Madeline Valente CFP®, Wealth Advisor at BlueSky, is a frequent contributor to the web-based investment Q&A forum, Investopedia. She recently provided the following answer to the question:
“How should a college student invest her funds inside a Roth IRA?”
First, kudos to your daughter for opening a Roth IRA at 19! I love to see young adults making financially sound decisions which have the ability to pay off in spades down the road. By starting her contributions to a Roth IRA now, she can benefit tremendously by the power of compound growth. Before looking at investment selection, your daughter should look at overall fees associated with the custodians with whom she’s considering holding the account. Keeping fees and expenses low is an important component to long-term growth. High fees and expenses can chip away at investment gains and be a headwind to growth. Discount brokerage firms like Schwab or Fidelity are good choices for low cost accounts.
Once a low-cost custodian is selected, I recommend looking at that custodian’s list of free-to-trade exchange traded funds (ETFs) and mutual funds. Index ETFs and many index mutual funds have rock-bottom expenses and look to match the performance of the overall market or a subsection of the market, as opposed to actively managed funds which attempt to outperform the market and charge higher expenses for doing so. History has shown that most actively managed funds have been unsuccessful at consistently outperforming over the long term and their higher expenses can be a drag on growth.
Your daughter is young and has a lot of time to weather the ups and downs that a stock-heavy portfolio would bring. That said, if the inevitable volatility of the market would be too worrisome for your daughter, making it hard for her to stick with a long-term investment strategy, a less aggressive allocation to stocks might be more appropriate for her.
Since your daughter’s initial account balance will be low, a free-to-trade, low expense target date fund would provide good diversification in an easy to manage option. Ideally, look for one that includes an allocation to foreign stocks as well as US stocks and that utilizes index funds. You may want to look under the hood of a few target date fund options, as there can be variation of the underlying investments and allocations from one target date fund to another. As the account balance grows, the simplistic approach of a target date fund may eventually not be the option that serves her best but for now it’s a good, solid choice.
Keep in mind that for 2017, your daughter can contribute the amount of her earned income, up to $5,500 maximum. That leaves her with the potential for an additional $2,500 in contributions above her initial $3,000, depending upon her earned income.