Pragmatic Finance

Earlier this year I made the decision to open an ira.  If you are unsure if you should open one, check out my earlier advice to start investing early with a Roth IRA.  I wasn’t that confident about where and how to open and invest in one. As tax day came closer, with it the deadline for 2005 contributions, I made a decision to invest in target year retirement funds. These are basically funds that set a certain asset allocation based on your retirement date. When you are young they invest heavily in stocks and shift more into fixed income and bonds as you get closer to retirement.

I think that these are a great idea for those that aren’t that knowledgeable about asset allocation, like me, or who just want to put their money away and enjoy other facets of life. I think in the future I will set my own allocation with index funds and possibly ETFs as I learn more and invest larger sums. Until then I think I will stick with the target date ones.

Well, I made a list of what I wanted; I guess I am hard to please.

I didn’t want to pay an annual fee maintenance fee. The account would have to be really good to have this every year.

I wanted a large selection of mutual and index funds for later when I got more experience.

A low expense ratio. The expense ratio refers to the amount they take off the top of your money every year for choosing the assets in your fund. Obviously this is a big deal as this will become very significant after years of compounding.

Trading fees, account and fund minimums, and my general feeling about the company were also important.

So the question, which choice is best?

Well, you can go with a discount brokerage. If you are going to be purchasing etfs then the price per trade could be a big factor. I am probably gonna stay away from them for the time being so there isn’t an advantage here. Also, some will charge fees for purchasing mutual funds as well. This didn’t appeal to me as I want to have the option of dollar cost averaging.

I eventually narrowed it down to three companies and compared the minimum requirements, fees, expense ratios, etc on their funds with a target retirement of 2040-2050.

Vanguard: I have heard great things about the mutual funds at Vanguard so I decided to look at them first. They have the Vanguard Target Retirement Fund 2005 through 2050 in increments of 5 years. The 2040 (VFORX), 2045 (VTIVX), and 2050 (VFIFX) all have expense ratios of around 0.21%. However, it takes $3,000 to open an account and there is a $10 fee for each fund you hold that is under 5k. So great expense ratio, but large minimums to avoid fees.

Fidelity: I had already had a brokerage account from their previous promotion so I was already familiar with their website and had poked around looking at different funds. I knew they had some very low expense index funds so that could be a plus later. They call their target date funds the Fidelity Freedom Funds and have 2005 through 2040. Being in my 20s the 2040 (FFFFX) was the main one I looked at. It has a higher expense ratio of 0.76%. The good thing, though, is that if you can contribute $200 a month you can open what they call a SimpleStart IRA. This allows you to avoid the $2,500 minimum that most of their funds have. This would be great for someone who wanted to start one but didn’t have a lot of savings he felt comfortable putting away at the moment.

T. Rowe Price: I wasn’t too familiar with them but then again a year ago I didn’t know what a Roth IRA was so that shouldn’t stop me from investigating. They have the T. Rowe Price Retirement funds from ages 2005 through 45. I zoomed in on the 2040 (TRRDX) and 2045 (TRRKX) ones. The expense ratios for these are in the 0.80s. It only takes 1k to open an ira with them but like Vanguard, you must pay a $10 fee for every fund that has less than 5k in it unless you have $50,000 in assets there. Overall, they have the same account fees as Vanguard but higher expense ratio. The benefit being an opening requirement in between the two.

I haven’t done much research into the Schwab Target 2040 (SWERX) or JPMorgan SmartRetirement 2040 (SMTAX) after seeing expense ratios of 0.99 and 1.30 respectively. Just seems too high. I might as well get a regular mutual fund for that cost. So is that enough symbols for you yet?

I ultimately went with Vanguard. Honestly, I waited until I had over 4k ready to go before I even started doing research as I wasn’t aware of programs like Fidelity’s Simplestart ira. So overall the main concern was what I wanted long term for the account. I liked the fact that Vanguard has a very low expense ratio on their funds. This will definetely pay over time and make up for that $10 fee I paid earlier. They also have a pretty good reputation for being investor friendly and not just profit friendly. Hopefully this will continue in the future.

I am curious if you have tried any of the choices I listed. If so, what is your opinion of them? Or are there any good choices out there that I missed?

If there is one thing I really regret financially is not starting a Roth IRA years ago. A Roth IRA is a retirement account that grows your investments tax free. The money you place in there is after taxes but you won’t pay any taxes on any of it if you pull it out after your 59 1/2 and it has been open for five years. This is fantastic if you think you are in a lower tax bracket now than you think you will be when you get older. This makes it especially attractive for younger workers that are just starting to save for retirement, such as myself, who will almost assuredly make much more money later in life than they do now.

If you have an employee sponsered retirement program where they match your contributions, such as a 401k, then you will probably want to contribute to that before your ira. You can’t beat free money. If you don’t fit my profile you might want to check out a comparison of traditional versus roth iras. In order to qualify for a roth, your income must be under $160,000 for married filing jointly and $110,000 for single.

For IRA’s you are allowed to contribute $4,000 per year total to all iras, assuming you’ve earned that much income. So, for example, if you contribute 4k to a roth ira, you can’t contribute any to a traditional ira. In 2008 it will increase to 5k. Also, you can fund an additional thousand if you are older than 50. You have until April 15 to fund the previous year’s contribution. This also means that anytime after January 1st until tax day you can fund the current or previous year.

One of the biggest advantages of Roth IRAs is that you can take out your principal contribution at any time without penalty. The only downside being that you won’t be able to go back and replace that previous year’s contribution that you took out. You can also take out up to 10k of your earnings for a first time house purchase.

You can put just about any investment into an IRA, including stocks, bonds, cds, mutual funds, and index funds. Heck, I think there is even ways to put real estate, treasury bills, and limited partnerships into them. If you are just starting out you might want to purchase one of the retirement mutual funds from either Vanguard, Fidelity, or T. Rowe. The retirement funds consist of a mixture of domestic stocks, foreign stocks, and bonds. They have a target date and are adjusted to be aggressive when your young and more conservative as you get older.

For some more information about target year retirement funds check out my post on Simplifying Your IRA. I discuss many of the options available and why I chose Vanguard’s Target Retirement 2045 Fund (VTIVX).