Retirement question from newly employed college grad

[IVSPORT]

Thanks in advance for any help and advice.

I just graduated and started my first full-time salaried position. I'm living at home in San Francisco (where I was born and raised) because paying rent in SF is ridiculous and I want to save/pay off student loans in the next year.

My financial situation is as follows:

Salary: 45K
Checking/savings: 2K
Student Loan Balance: 14.5K

Since I barely have any expenses (besides making more than the minimum payments on my loan balance and a little bit of food/gas), I want to be smart and start saving early in life. The taxes on my paycheck will cost me over 10K over the year and makes getting every paycheck a bittersweet moment. To deal with this, I've been told that starting an IRA is the way to go. My employer doesn't offer any direct plans so anything I do has to be on my own initiative.

I am wary of investing in stocks or mutual funds since I had a bad experience early on in life and don't know enough about the market so I just want something to store my money in and hopefully receive a small interest rate on (if possible).

So, basically, my question is what is the smartest thing to do with about 1,000/month: Regular IRA, Roth IRA, 401K or something I don't even know about? Any advice on which one is best and how to go about creating one of these accounts would be greatly appreciated.

[IVSPORT]

FYI, my interest rate on the 14.5K in loans is just over 6%.

[boosami]

Most financial experts would recommend you open a Roth IRA since you are young and just starting out career-wise.

The benefit of a Roth IRA is that the money you put in is post-tax. That means when you withdraw it in 40+ years, you won't have to pay additional taxes on it. You would have to pay income tax on Traditional IRA withdrawls.

I'd suggest opening a fee-free Roth IRA at Fidelity and choosing a managed portfolio. A Roth IRA will be mutual funds... If you're worried though, you can pick a portfolio aimed at retirement in 2045. It will automatically adjust your holdings and then you won't have to worry about dealing with it.

However, with any IRA (or any combination of IRAs) the maximum total contribution is $5,000 (for 2008). Next year, space out your IRA deposits to equal the maximum contribution and put the remainder in a high yield savings account like ING Direct.

[IVSPORT]

Thanks for the tip. My only question/concern is with the mutual fund. What do you mean when you say that I can pick a portfolio aimed at retirement in 2045 and that I won't have to worry about dealing with it? I don't understand what you mean when you say "It will automatically adjust to your holdings." I just want a very low-risk way to save my money and avoid taxes (a Roth IRA seems the way to go) even if it means a lower-reward compared to other investment alternatives.

[disneysteve]

A Target Retirement fund is diversified among US and foreign stocks and also holds bonds. As you get closer to retirement age, it gradually becomes more conservative, holding more in bonds and less in stocks.

I don't know what your prior bad experience with stocks was, but I'd say you really need to get over it and move forward. You will NEVER reach your financial goals without taking some market risk with your money. Just make sure you diversify - don't put all of your eggs in one basket. Don't invest more than 5-10% of your portfolio in a single company. Stick with no-load, low-cost mutual funds from companies like Vanguard, T. Rowe Price and Fidelity, among others, and you will do just fine.

$1,000/month earning an average annual return of 7% will be worth over $2.6 million in 40 years.

[boosami]

Traditional IRAs and Roth IRAs are both invested in mutual funds. In fact, they have some (or all) of the exact same fund choices between them if they are from the same company.

Different mutual funds have different risks associated with them. There are some very conservative mutual funds that are low, low risk (e.g. ones that consist of 100% bonds). There are also high-risk, high-return funds that consist of 100% stock and no bonds for example.

When investing for retirement, you want to adjust your porfolio so that by the time you retire your funds are stable, locked into low-risk funds. But you still want those big returns, so you shoulds start with an aggressive fund. As you get closer and closer to retirement the idea is to sell off the aggressive funds and buy more conservative ones. That way you get both benefits... big returns with ultimate security by the time you retire.

A managed fund with a target retirement date of 2045 means that it is managed by a professional who adjusts the holdings for everyone who buys into it based on that retirement date. You can put all your money in that fund and know nothing about stocks/bonds/the market and by retirement you will have a stable, low-risk portfolio that took advantage of high returns early on in your life.

Note: A Roth only avoids taxes once you start taking distributions from it after you retire. It does not save you any taxes while you are making deposits into it. A Traditional IRA does the opposite--you save taxes on it when you deposit into it, but then have to pay those after you retire when you take distributions from it.

[boosami]

Just another note: Retirement funds like IRAs are not short term savings vehicles. Do not put money in them that you want to be able to use before you retire. If you use them that way, you will be wasting your money because you will be penalized and in some cases taxed for early withdrawl.

[disneysteve]

Traditional IRAs and Roth IRAs are both invested in mutual funds.

I want to clarify this. IRA/Roth is just a type of account. There are many options of what you put into that account. The money in your IRA can be invested in individual stocks, individual bonds, CDs, money market accounts, stock mutual funds, bond mutual funds and more. You don't have to invest in mutual funds only within these accounts.

Many, if not most, investors choose mutual funds because they provide instant diversification regardless of the amount invested. If you are just starting out and putting in $1,000, a mutual fund allows you to own a piece of 20 or 30 or 50 or 500 or 2000 different companies from day one. You couldn't possibly have that kind of diversification without a mutual fund.

[IVSPORT]

Thank you all for the help. I understand things a lot better and feel prepared to take the necessary financial risks in order to ensure a better future. Thanks again.

[maat55]

As young as you are, I would just focus on getting out of debt first. Then, invest 10% of your gross income in Stock mutual funds. You'll retire rich.

[atomicrc11]

Also keep in mind that in any IRA's you open, you can only invest $5000 per year. Therefore, it may be best to invest the $5000 into a Roth IRA and then put the rest towards debt.

Also, once you pick a fund company and Target Date Fund, such as a 2045 fund, don't worry about the ups and downs. You're retirement is so far in the future you don't need to keep tabs on it that much. I make decisions once a year on my retirement funds.

Personally I like Fidelity, and you can open a SmartStart IRA for as little at $200 per month. You can do more of course. Also, you can't go wrong with the likes of Fidelity, Vanguard, TIAA-CREF, T. Rowe Price or Charles Schwab. They are all good companies with good funds.

[jIM_Ohio]

If the IRA is going to be invested aggressively, I would advise to invest before paying down the debt. Then invest more than the minimum once the debt is paid off.

example- put 15% of gross pay into retirement funds which are 100% equity and 5% of gross pay to debt, then once debt is paid off put 20% into similar allocation.

If you would invest conservatively, I would advise to pay down debt more earlier. Still invest for retirement some, but ramp up more later.

example- save 10% of gross pay for retirement and apply 10% to debt repayment (to pay debt off sooner than above). Investments for retirement might be 60% equity and 40% bonds. When debt is paid off, invest 30% of gross for retirement.

[osadg]

I'm personally a fan of the Roth IRA, and it's where my retirement money goes. If you look into the differences between IRAs and Roth IRAs they both have mutual funds, but since you're just starting out-you might really want to look into the Roth-it allows you to pull some money out if you're buying your first home. Mutual funds have different layers and you can be as risky or as conservative as you would like. You might want to check out a site like TDAmeritrade where you can read about the different types of retirement accounts you can save for and the different investment vehicles.