You want to open an Individual Retirement Account (IRA). You have stashed away an adequate emergency fund. You have paid off your high interest credit card debt. You have read about Traditional IRAs versus Roth IRAs, and you know which type best suits your needs. The next step is to open your IRA and start saving for retirement. This does not have to be a do-it-yourself assignment. Thousands of financial professionals are available to help you get started saving for retirement, but these services come at a cost. If you want to minimize the cost of saving and investing, I suggest you spend some time to get educated and do it yourself. I am going to share with you my evaluations and thoughts about opening an IRA and what I believe to be the best process. Hopefully, this discussion will help you feel better prepared to start saving for the important goal of retirement.
The initial step is to decide where to open your IRA. The major options are banking institutions, brokerage firms, and mutual fund companies. I believe mutual funds are the best option for investors just starting to save; bank instruments are too conservative, and individual stocks require too much research. Mutual funds can be bought through a brokerage firm, but the cheapest place to buy a mutual fund is directly from a mutual fund company. I would consider one of the three largest no-load mutual fund companies: Vanguard, Fidelity, or T. Rowe Price. Those companies offer a variety of mutual funds, so you can easily design an adequate investment allocation with all their available fund choices. Choosing among those three mutual fund companies requires an evaluation of their minimums and expenses.
The mutual fund companies have opening minimums and contribution minimums, so how much you can save may limit where you can save. The standard opening minimums for IRAs are $3,000 at Vanguard, $2,500 at Fidelity, and $1,000 at T. Rowe Price. That means you would need to save up the opening minimum amount first in your checking or savings account, and then you would invest the minimum balance all at once into the selected mutual fund. If you do not want to wait to accumulate the standard minimum, Fidelity and T. Rowe Price offer alternatives. You can start with as little as $200 per month at Fidelity or $50 per month at T. Rowe Price if you commit to contributing that amount every month to your IRA. If you forgo these options and contribute the standard initial minimum, the minimums for additional investments to the IRA will be $100 at Vanguard, $1,000 at Fidelity, and $1,000 at T. Rowe Price.
If the initial and additional investment minimum requirements have not narrowed your list of prospective mutual fund companies, a comparison of costs may be useful in your evaluation. Mutual fund companies sometimes charge fees to maintain your IRA, but these fees can be waived if your balance exceeds a certain amount. Fidelity does not charge a maintenance fee on IRA accounts. Vanguard does not charge a fee if you sign up for electronic delivery of statements; otherwise, Vanguard charges $20 per year unless your mutual fund balance is above $10,000. T. Rowe Price charges $10 per year unless your mutual fund balance is above $5,000. These maintenance fees are different than low-balance fees. The companies may charge low-balance fees if your mutual fund balance falls below the initial investment minimum. These fees are also different than sales load charges, which are not an issue if you are buying mutual funds directly from the company.
Based on an evaluation of the mutual fund companies, I have a preferred choice: Vanguard. The only problem I have with Vanguard is their initial investment minimum of $3,000. Accumulating that amount first in a bank account before moving it to Vanguard is not a problem, but I do not like the idea of a beginner investor buying $3,000 into the market in one day. I would prefer if the investor could average into the market over time, as with the special programs at Fidelity and T. Rowe Price. However, once you get started with Vanguard, additional contributions are very flexible. You are not committed to investing a certain amount every month. You can invest $100 or any amount above as often as you want until you reach the annual limit, or you can never add money again, assuming you maintain the minimum balance requirement. And if you do not mind getting your statements on the internet rather than by mail, you cannot get cheaper than Vanguard on fees.
The next step is to choose a mutual fund to buy within your IRA. Sometimes people get this confused, so I will explain. A mutual fund is a type of investment. An IRA is a type of account. To invest in a mutual fund, you can buy either through a taxable account or a tax-advantaged account. A taxable account is just a regular investment account with no tax advantages and no specified purpose. An IRA is a tax-advantaged account opened for the purpose of saving for retirement. Within an IRA, you can purchase several types of investments, including stocks, bonds, and mutual funds. If selecting Vanguard as the company with whom to open your IRA, Vanguard will be the custodian of your IRA, and Vanguard's mutual funds will be the investment within your IRA.
Vanguard offers about 100 mutual fund choices, so you might be wondering which mutual fund to choose. Selecting mutual funds for your IRA depends on your time horizon, your risk tolerance, and how much money you have. The mutual fund allocations will probably look different for an aggressive, young person with many years until retirement compared to a wealthy, conservative, older person near retirement. Asset allocations can differ as much as people do, so I cannot suggest one catch-all mutual fund allocation that is appropriate for everyone. However, since choosing a mutual fund is a critical step when opening an IRA, I will attempt to provide some guidelines. My comments will assume the investor has limited funds, a long time horizon, and a high risk tolerance.
If you are opening an IRA for the first time, you will probably just choose one mutual fund to start with. The IRA contribution limit is $5,000 per year for individuals under age 50. And since the initial opening minimum is $3,000 at Vanguard, that means you can only open one mutual fund during a year. Opening two mutual funds at $3,000 each would put you over the $5,000 annual limit. In such case, you might want to look at Target Date Retirement Funds. For these, you choose the mutual fund that most closely matches your expected year of retirement. Target Date Retirement Funds are usually a fund comprised of other mutual funds. The mutual fund company will change out the funds within the Target Date Fund to make it more conservative as you approach retirement. These funds offer an easy way to set-it-and-forget-it for those investors who do not want to monitor their asset allocation.
Another option is to select a mutual fund that is widely diversified, such as the Total Stock Market Index Fund or Total World Stock Index Fund. These funds invest in thousands of stocks, attempting to track the overall performance of the stock market. If you are using only one mutual fund, make sure the fund includes a significant portion of large cap domestic stocks. Do not use a mutual fund that invests just internationally, or just in small companies, or just in limited sectors because those funds are too risky to own as your only investment. A similar rule would apply to bond mutual funds. If using only one bond fund, make sure it has a high average credit quality and a range of maturity terms. When choosing one mutual fund, the key is to make sure it is diversified.
My comments have covered the high level concept of opening an IRA. I would give more details on the step by step procedure of setting up an IRA, but the mutual fund websites are pretty self-explanatory. Just go to the mutual fund company's main website and find a link that says something like "open an account." You will need to provide all of your personal information, including name, birthday, social security number, and contact information. You will need to supply information about your funding source, such as your bank's name, routing number, and your account number. You will have to indicate that you are saving for retirement and choose which type of IRA you want. And of course, you will have to select which mutual fund you want to purchase for your IRA.
There you have it, my summary of how to open an IRA. I may have made the process seem simple, but that is good. I hope you feel confident enough to attempt opening your own IRA. Do not feel discouraged if the process still seems complex. I have done a lot of reading and studying about the IRA over the years to become comfortable with this topic. You can find plenty of additional information on the internet about the IRA if you want to learn more before investing. Please do not avoid saving and investing because you think it is too complicated. If you feel like the process is too difficult to accomplish on your own, contact a financial professional who can help. At the least, I hope you get motivated to start saving for retirement. When you do, consider using an IRA.
