Roth IRA question, mutual fund options?

[Elaine]

Hi Everyone,
I've already been putting money away through Vanguard's VTSMX, but I want to add a Roth IRA to the mix. I went to do so on the vanguard site but as I went through the process I got to a point where it said "Select your Vanguard funds in one of two ways for your Roth IRA mutual fund account" I clicked through to the full list and it showed all these different mutual funds.
I'm confused, I thought Roth IRA was the investment in and of itself? I am guessing it means that there are many ways an IRA can be invested? I didn't realize I would have to select additional investment info for an IRA so I've put it off until I'm certain I understand what I'm doing. How do I know which type of fund to select? For info I'm 26, looking to retire around 35-40, I'd be using the IRA as a retirement plan in addition to my 401k. Thanks!
-Elaine

[matchewed]

The Roth IRA is an investment vehicle, not an investment in of itself.

What you invest in within the Roth IRA will be based on your risk tolerance, goals, and tax efficiency. Cumulatively these factors should sum up to your investment policy statement and asset allocation.

In short you determine your asset allocation that you're comfortable with first then divide it amongst your accounts in a tax efficient manner.

[Elaine]

Thank you, you have confirmed what I suspected. I guess I should do a bit more research on the options. Some of this finance speak is a bit overwhelming at first but describing a Roth as a vehicle and not the actual investment makes wayyyyy more sense to me- thanks!

[Elaine]

Ok, sorry to post on here again but I'm still having some confusion about what to choose for an IRA. Do you think that just calling Vanguard and talking to them about my goals could help? Or is that like asking a car salesman if you should get a new car?

[matchewed]

What is your asset allocation?

[Frankies Girl]

Ditto on what matchewed said. I also had to figure out my asset allocation, so I googled, then read a bunch and then came back here and searched for how others set their AA up, and then I did some thinking about just how much risk I was willing to take... and that's definitely something you need to do too.

Have you read this post?
http://www.mrmoneymustache.com/2011/05/18/how-to-make-money-in-the-stock-market/

And this?
http://jlcollinsnh.com/2011/06/14/what-we-own-and-why-we-own-it/

For your age, opening a Roth IRA, maxing it out if at all possible ($5,500 this year, probably the same in 2014) and putting this Roth IRA money into his recommended mutual fund - VTSMX, would be a solid move.

Again, the Roth is a container for whatever you want to invest in - stocks, bonds, CDs, mutual funds... but that doesn't mean you have to have all of that in there.

If you want to try to understand and get some other options, check out jlcollins' series on stocks/investing:
http://jlcollinsnh.com/2012/04/15/stocks-part-1-theres-a-major-market-crash-coming-and-dr-lo-cant-save-you/
(this is the first in a series)

And he's got his own portfolio setup which he explains here:
http://jlcollinsnh.com/2011/06/14/what-we-own-and-why-we-own-it/

While he's referring to VTSAX, and MMM refers to VTSMX, they are technically the same mutual fund, just different minimum amounts of money are needed to get those. As you'd be starting out with less than what you'd need for the admiral shares (the ones Collins refers to, that also have a slightly lower cost/expense ratio) you'd have to go with the investor shares that MMM refers to (although I'm pretty sure MMM probably has admiral shares himself, he's aiming his post at someone without $10,000 right off the bat to invest).

But by all means, call Vanguard and ask them questions. They should be happy to explain things to you and help you figure this stuff out. This stuff definitely is confusing if you're just getting started! (but do read the collins site - it was quite good at breaking things down at least in my case)

[hoppy08520]

Elaine, I gather that you have both taxable investments (VTSMX), a 401(k), and now you're thinking of an IRA. All good decisions. You really need to look at all of your investments as a whole portfolio and not as isolated accounts. No one can really advise you how to invest in an IRA without also considering what you're investing in the 401(k) and what other investments you have.

Generally, you'll want to start with a broad asset allocation -- what percentage of your portfolio to hold in stocks, and what percentage to hold in fixed income (bonds, cash). That's a very personal choice. A reasonable starting point might be 80% stock and 20% fixed income, although others might suggest doing more or less stock than that.

Next, of your stock investments, what percent do you want to hold in US versus international stocks? A reasonable default holding would be 70% US and 30% international, although some argue for less international while others will suggest holding US and International stock at their respective market capitalization which is around 45% US and 55% non-US.

