Expert: Paul Henneman - 5/31/2007

Question
QUESTION: Hi Paul, thanks so much for your time.

I am 23, newly married and trying to figure out how to get started in life.  I knew I needed to get started on my retirement, since the earlier the better...so I started a Roth IRA with $1,000 a few months ago.  However, upon the advice of someone I did it through T Rowe Price.  I have since read some things that it might not have been the best choice.  Especially with how high their fees are.

What should I do?  Should I leave it with them and continue to contribute?  If I understand the roth correctly, I can withdraw my contributions at any time without penalty, but not the earnings correct?

We also are renting and planning to purchase a house in the coming years.  With my limited knowledge of investing, the only plan I have is just to throw our savings into a money market with a 5% APY.  I know there are better ways to save for a downpayment.

Any and all help is greatly appreciated.

ANSWER: Thank you Jeff for your question!
First, regarding the ROTH IRA. I would need to now more about the T Rowe Price program you are enrolled in, but can tell you that you can move your ROTH IRA to a different administrator at any time, usually with no penalty (unless T Rowe Price has a penalty). So for example, you could contact one of the online trading services such as www.Etrade.com or www.FOLIOfn.com and they can transfer your ROth IRA over to them.  This really only makes sense if you are plannin gon administering your account yourself, and deciding on what mutual funds or stocks you want to hold in the account. Currently, your T Rowe Price service probably does that for you. If they do it well or not, and for how much in fees is the question.  This I am not sure I have the answer for.

My answer to your second question regarding how to save for a home also applies to how you could run your Roth IRA account yourself. There is something called an 'index fund'. These are mutual funds that basically track a major index exactly. So your investment can be expected to exactly match the overall market performance for that index. The most common index used for this is the S&P500, and Vanguard has the index fund with the ticker symbol VFINX that tracks this.
With mutual funds, as with any investment, so years will be good and some bad. However, over time, the good generally outnumber the bad. Based on the historical performance of the stock market, you could expect on average about an 11% return each year. Some years you may lose money, and some years you may be up over 20 or even 30%. but on average, 11% over a long period of time annualized.
This compares very favorably with a money market, as it is over twice the return. Of course there is short term risk, which is not the case for a money market account. If you need the funds in a year or two, and nex year is a bad one for the market, you will have less available than if you put it into a money market. But if you have five or more years, this risk begins to diminish and disappear, as any bad years will have plenty of time to fade as good years replace them.

To give you an example of the difference, see below for a link to an investment calculator:

http://www.ici.org/cgi-bin/calcs/SAV14.cgi/investment_company_institute

Enter how much you have to start (zero is fine if you are just beginning), The return you expect to get on a yearly average (11% for an index fund), leave the total amount you need blank, enter how long until you plan to need the funds, and the additional amount you plan to add to it each month.

There are several things to try here. First do it with 11%, then with 5%. Also, play with the length of time a bit. The longer investments work, the better off you will be. For example, if you start with $2,000, add $250 to that each month for 30 years, when you are 53 you will have about $750,000 if invested in an index fund. But in a money market account, you would have just over $200,000.  That is a half million dollar difference!
Reading an introductory book regarding how to invest is essential in giving you the basic background you need to being. I like "Investing for Dummies". While not exactly a flattering title, it has good info on just about all forms of investments, provides additional resources to look into topics that interest you most, and is readily available at most bookstores and at amazon.com . Read that, then make your decision on if you want to take on some risk in exchange for a higher return, and get started!

I hope that 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


---------- FOLLOW-UP ----------

QUESTION: Thanks so much for the helpful response.  I still feel like I just walked into a country where I don't speak a single word of the language.

Right now my Roth with TRP has performed pretty well (in my novice opinion), as in I've only invested $1,000 so far and its current value is approximately $1,075 over 2-3 months.  It has an expense ratio of .93.

I did go onto E-trade and set up an account.  I found they have an index fund of E*TRADE S&P 500, I'm assuming thats what you were referring to.  We plan on buying our house in 2-3 years.  So you think it would not be advisable to fund that index fund and transfer our house downpayment savings to there since there is a short term risk?  You think I would be better off just leaving it in the money market?  Do they act the same (the MM vs. the index fund) as in, all I have to do is occasionally add funds and not make any investment decisions?

Again, thanks again for sheding some light on a total novice!

Answer
Jeff,
  Thank you for the follow up!
  Yes, I hear what you are saying about feeling like you are in a foreign land with all this new terminology and subject matter you are not familiar with. Pick up a copy of "Investing for Dummies", it will be a HUGE help, and give you the foundation you need to understand the talk.
  Every investor is different. Regarding your home down payment, some would want to take risk, invest the downpayment, and try to make it grow as quickly as possible. But this is a risk, as you could lose money as well. The markets have been very strong, and this could continue. But when the markets turn, it is usually very fast!
  One thing that you could consider regarding the down payment savings you have are Certificates of Deposit. You should be able to get a CD with about a 5% return, and it is perfectly safe and locked in. No risk. You can purchase a one, two, or three year term CD. The only disadvantage is that you do not have access to the funds until the CD matures, so for that reason it may be best to buy one year CD's, then when the mature if you are not yet ready to buy your home, turn it over into a new 1 year CD.
   You can purchase CD's at almost all major banks, or through any organization that trades. ETrade probably offers them, www.NetBank.com is another online service that seems to have very good rates. I would do a little comparison shopping to see how gives you the highest rate of return.
   Yes, the Etrade S&P500 is likely an index fund that copeis the holdings of the S&P500 index. You could if you wanted to transfer your IRA over to Etrade, and put the funds into that.  It would be great if you could put at least a little aside each month into the Etrade account, in addition to what you are saving for your home.  You are young, you have a huge advantage the way interest compounds over time. Just a few hundred a month will result in a million or more when you retire!

Don't forget to get "Investing for Dummies". This will give you great information that you can use for the rest of your life. Barron's "Dictionary of Finance and Investment Terms" is another great book, it has never failed me. It offers great, usually easy to understand definitions of just about any financial term that I have come across. I have been in this business a while and still use mine regularly. Your financial well being should be a lifetime hobby.

I hope this helps, please do not hesitate to follow up with me if I can be of any additional assistance!

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