Expert: Paul Henneman - 7/15/2007

Question
Paul,
I'm a 24 year old single graduate student. The only debt I have is about
17000 in student loans, which are in deferment while I'm in school. I plan on
being in graduate school for several more years. During this time my loans
will be in deferment (i.e. I do not have to pay them but interest will still
accrue).
Now I have a couple of questions for you.
First I have a Roth IRA (~$3000 in four mutual funds) with Waddell and Reed
and I was curious how Waddell and Reed makes money off this. As far as I can
tell all I get charged is a yearly $15 service charge. Is this because they hope
to make a good relationship with me so later I other things with them and
that is
how they make there money?

Second: On my student loans. Should I
a) let them sit and have the interest capitalize (interest is about 19 cents a
day), and capitalize means that it goes in with the principle.
b) just pay the quarterly  interest that has accured
c) pay off slightly more than the interest so as to decrease the amount of
principle

Third: Should I continue to contribute to my Roth IRA as much as possible or
should I save up to start investing in stocks? (in a typical month I save about
$200)

Thank you James

Answer
Thank you for your question!
  Generally the firm that is holding your ROTH IRA account makes money each time you trade what is in the account, in the form of trading costs. These costs can vary, but every time you buy or sell a stock or mutual fund for example there is a fee associated with it.
Regarding your student loans, there is unfortunately no real correct answer to this. Every person is different. You could minimize your expenses by deferring the interest, but that interest compounds and has a nasty way of building up on you. I am of the opinion that paying off student loans as quickly as possible is a great thing, even if you could make more money in investments. It is a wonderful feeling that too many Americans will never have to be debt free.  So in my opinion your option c is the most attractive, but again everyone is different. Do not be afraid to develop your own ideas on this, whatever you choose will not be wrong.

Yes, the tax advantages to a ROTH IRA are so strong that they cannot be ignored. Contribute all you can (The current maximum is $4,000 a year, going up to $5,000 a year in 2008). If you can't do the maximum, just do as much as you can.
Keep in mind that your ROTH IRA can be invested in stocks. Think of the IRA account as an overall account structure, you can hold almost any type of investment in it. For example, you could move your ROTH IRA out of Waddell and Reed, and manage it yourself through an online firm like www.etrade.com or www.scottrade.com  You could buy and sell stocks or mutual funds with the funds in your IRA account yourself if you choose to. If this is of interest, just contact any major online brokerage firm, they will be happy to tell you how to move your ROTH IRA to them.  I don't know this for sure, but Waddell and Reed is probably controlling almost all aspects of your ROTH IRA. You probably told them your age and profile, and they have a process that identifies what investments your ROTH IRA will be invested in. This is fine if you don't want to spend any time researching or controlling your investments, but often comes at the cost of returns as some of these firms don't really generate that great of a return. Some do, it is worth looking into. If you control your ROTH IRA investments yourself, you could always start with a general index fund such as Vanguards fund that tracks the S&P 500 index (ticker VFINX). Then as you gain more experience, you could branch out from there.
I do recommend that you read 'Investing for Dummies'. This single book will give you the basic information to start, and covers almost all major forms of investments (including IRA and retirement accounts, stocks, cd's, mutual funds, and others).  Reading this will help you decide what is best for you.

I hope that this is helpful! Please do not hesitate to follow up with me if I can be of any further service,

Sincerely,
Paul Henneman
ValuEngine Inc
www.ValuEngine.com