Invest Today with a Roth IRA

In this post, I hope to convince you that you should open a Roth IRA investment account today.  Not tomorrow, not some unspecified date in the future, not when you have 'more money' or after you do 'more research' - right now. After reviewing the motivations for doing so (the 'why'), I'll conclude with  practical examples of how you might set up and configure your own account (the 'how').

Compound Interest

As you've probably heard many times before, compound interest is king:
At a slow, steady growth rate of a few percent, money will double in a relatively short period of time (~10 years).  The longer your money has to grow, the greater the probability that you will meet your goals later in life, and eventually, in retirement.

Inflation and Risk

In a previous article, I reframe risk to explain why you can't afford to avoid all market risk.  Even the highest savings account interest rates (from exceptional places like Ally Bank) are less than 1%.  The real value of assets held in a checking or savings account will erode with time due to inflation.  For this reason, overall risk is actually reduced by holding some of your assets in stocks and bonds.

Tax Advantages

In another previous article, I explain that many investment plans offer tax advantages in exchange for restrictions on the amount and timing of contributions and withdrawals.  By taking advantage of these tax breaks, the money you have available to invest will grow faster than it would in a regular taxable account.

Financial Security

The Social Security system is facing a serious funding shortfall, and jobs that offer a pension are harder and harder to find.  As these social safety nets face inevitable cuts and healthcare costs continue to rise, your personal savings will have to make up the difference.

The post-tax Roth IRA offers two additional layers of protection. First: by paying income taxes on the contributions now and making tax-free withdrawals in the future, you can hedge against the very real possibility of significantly higher future income taxes. And second: the Roth IRA doubles as an emergency account, allowing you to withdraw any of your contributions at any time and for any reason, with no taxes or penalties. If you can't currently afford to fund both an emergency account and a retirement account, the Roth IRA can temporarily cover both functions. In special cases (first-time homebuying, higher education or medical expenses), you are also permitted to withdraw some of the earnings in your account without penalty.

Saving Is Good For You

Learning to do more with less is invaluable life experience.  Especially in cases when your income is experiencing a large step-change (your first job out of college, or even going to grad school on a stipend), it's good to stay grounded by saving and investing that money instead of spending it away and letting your standard of living creep up.  Delaying gratification can pay off very handsomely over the long run.


There are lots of great reasons to open an account... but are you eligible?  To qualify to contribute to a Roth IRA on a given year, you must:
  1. Have earned income.  It's important to note that not all taxable income is considered earned income - it only counts if you receive a Form W-2!  If you are a student on a scholarship or fellowship, it's especially critical to double-check this - if you're paid on a research grant or through a government fellowship like the National Science Foundation Graduate Research Fellowship Program (NSF-GRFP), you will not be eligible to contribute unless you have other earned income on the side.
  2. Not have too much earned income.  If you file your taxes as single and earn over $110,000 or file joint and earn over $173,000 together, your annual contribution limit will be reduced:

As the graph illustrates, you may contribute up to $5,500 or your entire earned income - whichever is less - until you reach the upper income limits, above which your allowed contribution scales linearly to zero over the next $10,000 in income.  If you're over 50, the maximum annual contribution limit is increased by $1000 (not shown on the graph).  Fairly straightforward!

Making too much to contribute to a Roth IRA?  You can still contribute the whole amount to a Traditional IRA... which is a topic for another post.

Are you a graduate student paid with grants, fellowships, and scholarships and you can't contribute because you don't technically have 'earned income'?  Consider a 529 Plan instead.

Already have an employer-sponsored plan?  That's great—open a Roth IRA too.


Convinced that you want to open a Roth IRA and verified that you're eligible?  This section will give an example of one way to go about it.

