Open Roth IRA Now or Later: Reader Question Series

Reader:

First, I would like to thank you for your blog and the advice you give. I've learned a lot and feel much more confident when evaluating and understanding index funds and investing in general.

My question for you is about Vanguard's Target Retirement Date 2050 Fund. I cannot afford the $3,000 to buy the individual index funds from your The Simple Four Index Funds Portfolio just yet, but could do $1,000 minimum into a Roth IRA with the Target Retirement Date fund now. I would then add $1,000 yearly to this fund. Do you think this is a good idea to invest in Roth now until I'm able to purchase the core funds individually? One more question; is it easy to do asset reallocation online once I buy the four individual Vanguard funds?

 

Buy & Hold Blog:

First of all, congrats on thinking about investing for your future.

It is absolutely a good idea for you to start Roth IRA with the Vanguard Target Retirement Date 2050 fund. This will allow you to get started without having to wait until you have sufficient amount saved for individual funds.

Each year you are delaying investing in a Roth IRA, you are delaying taking the tax advantages that come with Roth IRA. Of course, with a Roth IRA, your investments are not deductible unlike a Traditional IRA, but you are getting an extra year or two (or however longer until you save enough to afford the core funds)  for your investments to grow and your withdrawals will be tax-free when you retire.

So, yes, go ahead and get started immediately. And, dollar cost average additional amounts you can afford at a regular frequency. The key is to start investing early so that your investments have longer timeframe to compound.

Since you are leaning towards the Simple Four Index Fund Portfolio, then as soon as you are able to afford to buy four core funds individually, then you can replace this fund with one of the funds from that portfolio. To get the maximum tax benefits of tax-free growth, it is generally a good idea to hold REIT Index fund in a Roth IRA as REIT funds are designed to distributes 90% of their income. So, your tax bill would be lower by holding this fund in your Roth IRA.

Good thing is that, replacing Vanguard Target Retirement Date fund with another core index fund will be an easier process and you will not be hit with a capital gains tax bill because Roth IRA is a tax-advantaged account.

To answer your other question on asset reallocation or asset re-balancing,  it is typically not a simple process. At least, it is not automatic where you can specify your targets and the funds balance automatically at the trigger point you provide. Vanguard and all its competitors make this harder because they want you to buy their pre-packaged Target Retirement Date Funds and probably rightly so.

So, the re-balancing process is manual, but I would not sweat too much into this as buy and hold investing is a long-term endeavor. You have plenty of time to correct your asset allocation if and when it deviates from your target allocation.

For asset re-balancing, there is a 5% rule of thumb that is suggested by experts. If your asset allocation deviates by 5% from your target, then you sell/exchange some shares of fund that has gone up and buy/exchange shares of the fund that has gone down. Vanguard makes buying/selling or exchanging funds very easier and painless online. You can also decides to exchange your money into Prime Money Market fund as a placeholder and dollar cost average your way slowly into the fund you want to buy. I usually do it this way.

Another way to re-balance would be to divert new investment money towards the fund that has gone down and less money towards to fund that has gone up until your asset allocation reaches the desired targets.

I hope this helps.