Start an IRA Today (If Not Sooner)

Clingdome2How would you like to retire a millionaire?  Well, if you’re a teen working a summer job and you put $1000 away into an IRA (Individual Retirement Account) today, you have a shot at reaching that goal even if you do nothing else.  That’s if you earn a 15% return between now and about 50 years later when you’re ready to retire.  If you earn only 12%, you’ll only end up with about $300,000, but still that’s not bad for a $1000 investment.

Now I know that $1,000 is a lot of money when you’re working for $7.25 per hour, especially after taxes are taken out and you factor in expenses like gas to get to work, so you really only earn about $6.00 per hour.  Still, that 170 hours worth of income you give up now could help set you up for retirement.  And it doesn’t even need to be your $1000.  As long as you earn at least $1000 from working, your parents or a nice uncle could give you another $1,000 to invest while you spend the $1,000 you earned.  Maybe you can work out a deal with your parents where they match your contribution, so you actually only need to contribute the earnings from about 80 hours ($500) yourself.

So what is an IRA?

An IRA is an account included in the tax code where contributions are allowed to grow either tax deferred – where you take the money out and then pay taxes, or tax-free – where you pay no taxes.  This means that your money will be able to compound without taxes being taken out all of the time as you go.  The more money you have to earn interest on, the faster your money grows.  If you use a traditional IRA, you don’t pay taxes on the money you contribute, which means Uncle Sam will be putting something like $100 of the $10000 you are investing in for you.  Whatever money you pull out when you retire, however, will be taxed at that point, so your Uncle Sam will take back about $200,000 of your $1 M.  If you do a Roth IRA, you’ll need to pay all of the taxes now, meaning you’ll need to come up with the full $1,000, but when you pull it out the money is all yours.

How do I setup an IRA?

The easiest way with $1,000 is to go to Vanguard, open an IRA (it takes about 15 minutes online), and buy into their Vanguard Target Retirement 2060 Fund.  I choose this fund because it has only a $1,000 minimum investment and because it has mainly stocks, which is what you want for the next 40 years or so.  You then just have your parents send in a check for you or transfer money from a bank account and you’re an investor.  Simple.

What do I do then?

Well, you don’t need to do anything, really, at least for while.  Once you reach the account minimums for Vanguard’s other funds, which currently are at $3,000, you should switch to the Vanguard Total Stock Market Index Fund because that will increase your returns over time since you’ll then get rid of the bonds that are in the 2060 fund and be invested in all stocks.  It will take you until about 2039 to reach that point, however, if you only invest the original $1,000.  (Compounding starts slowly and then accelerates at the end.)

I would rather you become a regular investor, sending in $50 whenever you can through college.  Once you’re working a regular job, see if you can contribute the maximum ($5,500 per year, plus another $5,500 into a spouse’s IRA if you get married).  Also get into the 401k plan at work if there is one.  While $1 M may seem like a lot today, the truth is you’ll need like $10M or $20 M by the time you’re ready to retire since $1 M won’t buy what it does today.  If you invest regularly through your twenties, however, you’ll have it easily.  In fact, if you do a good job of sending in money between 16 and 35, you really won’t need to contribute at all after you reach about 40 since you’ll already be set.

The other thing to do is something not to do:  Do not touch the money for any reason until retirement.  If you take the money out early, you’ll pay extra fines and taxes.  Plus, you’ll be undermining yourself.  Right when you were going to start earning really money from your investments, you’ll take it out.  If you try to start over in your forties or fifties, it will be much more difficult.

What if I wait?

I know, money is tight and you’re busy doing other things.  If you wait until you’re 25 to start investing, however, that $1,000 will only make you $300,000 ($100,000 at a 12% rate-of-return).  Wait until your 40, and it will only net you $33,000.  That means you’ll need to work a lot harder and sacrifice a lot more to retire comfortably.  The other choice would be to retire uncomfortably and be scrounging for food and heat.

So see if you can set aside $1,000 and a half hour to start an account.  Maybe take one extra hours or spend some time with friends doing things that don’t cost money.  Your future self will thank you.

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Disclaimer: This blog is not meant to give financial planning or tax advice. It gives general information on investment strategy, picking stocks, and generally managing money to build wealth. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. Tax advice should be sought from a CPA. All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.

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