How should a college student invest her funds inside a Roth IRA?
My daughter is opening her Roth IRA with $3K. She is 19 years old and in college. Where is the best place to put her money? We were thinking Target date funds, but we could use some advice.
Your daughter has a very long investment horizon and should be able to bear some risk. I'll assume this is her first investment and there are no other assets. $3,000 is a starter portfolio so you should be cognizant of costs like commissions. I would recommend one position, a stock index fund, for now. Vanguard's target date fund for 2060 is 90% stocks anyway and the target date structure adds a bit of cost. Additionally, as she starts saving her own money outside the Roth IRA, it get cumbersome coordinating target date holdings with the rest of her portfolio.
Given the amount invested, it makes sense to keep commissions low or zero. You can invest in Vanguard's Total Stock Market index (VTSMX) in a Vanguard account. Schwab has a commission free stock index fund (SWTSX) that you can trade in a Schwab account. Both of these funds give you broad exposure to the US stock market. Fidelity has its own stock index fund on its platform.
Reinvest the dividends and capital gains distributions so idle cash does not accumulate. As time goes on and money is added to account, you can look to other asset classes like foreign stocks or bonds.
Your daughter is young so I would be "aggressive" if you believe risks equals volatility (which I don't). You could put the whole thing in Amazon stock, AMZN, because they are the biggest growth company in the world assuming Apple's slowing growth continues. Then next contribution, buy one or two more of the best stocks in the world. By the time she is 30, she will have 10 to 15 of the best stocks. As you fill out the portfolio, go into other sectors like biotech or manufacturing, but keep up with large growth and reducing risk. The other thing you could do is invest in some of the best growth managers. Two tickers to research are CGMFX & GEGTX and this would provide diversity.
Alternatively, she could invest in QQQ which is the NASDAQ 100 ETF, the largest 100 companies on the NASDAQ like Apple, Google, Amazon, etc. A less "aggressive" approach would be the SPY, the S&P 500 ETF. An ETF is an exchange traded fund similar to a conventional mutual fund, but can be traded during the day (which would be irrelevant to your daughter).
The first approach with a few individual stocks will probably make the most money, but will fluctuate the most too. But by picking some of the strongest companies in the world with strong balance sheets, I believe your risks are minimal if you can put up with fluctuation. Then, the growth mutual funds or growth ETF QQQ would be next in order of "risk." Lastly, the S&P 500, ticker SPY, would be the most conservative.
Hope this helps, Dan Stewart CFA®
First of all, let me commend your daughter on making the decision to save for her future. By choosing to start saving so early, she will be taking advantage of her biggest ally, time. Since she will have somewhere between 45 and 50 years until she reaches full retirement age, the money that she contributes in the early years could have a significant impact on the long term outcomes.
With respect to how to invest the contributions to the Roth IRA, this is where the individual investor's feelings about risk come into play. When choosing the appropriate investment mix, it is a good idea to utilize a questionnaire that measures an investor’s time horizon (in this case, 40+ years), and the investor’s appetite for risk in their portfolio. To be clear, the definition of risk here is the possible short-term fluctuation in the value of a portfolio. When deciding where to open the account for your daughter, look for a risk assessment tool online. When working with my own clients, the risk assessment questionnaire is one of the first things I will review with a new client.
The purpose of the risk assessment is to provide the investor with a guideline for how to invest the funds in the account for the proper mix of equity (stocks), and fixed income (bonds) to match the investor’s tolerance for risk, and their time horizon. At this stage, it is a good idea to look for a mutual fund whose mix of equity and bond investments matches your daughter’s tolerance for risk. Could this be accomplished with a “Target Date” fund? Yes, it is possible, but when selecting any fund, be sure that the allocation mix of the funds matches the recommended allocation from the risk assessment tool, not necessarily just the target future year in the fund name.
There are a number of funds available that can accomplish this in a single mutual fund. And in a single mutual fund, this will ensure that the mix of stocks and bonds stays consistent over time. I will assume that your daughter will continue to make contributions over time, and having a single fund will simplify the process of adding new contributions as well.
Looking ahead, your daughter’s tolerance for risk may change over time. It is a good idea to take those risk assessment questionnaires periodically to ensure that the account is invested according to her tolerance for short term fluctuation in the portfolio.
Congratulations on instilling the importance of education, formal as well as personal, in your daughter!
Absolutely, a Roth IRA, in general, is a great place to stash money while your daughter is in the lowest tax bracket she will ever be in. And it doesn't matter where the money comes from as long as she has sufficient earned income to justify the contribution. For example, let's assume she works part time during school and made $3,000 last year. And spent it all on living and school expenses. You can give her money or use her savings to fund the Roth IRA up to $3,000. In addition, she may qualify for the Saver's Credit.
If your daughter plans to make regular, monthly contributions over many years, which is what I would suggest, then I would pick a handful of no-fee DRIP stocks that match her personal and ethical beliefs. Volatility is the friend of steady, long-term investors. But get an advisor to do a historical comparison of your DRIP portfolio versus a highly rated target date fund.
Best of Luck!
I specialize in young professionals, so your daughter is right in my wheelhouse. Target date funds are good, but I believe they tend to be a little more conservative than need be. My concerns for your daughter are:
1. Being too conservative - she has a lot of time. Upwards of 50 years, possibly longer with life expectancy trends.
2. Can she control the emotions of investing? If the market goes down, will she be strong enough to stay the course?
If she can do these things, then a simple S&P 500 index will work. She can add a small and mid-cap index or even an international for a little diversification. Though, at her age, diversification may be overrated. These are very specific comments and may not be right for her. Please consult someone who would know her situation and goals better. But this should be a good start.