Expert: Paul Henneman - 12/29/2006

Question
Thank you so much for the reply, it was incredibly helpful. I took your advice and went to AG Edwards today to talk to a broker about my IRA and mutual fund options. The discussion happened to raise more questions than it answered for me. I work under the table for extra spending money at college and apparently you have to be working and making an income to open a Roth (this confused me because I didn't think you needed to be employed to open a Roth). We then discussed mutual funds and AG Edwards happens to push American Funds almost exclusively and the minimum entry into their "Capital World Growth and Income Fund" is $250, which is great for me. After looking through the prospectus it looks as if 90% of the assets are invested into stocks, with about 65% in the foreign market. The broker explained that this is a fund that is aggressive and would be a good choice. So now I have three to choose from, this American fund, AARP aggressive and the Hodges fund. My question is, between these three, is there a fund that looks better than the others? Planning on LONGGG term investing, will it matter which one(s) I choose? Also, should I be doing these transactions through a broker or would it be easier online with my new Folio account? The AG Edwards office is the same one my parents use so I feel relatively safe although I like the idea of managing my account on my own. Thank you for your help.

Charles Broadway
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The text above is a follow-up to ...

-----Question-----
Mr. Henneman,
I am a 21 year old college senior graduating this spring and I have become very interested in investing. Luckily, I will not have any debt when I graduate. That said, my grandparent's have given me a large amount of money (for me at least) this Christmas and I would like to invest it before I end up spending it. I have been researching mutual funds and I have come across two that were highly recommended in a recent Kiplinger's magazine for people my age. They are the Hodges Fund and AARP's Aggressive fund. I have about $600 I am willing to invest at this point but I am not sure wether to split the money between the two or stick with one. I have chosen these two because the minimum for entry is $250 and $100 respectively. Which one would be the best choice for a long-term investment? Should I invest in both? I am juggling between mutual funds and starting a Roth IRA. Would an IRA be more beneficial? I know I can be a little more risky because of my age but I am still not sure which direction to head. If you have any other mutual fund picks or general investing strategies that would fit better please let me know.

Thank you,
Charles Broadway
-----Answer-----
Charles,
  Thank you for your question!
  Yes, I think you are very much on the right track. Those mutual funds are fine, and I would suggest investing in both, if possible. It spreads your risk out a little bit, while maintaining an aggressive stance, what you want for your age.
  I would strongly suggest that you set up a ROTH Ira. There are huge tax benefits. I will try to summarize some of them here.
  A Roth Ira is an account struture. It is not an investment in itself. So you could set up the Roth, then invest into the two mutual funds within the Roth. Your investments will grow tax free until you retire, this is a huge benefit. Also, as long as you do not work for an organization that provides a 401k or other retirement account to you, you can also tax deduct each year the funds that you contribute to your Roth.
   There are limits to what you can invest into a Roth, I believe that it is $4,000 per year. So in the future, as you begin working and hopefully investing more, should you ever want to invest more than $4,000 in a single year you will need to open a second, standard individual account. Also, you cannot open a Roth account if you make more than a certain amount of money, but this limit is well over $100,000 per year. If in the future you ever run into that problem, your Roth contributions up to that time can continue to exist, you just can't add any more. You could at that point open a standard IRA account. Of course if you make over $100,000 per year, it would be a great problem to actually have, and you would certainly have additional investments as well.
   The risk for the Roth account is simply what the investments you choose to buy into through the Roth. For example, you can hold stocks, mutual funds, bonds, or CD's. Mutual funds are typically middle of the road in terms of riskiness, but it does depend alot upon exactly what mutual funds you invest into.
   An IRA is essentially the same thing as a Roth IRA, but the tax advantages are not quite as good (but they are still very substantial).
   I congratulate you on thinking about this so early. The way interest compounds over time, the longer your investments have to work the better. The absolute best case would be if you could regularly add to your investments each month when you start to work. A few hundred dollars a month, accumulated over a few decades, with average returns, will result in a very large investment portfolio for you later in life. A million or more is easy to achieve for everyone, if they start early enough, have some discipline, and patience.
I hope this helps! Please do not hesitate to follow up with me if I can be of any further service,

Sincerely,
Paul Henneman
President
ValuEngine inc
www.ValuEngine.com


Answer
Charles,
   Thank you for your follow up!
   Yes, you are right that you do need to be working and earning an income to set up a Roth Ira. However, if you can't set up the Roth, it would be immensely beneficial for you to begin investing.
   The only word of caution I would have for you is regarding the broker you spoke with. You mention that he specifically recommended one family of funds that they work with. I am not very familiar with American Funds, and it may be a good group of funds. Just realize that the broker's company will have a relationship with a specific fund group, so he is pushing those funds to get his commissions, not becuase the fund is a good one for you. It may be, just realize that the brokers motivations are not necessarily in your best interest. This is the dirty secret of fincial advisors and brokers.
   I would actually recommend that you invest through a site like www.FOLIOfn.com  One reason is that the fees will be cheaper. The second is that you are in control, and can invest in any fund that you like, you are not limited to the funds that the broker will push on you.
   I also recommend that you purchase at least two funds if this is possible. One should be an index fund for stability. These are funds that basically copy a major market index, the S&P500 is perhaps the best known and stable. For example, Vanguard has the fund with ticker symbol VFINX. I would put some of your investments in that, and the rest into an aggressive fund of your choice. Over time you can compare the returns of the two, your aggressive fund may have periods, sometimes as long as a year or more, where it under performs. But as time goes on, it should out perform the VFINX.  In bad times, where your aggressive fund may see high losses, the other should balance out and reduce your losses a bit.
   One disadvatage is that VFINX does require a several thousand dollar minimum investment. I know that you are not there yet, but no worry. Simply invest in two of the funds that you are considering, add to your investments at least a little each month, and you will soon have enough.
  A money market account is a great place to save up the minimum investment to purchase additional mutual fund shares. This way you can save $50 or $100 a month, and perhaps each time you reach $1000 or so buy some additional shares. www.NetBank.com has a very good money market account, the interest they pay is one of the highest I have seen. There are no fees, and you can withdraw funds easily, just like a checking account. It is a great place to save up some emergency money, or simply accumulate funds before purchasing additional investments. It is all online, with no branch buildings if you are comfortable with that. If not, then all major banks also offer money market accounts, but the interest they pay is about half.
   I hope this helps! Please do not hesitate to follow up with me if I can be of any additional service.

Sincerely,
Paul Henneman
President
ValuEngine Inc
www.ValuEngine.com