choosing a Roth IRA

[md0127]

-I'm 25 years old, single
-$72K salary
-$15K in a checking account
-$30K in a Bank of America savings account earning only .10%
-$17K in 401K which I contribute 6% to get the max employer match.
-$14K in 3 student loans w/ fixed interest rates ranging from 5.5-6.5%
-I don't own a credit card so I have no other debt
-I rent an apartment and my car is paid off

I'm planning on opening up a Roth IRA and depositing the max contribution right away. How do you choose who to open a Roth IRA with? And how do you choose which one?

Thanks.

[Wino]

First off, pay off the student loans with the BOA savings. You are paying $840 per year for the privilege of making $140 per year in interest on that $14K. Basically, you are throwing away $700 per year.

There are three sites with consumer-friendly Roths that are commonly suggested to neophyte investors:

https://individual.troweprice.com/public/Retail (T Rowe Price)
https://investor.vanguard.com/home/ (Vanguard)
https://www.fidelity.com/ (Fidelity)

I have accounts on two of them, and I would rate neither above the other. They are both adequate to my needs. All three sites are generally well-respected in the financial world.

As far as the funds to choose, it is a personal preference. You must determine the amount of risk/reward ratio you are comfortable living with. Just because a fund has averaged 15% for 10 years, there is no guarantee or even suggestion that you'll continue to get such returns. It is quite possible that you'll lose 10% or more next year in such a fund. Most people tend to only look at the "Reward" side of the ratio. You need to understand and fully accept the sentence: Past performance is no guarantee of future results. I suggest, though, that you tend to temper that statement with WC Fields' observation: The race is not always to the swift, nor the battle to the strong, but that's the way to bet." (To allay future disagreement, citing the WCF quote should not be construed as me suggesting that stock-market-based investing is equivalent to betting.)

The long-term performance of most suitable funds, though, is positive. Many people will suggest a market index fund of some type. Others will suggest a retirement-year target fund (in your case, something like 2055). Personally, I find the target funds to become too conservative too soon, and I tend to use the target years well-beyond my retirement "target." I don't plan to die early just because the actuarial tables suggest it. I find it funny that Financial Planners tend to suggest the reward side of risk/reward, but tend to fall on the "die early" side of the "live longer/die earlier" actuarial tables, but that's just a personal observation which may or may not hold up under investigative scrutiny. I think the conventional wisdom of "plan to be broke by a certain age" in financial planning is somewhat short-sighted and counter-intuitive to my thinking. I plan to have money to leave to my children when I pass away, barring economic collapse, so I don't base my planned withdrawal rate on emptying my account at a certain age. In fact, my planning is based on not losing principal dollar-value. My after-retirement frugality will have to account for inflation.

Whatever fund or combination of funds you choose, make sure you continue to fund your Roth every year. When the market/fund is down, you get more shares. When the market/fund is up, you'll get fewer shares, but your "confidence" will be high because the value is going up. Of course, if the fund value continues down for years and other funds are increasing, you may want to shift the account to more advantageous funds, but these decisions become problematic and your personal style will vary. I suggest you solicit advice in forums such as this (there are others, as well) before you shift funds; however, be aware that the final decision is always yours and yours alone.

Short answer: Go to one or more of the three links above, and ask in reputable forums about specific funds you fancy before you make your share purchase. Always read the prospectus yourself and ask for clarification of any items you do not understand. Be aware that the account set up process can take more than a week, so don't wait until the last minute to set up the account.

[MatthewC]

md1027,

I heavily recommend that you invest $30 and buy yourself the book "What Works on Wall Street" (4th Edition) by James P. O'Shaughnessy. I cringe inside anytime someone says "risk/reward ratio" in regards to investing. This book shows how you can have greater rewards and less risk at the same time. The average person who reads this book AND who can and does implement what they learn within in should easily add (over the long run) about 3% to their return if they were absolutely lazy (but implemented it properly), 5% if they were serious about it, or somewhere around 8-10% if they data mined the book and walked away with a highly complete understanding of all the statistics contained in the book and were able to implement their understanding.

The important difference between this book and other books on stocks is that this book operates on hard market data, giving you the statistics to back this up. Most books on stocks will give you the author's view on how the stock market works. This book gives you the numbers *showing you* how the stock market has worked for more than four decades, with some charts going all the way back to 1927. That is why this is the only book on stocks that I will recommend to people. It has the numbers to back up what it says, not merely the opinions of the author like so many others.

