Financial Challenge - Day 6
In the last challenge we talked about contributing to your 401(k) plan to get the matching funds. Unfortunately, some people don’t have access to a 401(k) fund or their company doesn’t match any contributions to the 401(k) fund. If this happens to be the case, then for most it’s time to move onto the next investment option on our “easy investing” list - opening a Roth IRA account.
The Roth IRA works a bit different than the 401(k) in that you save after-tax dollars instead of pretax dollars. This means that you don’t get a tax deduction the year your contribute to a Roth IRA, but all the earnings grow tax-free and there are no taxes to pay when you withdraw the money (with your 401(k) you have to pay taxes on all the interest earned when you withdraw the money).
You’ll have even more choices with a Roth IRA of what type of instrument(s) you want to invest in than than you do with a 401(k), but the investment strategy should be the same. Even though stocks are more volatile than other investments, for long term growth they are still your best bet. If you have a large chunk of money to begin, you want to diversify that, but for all contributions you make from now the should go into a broad based stock fund.
Roth IRA - Time and Money
In fact, the Roth IRA has a fairly small limit and the goal is to max it out. For 2005, the annual limit for a Roth IRA is $4,000 ($4,500 if you’re over 50). There are some limits which can reduce this amount if you don’t have enough earned income or if you make too much, but most should qualify for the full amount. The reason I used 2005 numbers instead of 2006 numbers is that you can still make contributions toward your 2005 limit until April 15 - if doing so just make sure to indicate that the contribution is for 2005 and not 2006 (the limit for 2006 is $4,000 for those under 50 years old and $5,000 for those over 50 years of age).
Since the limits on the Roth IRA are fairly low, the goal will be to max out this retirement account (and you’re spouses, too, if it applies) each year (that comes to $333 a month - more than our $100 minimum goal, but I think if you truly attempt each of the challenges you’ll find that $100 is a quite conservative number and the $333 is quite doable).
Some people argue that a 401(k) plan is a better investment even without a match than a Roth IRA due to the better protection it affords against creditors. While Federal laws do provide sturdy protection for 401(k) retirement savings from credit card companies, this really is a non issue to us because by the time you begin investing, your credit card debt should already be paid off.
In the time you have set aside for today’s challenge, you should open a Roth IRA account in a stock fund. I personally have mine in a Vanguard S&P 500 Index Fund, but there are many to choose from. If you are just beginning to invest, what you might find is that you don’t have the minimum amount required to open a fund. If that is the case, then you should place your savings into one of the online high interest bank accounts you opened until you reach the minimum required to open the Roth IRA account of your choice.
NOTE: The entire challenge series is what I would do with my money and is merely my opinion. You should do thorough research and seek professional advice and decide to do what is best for you. My Disclaimer
Many mutual fund companies will waive the initial minimum if you agree to a regular investment plan (monthly or quarterly). If you have the $100+ to invest each month, this may be a good option for avoiding the minimum fees. Good luck everyone!