This Should Be Your First Investment
May 7th 2012 9:51AM
Updated May 7th 2012 9:52AM
Young people are facing more financial challenges than ever. With soaring student loan balances, a tough job market, and general uncertainty about their future prospects, young adults have found it difficult to figure out how to dig their way out of the hole they find themselves in -- let alone start building a financial foundation for their future.
But if you only take one step toward starting to build up some savings for the long run and have at least some earnings from a job, your first step should be to set up a Roth IRA. It's hard to see down the road, but in time, if you can set aside even modest amounts toward your future now, they'll pay huge dividends in the decades to come.
Financial planners recommend retirement accounts generally because of the tax savings they offer. Instead of having to pay taxes on all your income year in and year out, IRAs let you avoid all the hassle and expense of income taxes as long as your money stays in the account. That comes at the price of penalties in most cases if you have to take money out early, but that can provide a much-needed incentive to stick with an IRA even in tough times.
What Roth IRAs add to the mix, however, is the even bigger benefit of tax-free growth throughout your career. By contrast, traditional IRAs can give you a deduction for contributions now -- but if you don't make much money, then your tax rate is already quite low, making that deduction almost worthless compared to what it might save you during retirement.
Many young people never bother opening brokerage or mutual fund accounts because they don't have very much money to invest. But it's getting increasingly easy to open accounts with even modest amounts to start out with.
For brokers, account minimums look like they're rapidly becoming a thing of the past. Scottrade, ING Direct, Fidelity, TD AMERITRADE, and E*TRADE Financial (NAS: ETFC) are just a sampling of the brokers that don't require any minimum investment for IRAs, making it easy for savers who are just starting out to get an account opened. Even Schwab's (NYS: SCHW) account minimum of $1,000 isn't out of reach for some to open an account.
On the mutual fund front, it's rare to find a true no-minimum account. But many mutual funds will let you make very small initial contributions of $50 to $100 if you commit to adding more money on a monthly or quarterly basis. By setting up automatic contributions, you can get access to mutual funds you otherwise would need a higher minimum investment to get into, and it can also help impose some discipline on your saving process.
As easy as it is to use traditional mutual funds to invest, I think your first Roth IRA investment should be an exchange-traded fund. ETFs can help you minimize your ongoing money-management costs, and many brokers offer commission-free ETF investing -- a crucial element for making ETFs work in small-balance accounts.
A broad U.S. stock-market ETF can start you off on the right foot with diversified exposure to some of the biggest companies in the world. Vanguard Total Stock Market ETF (NYS: VTI) is available commission-free from both TD AMERITRADE and Vanguard and boasts annual expenses of just 0.06%. Most other brokers that offer ETFs have a similar fund in their lineup.
From there, it's easy to expand to other types of investments. Vanguard Total World Stock (NYS: VT) expands your investing horizon to cover stocks around the world. If you want to add bond exposure to your portfolio, then Vanguard Total Bond Market (NYS: BND) is just one of the viable choices you can use. With many brokers offering dozens of different commission-free ETFs to choose from, you should be able to put together a very precise portfolio that meets all your needs.
Thinking about your future when you're struggling just to meet your present needs may seem like a luxury you can't afford. But when you think about it, you really can't afford not to start providing for your future. A Roth IRA makes that both simple and profitable by getting time working on your side for a change.
Eventually, a Roth IRA can go beyond ETFs to include individual stocks. To see what kind of stocks you should think about when you get to that point, let me suggest taking a look at the Motley Fool's special report on long-term investing. Inside, you'll find some great ideas on stocks that will serve you well over the years. Click here and get your free copy right now.
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At the time this article was published Fool contributor Dan Caplinger didn't have Roth IRAs to use when he made his first investment, but he does still own that first fund. He doesn't own shares of the companies or ETFs mentioned in this article, although he does own similar ones. Motley Fool newsletter services have recommended buying shares of TD AMERITRADE and Schwab, as well as creating a bull put spread position in TD AMERITRADE. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Fool's disclosure policy always finishes first.
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