There are two key features that you need from your Roth IRA account:

1) the ability to automatically invest in stocks and/or mutual funds.

2) low fees.

You will hold the investments in your Roth IRA for at least 30 years. Over such a long time horizon, stocks and/or mutual funds will offer you the best return on your money. Bonds may return 5% over the long haul, and money market funds would be lucky to return 4% per year. However, from January 1926 through June 2006 the annualized total return for the S&P 500, a broad index of large US companies, was 10.40% per year (according to Standard and Poors). By including small and foreign companies in your portfolio, you may be able to increase those returns. So you will need an account that allows you to invest in stocks and/or mutual funds.

Unfortunately, there are costs associated with investing no matter how careful you are, but by being a smart and informed investor you can minimize the negative impact of these costs. So the second feature to look for in a Roth IRA account is low fees.

Mutual fund managers make their money though a fee called a expense ratio, often 1-2% per year. The expense ratio comes directly out of the funds return. While you will not pay out-of-pocket dollars to cover the expense ratio, it reduces your returns significantly over the long term. (For a harsh example of how much your returns are affected, read Robert Kiyosaki’s article “Why Mutual Funds Are Lousy Long-Term Investments.”)

Also, do not let anyone sell you a loaded mutual fund; where you have to pay a commission either to buy or sell the fund. No-load funds, which cost you nothing to buy and sell (but still have an expense ratio), have been proven to perform equally as well or better than comparable loaded funds, after fees. If you are considering or are currently invested in a loaded fund, check out this list of loaded funds and their no-load alternatives.

You can invest in no-load mutual funds by opening an account directly with a mutual fund company like Janus, Fidelity, or Vanguard. I highly recommend Janus for their excellent customer service, and Vanguard is widely known for their low expense ratios. Investing in mutual funds is appropriate if you don’t have the time or interest to develop your own portfolio.

Instead of mutual funds, I prefer to invest in a diversified basket of exchange-traded-funds, or ETFs - funds that track established market indicies yet trade like normal stocks. ETFs are not actively managed like many mutual funds, meaning much less work for the fund managers. Accordingly, the expenses associated with ETFs are often far less than comparable mutual funds. You will, however, have to pay commissions a broker to purchase and redeem shares of ETFs.

To invest in ETFs, you should open a brokerage account that charges low commissions, such as Scottrade, TD Ameritrade, Sharebuilder, or BuyAndHold.com. I prefer Sharebuilder, because with monthly or quarterly contributions, their $4 commission per transaction is less than you will pay with other brokerages. And you can earn $75 for opening a non-retirement account, or $20 for opening a Sharebuilder Roth IRA through Ebates.

Should you pay commissions to buy ETFs instead of no-load mutual funds? I believe so.

Imagine investing $333 (not coincidentally, the amount you need to contribute each month to max out a Roth IRA in 2006) for one year in both a no-load mutual fund and in ETFs through a Sharebuilder account. Assuming both investments earn 10% before fees. The mutual fund skims off 1.5%, leaving you with $361.31 at the end of the year ($333 with an 8.5% return). The Sharebuilder account ends up with $361.90 ($333 - $4 commission with a 10% return). The fifty-nine cent difference may seem insignificant, but remember that the Sharebuilder commission is a one time fee, whereas the mutual fund expense ratio hurts you each and every year…making the Sharebuilder account a much more attractive option.

Action Items:

• Open a Roth IRA account at Sharebuilder.com. If you use Ebates to open the account, you will earn a $20 rebate.

Disclosures: I invest personally with Sharebuilder and Janus, and receive $20 for Sharebuilder signups through this site (unless you use the Ebates service). I receive no compensation from Janus, Fidelity, Vanguard, Scottrade, TD Ameritrade, or BuyAndHold.com.

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This entry was posted on Sunday, September 17th, 2006 at 12:51 pm and is filed under "The Plan", Retirement, Roth IRA. You may e-mail this post to a friend. You may print this page. You can leave a response, or trackback from your own site.