that, that one egg is going to break because it is the only one in the bag. You can decide to spread out Your risk by buying shares of multiple stocks from any of the thousands of companies that are traded on the stock market. This would be like putting multiple eggs in a bag if you drop that bag, then your odds of breaking all of the eggs would greatly decrease. But the problem with investing in single stocks in your Roth IRA is that, out of the thousands and thousands of companies traded on the stock market, how do you know which ones are winners? And how you know which ones are losers?.

I agree that there are different ways to evaluate a company to decide if you should buy or not. But it is not as easy as it sounds, and it takes quite a bit of time to even come close to being good at it. So while you can't invest in single stocks, and a lot of people make money from doing this, it is a lot riskier for someone who is not interested in spending the time to evaluate all of those different companies.

Target-date funds (TDF)

Another investment option for your Roth IRA could be a target-date retirement fund. These are extremely popular within a lot of companies sponsor 401ks because they are super, super simple to invest in. Just like a company sponsor 401k, you do have the ability to invest in a target-date fund through your Roth IRA. The fund you choose is all based on the year you plan to retire. A target-date fund holds many different investments to spread your risk among many different things. I will walk you through an example in a minute. The allocation of how your money is invested is based on the date you plant or Hire. These funds basically handle the management of how your money is invested. So it is less that you have to worry about on a day-to-day basis. For example, Vanguard lists these target-date funds like this.

Target retirement. Then, the year that you plan to retire. You will notice that these are in increments of 5-years because if you are within five years of retiring. Vanguard is assuming your strategy is not going to change very much, since a person investing in this fund is not planning to retire for another 46-years. The fund manager has less money invested, into less risky bonds, ten percent to be exact. The further you are from retirement, the riskier investments can be. So that you can capitalize on the upside of the stock morgan over the long term to grow your money. Investing for the long term also gives you the ability to make up for any of those years that the stock market is down, the market generally rises over the long run, over 36 years from 1985 to 2015, the S&P 500 was up to 27 of those years, which means, it was only down 9 of those 36 years. So it was basically up 75 percent of the time.

Index funds

Specifically, low-cost index funds. I will be straight up with you and tell you that these are probably my favorite Investment vehicles for my Roth IRA. Index funds are funds that hold many different single stocks. The goal of an index fund is usually to match another index within the stock market. Probably the most famous and most popular index to try to mimic is the S&P 500, for example, Vanguard total stock market index fund VTSAX holds over 3400 different stocks, and different amounts within each stock, on their website. They gave you a breakdown of the ten largest holdings for this fund. And also, what percentage of the fund is invested in two different sectors so the top ten investments are spread among many of the largest companies in the world from Microsoft, to Apple, to Amazon, to ExxonMobil, financial services technology health and Consumer Services are some of the largest sectors that the VTSAX fund Invested

Once again, the goal of an index fund like VTSAX is to mimic what the total stock market is doing. VTSAX does this by investing in all of the companies that are in the S&P 500 index and then some because they are essentially investing in over 3,400 companies. As we know, over the long run the stock market has gone up. This fund's goal is to help you benefit from the overall rise in the stock market. So investing in a total stock market index fund like VTSAX, VFIAX. or there ETF's which are a VTI and VOO. Gives you a good chance of a return that is about the same as the total stock market in the long run. The fees for index funds are usually cheaper because it is not being actively managed by a fund manager. One thing to pay attention to is that some index funds will hold very little or even zero bonds in their portfolio. So if you are managing your investments on your own. Then you will need to think about how much you also want to invest in bonds based on when you plan to retire. We will cover more about that. Once we get into the allocation part later in this article.

Mutual fund Investing

On the surface, some mutual funds may look like a low-cost index fund. But the big difference is that most mutual funds are actively managed by a fund manager. Some people will refer to a low-cost index fund as a mutual fund, for the purposes of not confusing you in this article, think of a mutual fund and an index fund as two separate things. Mutual funds are made up of many many different investments. The type of investments each mutual fund holds is based on what the fund manager chooses to buy and sell. The cost of owning shares or the expense ratio in a mutual fund is usually high because of the many people working for that particular fund. Like the fund manager, and the people who work under him or her to decide which stocks to buy and sell. Because the buying and selling of investments are up to the fund manager, you were basically betting that that fund manager knows how to pick investments that will beat the stock market and give you a higher Return On your investment.

There have been many different studies that show that over the long term fund managers are not that good at guessing what to buy. I am not telling you not to invest in mutual funds, but I am just saying that I never would, because of the high fees associated with most of them, and the fact that the odds of that fund manager beating the market is extremely slim. So slim that the famous warren Buffett once bet a fund manager 1 million dollars on it, the fund manager was able to choose five mutual funds and bet that one of those five funds would beat the performance of the S&P 500 or the 500 largest publicly traded companies. just a reminder, back to our index fund talk. VOO, that low-cost index fund matches the S&P 500, and they invest in everything that the S&P 500 invested. This bet lasted 10-years, and the S&P outperformed every single one of those five funds that the fund manager choose.