The process has three steps:
  1. Open a Roth IRA account (question: with what brokerage?)
  2. Fund your account by transferring money from a bank (question: how much?)
  3. Buy securities (question: what kind, and which ones?)
Potential answers to these questions, with my justifications:
  1. Use Vanguard Investments.  They are one of the largest brokerage firms, currently managing around $2 trillion in investments.  They're a nonprofit, established by the legendary John Bogle to give individual investors a mechanism for inexpensively investing in large sections of the stock and bond markets with a single product - the index mutual fund.  It's free to set up an account, and their expense ratios - management fees for running the mutual funds that you are invested in - are the lowest in the business (in the range of 0.05-0.25% of your holdings annually, compared to 0.5-2.0% elsewhere).  I use Vanguard, and it's what I suggest to my family and friends (and I don't receive any sort of kickback).  They offer a great selection of investments and have a clean web interface, Mint.com compatibility, and excellent customer service.  You can open a Roth IRA in 10-15 minutes by following this link.
  2. You don't have to fund your new account immediately - you can select 'mail a check' and wait as long as you want to actually transfer money in.  This is an excellent reason to open the account right this second - it'll reduce the activation energy barrier when you do commit to funding.  On Vanguard, you can get started in a target retirement date mutual fund for $1000.  Don't have $1000 to spare?  Login to Mint.com, link your accounts, make a budget, and set a goal to save that money.  Vanguard's more specialized mutual funds become available at $3000, but don't worry - you can invest $1000 now, then move the money into a different fund whenever you reach $3000.  You can transfer money into the account using an Electronic Funds Transfer (EFT) from your bank, or by mailing a check
  3. As mentioned, there are no taxes, penalties, or fees for moving money between securities inside a Roth IRA.  Your pick of securities will determine your risk, rate of return, and expense ratio, but you can always change things as you learn more!  Vanguard has built its entire business on index mutual funds, and they are widely considered to be the best choice for most investors (don't believe me? Google it).  An index fund simply tracks the returns of a public market index, like the Dow Jones or the S&P500.  Because a fund manager isn't being paid exorbitant amounts to try to beat the markets, and because the index buy-and-hold strategy does not generate lots of trading expenses for the fund, these funds have ridiculously low expense ratios.  Research has proven, over and over again, that random investment strategies perform just as well or better than targeted rational strategies.  Paying less for the more successful strategy?  Yes please.

What To Invest In

I won't tell you what to invest in, but I will tell you what I do.  The core of my profile is Vanguard Total Stock Market Index Fund (VTSMX) - if you're just getting started, this is an excellent first holding.  VTSMX currently holds $230 billion in investments, so they must be doing something right.

If you would like to hold some bonds, which generally have less volatility and a lower return on investment than stocks, you should check out Vanguard Total Bond Market Index Fund (VBMFX).  While bonds are a questionable choice for long-term investments by young people, they can be a good idea if you are also using your Roth IRA as an emergency fund.  For more risk and potentially higher returns, I add some worldwide market exposure with Vanguard Total International Stock Index Fund (VGTSX).  Companies with smaller market capitalization ('small cap') also have greater volatility but improved long-term rates of return, so I overweight on small- and mid-cap companies with Vanguard Extended Market Index Fund (VEXMX) and Vanguard Small-Cap Index Fund (NAESX).  To maintain a healthy level of insanity in my life, I have a small holding of the even-more-volatile Vanguard All-World ex-US Small-Cap Index Fund (VFSVX).

For one-stop shopping and a low $1000 minimum initial investment, see Vanguard's Target Date funds.  These funds simply hold some combination of the above index funds, the ratio of which is automatically adjusted as you approach retirement.  The 2060-2040 funds all currently contain the same thing, but the 2035-2010 funds show a more conservative balance of international stocks (VGTSX), domestic stocks (VTSMX), bonds (VBMFX), inflation-protected securities (VIPSX), and money market cash (VMMXX):
  1. Target 2040 (63% VTSMX, 27% VGTSX, 10% VBMFX)
  2. Target 2035 (60% VTSMX, 26% VGTSX, 14% VBMFX)
  3. Target 2030 (55% VTSMX, 23% VGTSX, 22% VBMFX)
  4. Target 2025 (50% VTSMX, 21% VGTSX, 29% VBMFX)
  5. Target 2020 (44% VTSMX, 19% VGTSX, 37% VBMFX)
  6. Target 2015 (38% VTSMX, 16% VGTSX, 40% VBMFX, 6% VIPSX)
  7. Target 2010 (29% VTSMX, 13% VGTSX, 42% VBMFX, 14% VIPSX, 2% VMMXX)

Target 2040
Target 2030
Target 2020
Target 2015
Target 2010


Congratulations, you're investing!  Future You will be pleased.

But... now what?

Don't obsess.  Don't waste your time reading lots of financial news or compulsively checking your account balance.  If you want to keep track of your investments in the context of your overall financial situation, add your brokerage to your Mint.com account.

Do automate.  The less you have to think about your saving and investment, the more likely you are to do it and the less likely you are to do something stupid by following the crowd and 'buying into a bubble'.  Vanguard offers a free automatic investment service for scheduling automated transfers from your bank account into your mutual fund of choice; you can even tell Vanguard to do the math for you and make sure that your transfers add up to your contribution limit for the year.  Set this up now and leave it alone - in reality, you probably only need to log into the account once per year to download any tax forms and make contribution adjustments as your financial situation dictates.

And there you have it!  If you follow these steps and set up a Roth IRA today, you'll already be (sadly) ahead of the curve - read a few articles about retirement, and you'll quickly discover that most people are sorely under-prepared.

If you have specific questions that are stopping you from getting started, contact me!