Financial Planner – Roth IRA Sample Case: The Vanguard Target Retirement Fund

For most young professionals in the lower tax bracket, choosing a Roth IRA (Individual Retirement Account) is generally a no-brainer. As a thrill-filled retirement account, the Roth IRA allows you to grow, accumulate your retirement savings tax-free and avoid hiring a financial planner. If you cash it out during retirement, you won’t owe Uncle Sam a cent!

For those that haven’t considered a Roth IRA (or a traditional one), it’s highly recommended that you take the time out to research more on the topic. Although the deadline for the 2007 contribution has already passed (April 17 tax day), learning more about your choices now will enable you to better allocate your future budget to maximize your 2008 IRA contribution.

To better help you see the process in choosing and opening a Roth IRA account, let’s take a look at the thought process of Trent from The Simple Dollar, who has chosen Vanguard to start his Roth IRA.

When am I going to retire?

I plan on “retiring” (which may involve working a part time job of some sort) as early as possible, which for most of my assets (save Social Security) means at age 59 1/2. I’m currently roughly 28 1/2 years old, which means I’m 31 years away from retirement, and my financial planner says my year for retirement is 2038.

How much risk am I willing to take on?

I’m fine with carrying quite a bit of risk until I get pretty close to retirement, after which I want to shift back to bond holdings rather strongly. This means that I might put my retirement date even a bit later in terms of picking out a “target retirement” fund, to 2045 or so.

How much do I want to micromanage?

Admittedly, not much. I plan on keeping an eye on the funds and expense tracking, but in terms of investigating individual stock picks, I’ll save that effort for my own individual stock investments outside of the Roth IRA, thank you.

Given that I have an approximate target retirement date (2038 to 2045) and that I want to do minimal research for the Roth IRA, I’ve elected to try out the Vanguard Target Retirement Funds — more specifically, the Vanguard Target Retirement 2045 Fund. All of their funds start out aggressively and then gradually shift your assets from stocks into bonds and eventually even into a bit of liquid cash holdings as you enter retirement age.

What’s in the Vanguard Target Retirement 2045?

It’s a combination of five separate funds: four stock funds (Total Stock Market, about 72% of total holdings), European Stock (10.5%), Pacific Stock (5.0%), and Emerging Markets (2.7%)) and a single bond fund (Total Bond Market, about 9.9%). Through 2020, the portion of stocks to bonds (9:1) will remain the same, and then will move about 1.5% a year from the stocks into the bonds until 2045, where the split will be about 50/50. After that, the portfolio becomes more and more conservative as you use it to live out your golden years.

It’s reasonably diversified and has returned 13.84% annually since inception (yes, past is no indication of future), which is a rate of growth that has strong appeal to me. I think I’ll buy this one and just let it sit, reinvesting any dividends and capital gains, and keep an eye on it over time.

There are a few key points you should note from this specific example.

• Be like Trent and start expense tracking. When you have a more specific goal, choosing the necessary investment strategy to reach that goal will become much easier.
• Assess your risk tolerance. Once you figure out how much risk you can handle from your investment, the better you can narrow down your investment fund choices.
• Figure out how much involvement you want with your IRA. Do you want to pick your own stock or do you want to let someone else do the work? Knowing the answer to this question will allow you to better pick the correct institution for you to open your IRA.
• Understand how the fund is allocated and how the assets will shift based on the retirement time frame and risk tolerance (e.g., a fund shifts from stocks to bonds as it reaches the target retirement date to decrease risk to the fund).

Other key notes:

• When you choose an institution to open your IRA, you should consider the account fees and minimums. If you do decide to go with a fund like the Vanguard Target Retirement Fund, you need to consider its expense ratio.

The above post contains content written by Trent of The Simple Dollar.