You can then break it down even further if desired into even smaller asset classes.

Where does this leave you? If you are already investing in VTSMX (Vanguard Total Stock Market Index Fund), then you ought to have some complementary holdings in international stocks and bonds. And we don't know what you have in your 401(k).

One thought is to leave your VTSMX where it is, and then just select "target retirement date" funds in your 401(k) (assuming it has good options there) and in the IRA. With target date funds, you would be assured to have a good investment balance. You should pick the target date funds that come closest to your desired asset allocation (stocks vs bonds) but lean a bit more on the bond side given that you have 100% stock in VTSMX which pushes your overall portfolio more into stocks. You could certainly do worse than this strategy.

I'm not trying to make this sound difficult, but you should try to ensure that your overall portfolio is well thought out and not just a grab-bag of different funds that don't necessarily make sense together.

BTW, a really good introductory book on all of this is just 99 pages and $5 (on Kindle/iPad) here: Investing Made Simple: Index Fund Investing and ETF Investing Explained in 100 Pages or Less.

[thosemiddlesons]

For info I'm 26, looking to retire around 35-40

As matchewed mentioned an IRA is a vehicle for your investments.  It certainly has many positives, but you'll also want to look at the negatives.  As mentioned on the IRS site, if you're planning on retiring before 59.5 and taking withdraws from your IRA, you'll have to pay a 10% penalty.  Just something to think about when using an IRA as an investment vehicle.

http://www.irs.gov/Retirement-Plans/Retirement-Plans-FAQs-regarding-IRAs-Distributions-(Withdrawals)

Can I take money from my SEP, SARSEP or SIMPLE IRA plan while I am still working?
You can take distributions from your IRA (including your SEP-IRA or SIMPLE-IRA) at any time. There is no need to show a hardship to take a distribution. However, your distribution will be includible in your taxable income and it may be subject to a 10% additional tax if you're under age 59 1/2. The additional tax is 25% if you take a distribution from your SIMPLE-IRA in the first 2 years you participate in the SIMPLE IRA plan. There is no exception to the 10% additional tax specifically for hardships.
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[matchewed]

For info I'm 26, looking to retire around 35-40

As matchewed mentioned an IRA is a vehicle for your investments.  It certainly has many positives, but you'll also want to look at the negatives.  As mentioned on the IRS site, if you're planning on retiring before 59.5 and taking withdraws from your IRA, you'll have to pay a 10% penalty.  Just something to think about when using an IRA as an investment vehicle.

http://www.irs.gov/Retirement-Plans/Retirement-Plans-FAQs-regarding-IRAs-Distributions-(Withdrawals)

Not necessarily, there is the Roth pipeline, SEPP, and if your taxable income is low via withdrawing from various accounts in a tax efficient manner that 10% penalty may be negligible. The IRA as an investment vehicle allows you to save more in the present.

[thosemiddlesons]

describing a Roth as a vehicle and not the actual investment makes wayyyyy more sense to me- thanks!

This post seems to summarize different vehicles, or buckets to invest money.
https://forum.mrmoneymustache.com/investor-alley/coming-from-the-school-of-dave-ramsey/msg146020/#msg146020

Do you think that just calling Vanguard and talking to them about my goals could help? Or is that like asking a car salesman if you should get a new car?

I would really recommend calling them.  From my experience they're the complete opposite of a sales person.  I mean yea they're interested in having your money with them but the goal of the people on the phone is to make you feel good and comfortable about your investing decisions with them.  They're pretty good about explaining their services and helping you get what you need.  Plus in order to talk to someone they have to have graduated from several finance courses, so they're pretty knowledgeable. (i forget what courses, but that was one of the first questions i asked a phone rep before signing up with vangard)

Not necessarily, there is the Roth pipeline, SEPP, and if your taxable income is low via withdrawing from various accounts in a tax efficient manner that 10% penalty may be negligible. The IRA as an investment vehicle allows you to save more in the present.

I don't quite understand the 10% penalty for withdraws prior to 59 1/2.  Is it 10% taxed off of your withdraws that year or only if you're withdrawing over the principle? I'm still learning about Mustachian finances, do you happen to have some detailed info I could read on withdrawing from IRAs before 59 1/2?