In the past month, I have helped two friends open their very first Roth IRA’s. Both friends were in their mid 30’s. Both friends had put it off for years because they didn’t know where to start. Both friends let the fear of making an investment mistake prevent them from taking action. The path of least resistance was to do nothing.
They should have probably started their IRA’s a decade earlier, but I’m here to tell you, it is never too late to get started.
So what is a Roth IRA anyway? Simply put, it is a retirement account, funded with after-tax dollars, that grows tax-free.
The Roth IRA, established by the Taxpayer Relief Act of 1997, created one of the most powerful savings tools ever offered to Americans. Senator William Roth of Delaware is credited with sponsoring the bill.
With decades of tax-free growth and the power of compounding interest, you could become a millionaire with very little effort. In 1997 the contribution limit was $2000 and today has grown to $6000 per year. For married couples, this amount doubles to $12,000. The limit is occasionally raised based on inflation and was last increased in 2019. Prior to 2019, the limit was $5,500.
The top 4 reasons you should open a Roth IRA today
- A Roth IRA is not tied to your employer. You can change jobs without the hassle of having to transfer accounts. As you move along in your career you may change jobs several times. That usually means a new 401k with each new employer. Before long you have several ghost 401k’s. Not so with the Roth IRA.
- All market returns and dividends grow tax-free. You might think that if your 401k account balance reads $100,000 it is all yours. Nope. Don’t forget Uncle Sam. The government will take somewhere between 15-35%. In addition, there may be state taxes as well. So your $100,000 account balance might be worth only $75,000. Bummer huh!
- You can control your fees. This is where things get exciting. You see, all index funds and mutual funds charge a fee. These fees are called expense ratios. Your goal is to find the smallest expense ratio(fee) possible. Contrary to what you may think, there is no correlation between what an index fund charges and the returns it generates. So for example, my favorite index fund for a Roth IRA is VTSAX. It has an expense ratio of 0.04%. Compare this to another popular fund such as The Growth Fund Of America (VGTHX) with an expense ratio of 0.62%, and the difference can add up to 10’s of thousands of dollars over your working years.
- You get to decide what investments go into your Roth IRA. For your employer 401k, your investment choices are limited to what your employer allows you to invest in. Sometimes this can mean high fee funds or poorly thought out investment options. But with a Roth IRA the investment choices are nearly limitless.
Bonus: Reason #5 You Should Start A Roth IRA Today.
Compound interest- Albert Einstein is often quoted as saying that compound interest is the eighth wonder of the world. If one of the smartest people in the history of humanity thinks compound returns are amazing, then I want every part of it.
Here is a real-world example of compound returns and how starting early can work in your favor.
Meet Tim. Tim wants to be a millionaire by the time he turns 65 years old. If Tim starts a Roth IRA at age 20 he would need to invest $306 dollars per month to have $1,000,000 at age 65. If Tim waited until age 30 that amount would double to $645 per month to have the same one million at age 65. If Tim waited until age 40 he would need to invest $1,396 per month and If Tim waited until age 50 he would need to invest $3,406 per month to reach 1 million dollars by age 65.
From this example, you can see how important it is to start early.
Where to start your Roth IRA
My top three investment companies to open your Roth IRA online are: Vanguard, Charles Schwab, and Fidelity. I personally use Vanguard and Charles Schwab, so I will focus on these two brokerages. Think of Vanguard as a co-op or credit union where the investors own the company. Vanguard is not publicly traded and thus has no need to earn a profit for shareholders.
On the other hand, Charles Schwab is a publicly traded company that has a mission to offer low-cost brokerage services to clients. Charles Schwab aggressively competes with Vanguard and Fidelity to reduce expense ratios. Usually once a year, these companies announce that they are lowing fees on their funds and the other companies will follow suit.
So there you have it. The top 4 reasons you should open a Roth IRA today, with one bonus reason. No more procrastinating. Go online and open that Roth IRA today.
If you have questions or ideas for future posts leave me a comment. Together we can retire early.
*Full disclosure. I own Vanguard and Charles Schwab funds in my Roth IRA and taxable accounts. I was not paid in any way for this post. Just trying to share my love for low-cost index funds.