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Why Young Investors Should Start Saving with a Roth IRA

Stephen Fletcher, wealth advisor at BlueSky, offered the following advice to a young investor.

A 21-year old who makes $600 every 2 weeks, wants to start saving for the future. After some research, she realized the earlier she started, the better, and she wants to open an IRA account. However, she’s not sure which IRA to go with or how much to contribute every month.

You are absolutely correct, the earlier you start saving, the better. By getting started now, you are giving your money more of an opportunity to grow. Since you are in your early 20’s, you should save through a Roth IRA. Contributions to a Roth IRA are made with post-tax dollars. The reason to make post-tax contributions rather than tax deductible contributions is the taxation of the withdrawals; given your age and income level, you are not being taxed in a high tax bracket right now. When you have reached retirement and are pulling funds out of your account, odds are you will be taxed at a higher rate. By using a Roth IRA now and only making qualified withdrawals (withdrawals after age 59 ½) later, you won’t have to pay any tax when you access the money.

You can open a Roth IRA virtually anywhere, at a bank branch or online. Firms like Fidelity, Charles Schwab, TD Ameritrade and Vanguard are generally popular choices, but your bank of choice will certainly be able to open an account for you. Your contribution limit to a Roth IRA is $5,500 per year. Depending on how aggressive you want to be with your saving, your monthly contribution can vary. The maximum amount you could contribute each month is $458. If that seems like a lot, or if you have monthly expenses that need to be covered and can’t do without all of that $458, somewhere in the region of three to five percent (or $36 to $60 per month) is a good starting point.

Finally, once you have made the contribution to the account, you need to determine how you want the funds to be invested. Investment allocations are very much subject to personal preference, so you’ll need to determine how aggressive you want your investments to be. Since you are young and are saving for the future, you can afford to have a greater tilt towards stocks and stock funds than bonds. A few well diversified, low cost mutual funds or exchange traded funds would be a good place to start (each provider should give you their list of recommended funds), or you can reduce the headache and hassle of trying to construct a portfolio and invest in a target-date fund. Target-date funds are based on the year you want to retire (or start withdrawing your money from the IRA). These funds will automatically adjust their holdings (stocks, bonds or cash) as they get closer to their retirement date, shifting from maximizing return to preserving your money. Vanguard offers a good lineup of target-date funds.

Whichever way you go, target-date or your own mixture of funds, you’re off to a great start. It’s especially important to remember that you’re investing for the future, so you shouldn’t get too scared about the ups and downs of the markets in the short term. History has shown us that over time, with a well-diversified portfolio, investors can do very well. It’s when you check your account every day and try to time the market that you get into trouble.

Happy saving!