[Wino]

That is why this is the only book on stocks that I will recommend to people. It has the numbers to back up what it says, not merely the opinions of the author like so many others.

Let me get this straight.

You're suggesting a neophyte investor start by picking stocks based on a single book's recommendations?

Did I read your suggestion correctly? If I did, then I must disagree completely. He would be much, much (a few more "muches") better off in any target or index fund.

[MatthewC]

People are neophyte investors because they are either uninformed or mis-educated. You just recommended indexing to that neophyte investor. I, on the other hand, recommended a way to end their neophyte investor status and turn them into an above-average investor.

Being a neophyte investor is not about how long you have been investing or your track record. It has to do with knowledge. Anyone that, without knowledge, goes from individual stock picks to indexing, has just graduated to the state of being an "average" investor. I'd rank these people as novice instead of neophyte.

But, offering knowledge that would allow for better returns than indexing, and a recommendation to act on that knowledge... You're upset about that?

A little over a year ago, I sent someone a stock portfolio to buy. I haven't received a message from them telling me that it has been sold yet, despite that it was supposed to be sold after one full year. I based that portfolio on information within that book that I had studied, acquired the database skills so I could implement what I could learn, and also acquired a source of market data so I had something to work with. If that person hasn't sold the portfolio yet, then it has gained 46.5% since it was bought (this is including expenses, but not including the dividends that those stocks earned). What did the mighty S&P 500 do over the same time period? 15.42%.

So yeah, I look down on indexing because I know there is something better. You seem to look down on individual stock picks because you refuse to believe that a system as easy as crunching a few numbers and scanning the news briefly (this takes me 2 1/2 to 4 hours total) can so easily beat indexing. At $30, that book is a bargain. Why settle for average results when you can do better?

From 2000-2009, the S&P 500 lost around 20% of its starting value. From the same decade of time, the best strategy in that book (results shown on page 590) returned a total gain of 646%. (slightly more than 20% a year compounding)

That's the difference between indexing and using a superior stock-picking system. I am sure you know that there are funds out there that mimic the S&P 500. And the S&P has a decent track record, compared to many funds. But you have just recommended that this guy stay away from learning how to invest properly and trust his money to people who, between the dot com crash and the great recession, likely lost money in the stock market, when following a solid system for picking stocks and doing it yourself could have much better results.

If you're fine with getting into funds that can lose money over 10 years, then pick a fund. If you want to learn how to pick a group of individual stocks that will provide superior investing returns, then read What Works on Wall Street (Fourth Edition). (There are TONS of strategies in this book that have NOT lost money over 10-year periods. Can the popular S&P 500 claim the same? No.)

[Wino]

But, offering knowledge that would allow for better returns than indexing, and a recommendation to act on that knowledge... You're upset about that?

(snip)

So yeah, I look down on indexing because I know there is something better. You seem to look down on individual stock picks (snip)

From 2000-2009, the S&P 500 lost around 20% of its starting value. From the same decade of time, the best strategy in that book (results shown on page 590) returned a total gain of 646%. (slightly more than 20% a year compounding)

That's the difference between indexing and using a superior stock-picking system. (snip)

If you're fine with getting into funds that can lose money over 10 years, then pick a fund. If you want to learn how to pick a group of individual stocks that will provide superior investing returns, then read What Works on Wall Street (Fourth Edition). (There are TONS of strategies in this book that have NOT lost money over 10-year periods. Can the popular S&P 500 claim the same? No.)

Where to begin?

1. I'm not upset. You're some stranger on an internet forum peddling bad advice. I wanted to make sure I was correct in my interpretation of your suggestion. I was correct. You want a new investor who doesn't even know how to set up a Roth IRA to read a several-hundred page tome filled with data table after data table in order to pick stocks according to some plan or scheme to be grasped by him reading over 700 pages of numbers and formulas.

2. 2000 - 2009. Well, that's a fine way to cherry pick data. Of course, if you went from 1995 to 2005, the returns would have been the opposite. Also, the Roth investor is forced to dollar-cost-average due to its annual limit, so in 2009, his money would have been buying many more shares than he purchased in 2000, and the rebound since 2009 would have doubled his money again. Your stock plan? Periodic re-assessment and constant juggling, and continual losers. If it were as easy as putting in 2 to 4 hours per week, you'd be in Tahiti picking stocks while your portfolio grows by 50% annually rather than peddling a book on an internet forum.

