Friday, July 24, 2009

Opening a Roth IRA

As soon as I figure out who my employer is, I will be opening a Roth IRA account with Vanguard. (Don't laugh at me. They require it for the paperwork, and I really don't know who is officially my employer. The structure of my fellowship is so byzantine that I can't tell if I'm employed by (a) the US Navy, (b) the DoD in general, (c) the American Society for Engineering Education which is paid to administer the program, or (d) self-employed as a contractor, though I'm pretty sure I'd know if it were that one. This is ridiculous.) For those of you wondering what a Roth IRA is, I refer you to this series over at Get Rich Slowly (he's got links at the bottom to the rest of the series).

You may say, "Why are you worrying about retirement already? That's like 40 years away!" The answer, my friends, is the magic of compound interest. The sooner you start, the less you need to sack away to pay for retirement. For example, my wife and I deciding to wait two or three more years to begin funding our retirement account(s) could mean a difference of something like a hundred thousand dollars in the retirement fund come time to retire! We'd have to contribute significantly more each year to make up that gap. (Of course that all depends on assumptions about rate of return, etc.)

So, why open it with Vanguard? Why not some other firm? First, I like their corporate structure. That sounds ridiculous, I know. But unlike every other investment firm I know of, Vanguard eliminates the need to milk the investors to return profits to the owners by actually having investors in its funds be the owners. What does that mean in real terms?

It means essentially the lowest costs out there - the second reason I'm going with Vanguard. There are no sales loads, and they charge a minuscule percentage of assets per year. For example, the fund I'm investing in charges 0.19% per year (which is essentially deducted from returns), and has no sales load. Compare this to a random Thrivent fund I looked at, which charges 1.04% per year, and has a 5.5% front-end sales load, meaning that for every $100 you invest with them, only $94.50 actually goes toward buying shares, while the rest goes toward administrative costs. The math seemed obvious to me.

These low costs are intimately connected with the investment strategy, the third reason I'm going with Vanguard. Vanguard specializes in Index Funds, which essentially embrace the philosophy that trying to beat the market is a sucker's game, and that the best strategy is to try to track the market as a whole, ensuring the investors get average gross returns. This allows them to drive costs way down, since they're rarely doing much buying and selling, and thus the investors' net returns actually end up being above average.

Finally, Vanguard offers a "Target Retirement 2050" Fund that essentially automatically executes a close approximation of what my investment strategy would be. This is an example of what's known as a lifestyle fund, where you buy shares in a fund (which in this case in turn owns shares of several index funds), essentially acquiring a well-diversified portfolio in a single fund. On top of that, this means I never need to worry about rebalancing the portfolio, since the managers of the fund do that for me, and as the target retirement date approaches, the asset allocation is shifted to gradually less risky investments. Essentially, this is the ultimate in set-it-and-forget-it retirement plans. It will automatically execute a sound investing strategy with no input from me other than my monthly investment checks, and I don't need a bajillion dollars in assets (or a fat fee) to hire a financial planner.

So why am I telling all of you this? As with my other personal finance posts, I assume that many of my friends will be at least starting to think about these things soon, and so I figure by posting about what I'm doing, I can give them a small window into the process and maybe a starting point for their own financial journey. If nothing else, at least it fills some of my spare time!

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