Which is another reason that I like low-cost total stock market index funds like VTSAX, VIT, VOO, and VFIAX? 

Bonds Investing

You can invest in bonds within your Roth IRA. Now bonds are a lot less volatile. Their price generally is not going to fluctuate as much as any of the other investment options that I mentioned before. we will go more into using bonds within your Roth IRA in the allocation section of this article

Investing Platform Options

Knowing exactly where to invest your Roth IRA is not as difficult as it might sound. There are so many different places for you to choose from, I am only going to lay out a few of them for you. Each platform has its pros and cons based on your level of knowledge at this point in time, while the more important part of this whole thing is what you invest in choosing a platform is going to help you decide which investment options that you have. I do not want this decision to hold you up from funding your Roth IRA with at least something as soon as possible. Keep in mind that, you can open and fund a Roth IRA with multiple companies at once, as long as you don't exceed that yearly maximum that you are allowed, either $6,000 if you are single, or $12,000 if you were married filing jointly, then you are good to go. For example, if you decide to invest $1,000 this year in a Roth IRA through Fidelity. Then realize that you like the investment options that m1 finance offers just a little bit better, then you can turn around it and open a Roth IRA with m1 finance and start funding that account with up to $5,000 more dollars for the current year. Because $1,000 plus $5,000 equals $6,000 

Robo Advisors 

The first option I want to mention is Robo advisors. In my opinion, the three best companies in this space are betterment, wealthfront, and m1 Finance which is like a hybrid Robo advisor. With the Robo advisor like betterment and wealthfront you basically pick your goals, and they choose how to invest your money based on these goals. They will usually invest your money into low-cost index funds like we said before, are really good, like the ones that Vanguard offers. I Love these options for people who just want to throw their money every single month and let someone else handle the investing for a very reasonable fee. M1 Finance is like a hybrid Robo-advisor for many different reasons that I don't really have time to get into, in this article.

Traditional Investing Platform 

Your option would be to invest through one of the larger financial services companies. These would be companies like Vanguard, Fidelity, and Charles Schwab. These are all great places to invest your Roth IRA money. I like all of these options for hands-on investors and even passive investors as well. Even though, you can invest in these companies more passively. To get started and get things set up. You will need to at least have a little bit of knowledge when it comes to investing so that you know what to look for. 

Investment Advisors

You have to be really really careful with who you are working with if you choose to have an advisor help you. There are different types of investment advisors like brokers or even insurance Agents. You want to avoid these people because they basically make a commission on what that gets you to invested. This is problematic because their investment recommendations could be ones that benefit them more than it benefits you. What is even more messed up is that this horrible practice is completely legal. If you really want a financial adviser, then make sure that he or she is a fiduciary. And they are always working with you as a fiduciary. 

These types of advisors are legally required to keep your best interest in mind when advising you on what to invest. 

Choosing Investment Allocation

The last area you need to know about when it comes to your Roth IRA, is what you want your asset allocation to be, based on different asset classes like the ones that we talked about earlier in this article. For the sake of simplicity, think of it like this. Out of 100%. What percentage of your money do you want to be Invested in things that could grow your money? And what percentage you want to be invested in bonds which are a lot less risky and a little bit more stable. For example, someone who is younger that does not plan on needing their retirement money for another let says 40 years, might choose a 95, 5 allocation. 95% of their investments are in things that have have a higher potential to grow like single stocks, index funds, REITs, and things like that, and 5% of their money is in bonds which like we said, is a little bit less risky, and a little bit more stable.

You could also have a person who is 5 years from retirement, that has enough in their retirement portfolio, who wants their money to have the potential to grow a little bit and still be safe at the same time. This person might choose a 60/40 split. 60% of their money is investments that have the potential to grow. And 40% of their money is in bonds. One strategy some people use to determine their allocation is by taking 110 minus your age, and that's how much money you should have in assets that could grow. 

  • 110-40 = 70
  • 70% In Growth Assets
  • 30% in Bond 

If you were 40 years old, and you wanted to use that logic, you would take 110 minus 40 which equals, 70. This line of thinking would say to invest 70% of your money into things like single stocks, index funds, REITs, etc. And 30% of that money into bonds. One of the main problems with this strategy is that everyone is in different financial situations at any given age. For example, if you and I, were both 40 years old, and we each wanted to have 1.5 million dollars in our portfolio by the age of 60, you have a 1 million dollar portfolio right now, and I only have $100,000 in my portfolio, then do you think our investment allocations would look exactly the same? Probably not. I would most likely need to be investing more aggressively, which means, I would have more money in growth assets and less, and more stable investments like bonds. Your asset allocation needs to be based on where you are today and where you need to be by the time you want to start withdrawing that money for retirement.

So it has to be based on your specific needs, your specific goals, how much you are willing and able to save and invest every year, and when you will need that money. This is where a fiduciary Financial adviser would come into play, especially if you feel like you are way behind when it comes to your retirement investments.

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