3. The difference between indexing and a "superior stock picking system" is the difference between slow, steady, reliable growth and gambling. If your method is so good, why not set up an automated system to do the picks? I can show you how to look up stock and bonds with a spreadsheet, how to parse an RSS feed, and how to manually enter your 2 to 4 hours of work each week. Any "system" can be automated. Why, we'd both get rich in no time! I need to come up with a catchy phrase for that. I know! Let's call your plan the "stock picking get rich quick scheme!"

4. 90% of the people who individually invest in the stock markets lose money. Why? Because they follow some hare-brained scheme that may or may not work and don't have the knowledge and time to do the research and diligence regularly. People who index pay someone else to put in the due diligence and research. I bet most fund managers can read and have access to Amazon to buy the book you're espousing. Why, for 600% returns, you should be running your own mutual fund and keeping 1% of a billion dollars annually for your services. In ten years, your billion dollars will be nearly $8 billion! Who wouldn't pay for those returns?! And you'd be making nearly $100 million a year for your troubles. There's a win-win situation, if your scheme works.

I stand by my original post. If your plan is so good, you'd be using it yourself and you would be turning down calls from Warren Buffet because you can't be bothered with amateurs. Instead, you're on an internet forum trying to get people to buy a book and adhere to some scheme. Why isn't everyone on Wall Street using this book if it guarantees 600% returns in a few years?

I'll leave it to the OP to decide which course is right for him. I hope he has also asked his question elsewhere so he can get more than the opinions of two strangers.

[MatthewC]

What is in the book is simple enough for a 5th grader to understand, assuming of course you actually passed 5th grade math. 2000-2009 was not "cherry picking". It was the most recent 10 years of data covered in the book and covered two major disasters in the stock market, making it a difficult time. If a strategy could excel there using long positions, it should be able to excel just about any decade, wouldn't you think?

Regardless, during those years, the S&P 500 went up about 164% total, slightly more than 10% a year.

During those same 10 years, this system returned 1094% (just over 27% a year).

So yeah, this system still crushed the S&P 500 by moving it to more favorable years.

To get any more automated than it is right now, I'd need a programmer. I already spent hours "prepping" so I can sort the data fast. (used to take more than 5 hours just to screen for stocks, never mind the news)

And to answer your accusation that this is some "hair-brained scheme", all this data was gathered using the CompuStat database on stocks.

People tend to do poorly in stocks because they try to time the market, pulling money from it when they are scared of losing more, and putting money in when they feel like it will do well. There have been many studies on this, which have shown time and time again that a simple automated system will beat groups of people who trade this way consistently. If you want to "beat the market", you need to leave your money in the market in good times and in bad times. People just don't have the predictive ability to tell when is the right time to go in. If they did, you wouldn't have your 90% don't beat the market stat. But that's the sort of thing people are likely to do.

Of course, you realize that although Warren Buffet *recommends* others index, he himself buys individual stocks.

[md0127]

Thanks for the input everybody. I plan on opening a Roth IRA with Vanguard as it sounds like their low fees are a huge advantage. Now choosing the funds...
I don't know much about the stock market so I'm planning on going with an index fund or target 2055 fund. Is there any advantage for one vs. the other?

Thanks.

[Petunia 100]

Thanks for the input everybody. I plan on opening a Roth IRA with Vanguard as it sounds like their low fees are a huge advantage. Now choosing the funds...
I don't know much about the stock market so I'm planning on going with an index fund or target 2055 fund. Is there any advantage for one vs. the other?

Thanks.

Vanguard's Target Retirement Funds invest in Vanguard's index funds. So, TR 2055 will hold Total Stock Market Index Fund, Total International Stock Index Fund, Total Bond Market Index Fund, and a tiny bit of the new Total International Bond Market Index.

The TR fund will automatically rebalance for you, and will slowly grow more conservative as the target retirement date approaches.

I think you have made an excellent choice.

[Petunia 100]

What is in the book is simple enough for a 5th grader to understand, assuming of course you actually passed 5th grade math. 2000-2009 was not "cherry picking". It was the most recent 10 years of data covered in the book and covered two major disasters in the stock market, making it a difficult time. If a strategy could excel there using long positions, it should be able to excel just about any decade, wouldn't you think?

Regardless, during those years, the S&P 500 went up about 164% total, slightly more than 10% a year.

During those same 10 years, this system returned 1094% (just over 27% a year).

So yeah, this system still crushed the S&P 500 by moving it to more favorable years.

To get any more automated than it is right now, I'd need a programmer. I already spent hours "prepping" so I can sort the data fast. (used to take more than 5 hours just to screen for stocks, never mind the news)

And to answer your accusation that this is some "hair-brained scheme", all this data was gathered using the CompuStat database on stocks.

People tend to do poorly in stocks because they try to time the market, pulling money from it when they are scared of losing more, and putting money in when they feel like it will do well. There have been many studies on this, which have shown time and time again that a simple automated system will beat groups of people who trade this way consistently. If you want to "beat the market", you need to leave your money in the market in good times and in bad times. People just don't have the predictive ability to tell when is the right time to go in. If they did, you wouldn't have your 90% don't beat the market stat. But that's the sort of thing people are likely to do.

Of course, you realize that although Warren Buffet *recommends* others index, he himself buys individual stocks.

I agree with Wino. If it were really that easy, then everyone would be doing it. Plenty of professional money managers with MBAs from Harvard fail to consistently match the market, let alone beat it.

Yes, there is the occasional excellent stock-picker such as Warren Buffet, Peter Lynch, or Bill Nygren. I know that I am not in their league, so I will happily "settle" for market returns less expenses.

Perhaps you will one day join their ranks.

[MatthewC]

If I join the rank of indexers, it will only be when my portfolios, which I post on my forum (linked to below) start consistently doing worse than the market than better than the market.

Do you know why more people don't invest this way? It is because there are a lot of people like you, who claim it "can't be that easy". Or that "everyone would be doing it". Well, it probably wouldn't work if everyone did it, because then the market would be based totally on fundamentals and then my method would become basically the same as indexing as the ratios for the various stocks evened out quite a bit. The reason it works, and continues to work, is that 1) Not everyone uses it. There are people that use the company's financials, the news, various technical indicators, indexing, stock tips from people, etc. This method works because the majority of investors are not being rational, despite the belief of many that the markets are efficient. The book that I recommend shows that, in fact, the market is not efficient. If that theory was true, this couldn't work. And 2) Many people are emotional investors, not treating stocks equally. Can you really justify the movement of a stock at IPO which skyrockets the first couple weeks and then comes crashing down? An efficient market would keep it more level and reduce such fluctuation. The fact that stocks are not treated equally is what creates the inequality that leads to value investing producing superior returns. You can't possibly justify the way that people were investing in tech stocks that represented companies that had absolutely no sales and yet continued to have their stock climb and climb in price before the crash. The markets are not efficient. But because many people believe they are, it leads to exploitable situations.

The book has praise from several reputable sources, including Barron's. The quote that I like best is from The Financial Analysts' Journal, which says, "What Works on Wall Street is indisputably a major contribution to empirical research on the behavior of common stocks in the United States.... Conceivably, the influence of What Works on Wall Street will prove immense."

Of course, the fact that you are just blasting it without doing any research shows why the knowledge isn't spreading. If everyone behaved the way you did, we'd never make any technological progress. There'd be no planes because people would still be saying, "We didn't fly last year or the year before. If man were meant to fly, he'd have been born with wings."

This is relatively NEW research that started coming to light in the 1990s, which means that most long-term investors likely never heard of it before. In fact, the only reason that it is even possible to know today is because of the databases that we have, along with the software that lets us analyze results. You, thinking that the market is efficient, would assume that the very existence of such knowledge would "correct" the stock market and make it no longer workable. However, this information has continued to work for more than a decade after which it was discovered, showing that indeed the market is inefficient and just because people believe that the market self-corrects based on all available knowledge does not make it so.

This is use of fundamental data used from the value investing perspective. Even if you get to where you have people who are using fundamentals, more people are interested in growth stocks instead of value stocks. However, this book shows conclusively that value stocks outperform growth stocks.

[Petunia 100]

If I join the rank of indexers, it will only be when my portfolios, which I post on my forum (linked to below) start consistently doing worse than the market than better than the market.

Actually, what I meant was that perhaps one day you will join the ranks of Warren Buffet, Peter Lynch, and Bill Nygren.