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Author: pmmcateer One star, 50 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 76237  
Subject: Buying funds straight or through IRA Date: 2/10/2004 12:19 PM
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Hello all, I have another newbie to investing question. I do'nt have any investing experience, but have been doing some research for the past month on investing info. From what I have read, the advantages of an index fund with it's low cost and low volitility seem to be a good place to start as a base or core of my portfolio. And in looking at the index funds(such as vanguards s&p 500 and total mkt indx) it has 2 options. One is to buy each fund for 3k, the other is to start an IRA and you get it for 1k. My question is, is there any disadvantage to buying it through an IRA account as to buying it straight? And since I can only contribute 3k per year to an IRA that would mean I am restricted to purchasing 3 funds, and then would have to wait until 2005 to contribute any more funds if I started with the full 3k? Basically I am getting a tax return of about 5k, and am trying to build a solid foundation to my investing portfolio. I'm 23, and wanting to start off early but on the right foot. Any advice on any of the above would be greatly appreciated...thanks!

Patrick
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Author: pauleckler Big funky green star, 20000 posts Top Favorite Fools Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 39107 of 76237
Subject: Re: Buying funds straight or through IRA Date: 2/10/2004 1:34 PM
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Welcome Patrick. Glad you could join us.

First, lets clarify that you are allowed to contribute a total of $3000 each year to your IRA and/or Roth IRA. If your income is below certain levels, the IRA contribution is tax deductible, but your IRA distributions are taxed at regular income tax rates in retirement. Above the limit, IRA contributions are still allowed, but they are no longer tax deductible.

Roth IRA is a bit different in that if you are below the income limit, you are allowed to contribute. The contribution is not tax deductible, but the Roth IRA distributions are tax free in retirement. (If income is above the limit, Roth IRA contributions are not allowed, but conventional IRA contributions still are.)

For those who qualify Roth IRA is usually preferable.

So first you should contribute to a Roth IRA if you qualify. You can contribute up to $3000 per year. But there is no requirement to spread that over 3 funds. You can put all of it in one fund if you like. Because Vanguard funds often charge extra fees for accounts below $10000, putting it all in one fund is probably a good idea until you get over that minimum.

As to IRA vs taxable account, the IRA is tax protected. That is to say, you can move your funds from one investment to another without paying capital gains taxes. You can receive dividends or other distributions without having to pay income tax on them in the year received. This allows you to reinvest all your gains and grows your money faster.

The fact that taxable accounts generate tax liabilities is their major limitation. However, by selecting certain investments that you can hold long term and that pay little in capital gains, you can minimize the taxes that are due. This is called long term buy and hold (LTBH) in the Foolish lingo. An S&P Index fund is excellent in an LTBH account because capital gains distributions tend to be small. They do pay dividends, but dividends these days are also taxed at a favorable 15% rate. Tax managed mutual funds and growth stocks also work well.

So with $5K to invest, I would suggest that you fund your Roth IRA first, and then begin a cash account. If you are below the minimum for a Vanguard cash account, go to a discount broker. Scottrade or Ameritrade are often mentioned on these boards, though I use Fidelity. They will offer mutual funds too, but you can buy SPY the S&P 500 tracking stock traded on the Amex. At a discount broker, commissions are small, so costs are low. You can start small and grow the account according to your means.

If you can do only one, I would do the Roth IRA first. That gives you the flexibility to adjust your investments as you learn without having to worry about tax effects.

Best of luck to you.

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Author: rookieJoe Two stars, 250 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 39108 of 76237
Subject: Re: Buying funds straight or through IRA Date: 2/10/2004 2:05 PM
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Patrick<<....then would have to wait until 2005 to contribute any more funds if I started with the full 3k?....>>

If you fund the IRA before April 15, you have the option of saying it is a contribution for 2003 or 2004. If you specify it as a 2003 contribution, that would give you the option of making another contribution between now and April 15 2005 for the 2004 tax year.

Even if you don't have a whole 3k now, if you think you might want to invest more than 3k this year, consider putting in what you have before april 15. That will keep your options open for the rest of the year.

-Joe

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Author: pmmcateer One star, 50 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 39109 of 76237
Subject: Re: Buying funds straight or through IRA Date: 2/10/2004 2:31 PM
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Paul, thank you very much for your reply. One question regarding:

"So with $5K to invest, I would suggest that you fund your Roth IRA first, and then begin a cash account."

Like I said, I'm new to investing and this may be an annoying question but are you referring to a money market account when you say a cash account? I've looked on the 3 sites(vanguard, scottrade, and ameritrade) and fail to see anything with a cash account. Again, my apologies for my lack of knowledge and thanks for your insight.

Patrick

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Author: pauleckler Big funky green star, 20000 posts Top Favorite Fools Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 39110 of 76237
Subject: Re: Buying funds straight or through IRA Date: 2/10/2004 2:39 PM
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No problem, Patrick.

When I said "cash account," I meant a taxable account as opposed to an IRA, Roth, 401K or other tax deferred account.

Most brokerage accounts are set up so that when you make a deposit or one of your investments pays say a dividend, the money is automatically swept into a money market account. It remains there (at ridiculously low interest rates) until you give instructions to invest it. (IRAs and Roths worth that way too if they are brokerage accounts.)

Usually when you give a broker instructions to buy something, you have 3 days to get the cash into the account. That can be a problem if you have to mail in a check. If the cash is not there, the brokerage loans you the funds and charges you interest on them (usually at the rate for margin loans). To avoid that, its best to mail them a check, make sure its received, and then place your order.

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Author: telegraph Big funky green star, 20000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 39112 of 76237
Subject: Re: Buying funds straight or through IRA Date: 2/10/2004 3:13 PM
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Patrick: From what I have read, the advantages of an index fund with it's low cost and low volitility seem to be a good place to start as a base or core of my portfolio.

Yes, a broad market index fund gives you less volatility, less risk, and more diversity across market segments.

You might want to consider the Vanguard Total Stock Market index fund.


And in looking at the index funds(such as vanguards s&p 500 and total mkt indx) it has 2 options. One is to buy each fund for 3k, the other is to start an IRA and you get it for 1k.

Vanguard has rules for IRA accounts, and other accounts. FOr IRAs, the minimum to buy a fund is less..otherwise, folks couldn't start investing if they have a $500-2000 limit on annual contributions....((ie, spousal lRA). That, and they expect you to not churn your IRA frequently, nor take the money out for a long term, which is good for the fund overall, and minimizes expense to all in the fund.

For non-IRA accounts, you have to start with more.

You don't have to buy 3 funds if you have $3000 to start.



My question is, is there any disadvantage to buying it through an IRA account as to buying it straight?

Yes...if you put it in an IRA, Uncle Sam defers taxes on your gains.
If it is a traditional IRA, you also don't pay income tax on the money you put into the IRA, thus having Uncle Sam make part of your investment, which you both hope will make lots of money.

In a ROTH, only the gains are taxed when you take the money out....at regular income tax rates (up to 33%)

In a regular IRA, everything is taxed when you take it out, at regular income tax rates.

In both forms of IRA, the contributions accumulate tax deferred until you take it out....any cap gains, distributions, dividends, are not taxed each year...only when you take the money out....

If you put money into a regular account (no IRA of any kind), you will be taxed yearly on cap gains and dividends. The SP500 pays a between 1 and 2% dividend each year.....occasionally a fund will have cap gains distribution, but most won't for a while....still in the negative area from 2000-2003, and they carry the losses forward. An index fund traditionally has small annual distributions.

You should consider both..the world isn't all one or the other.

Depending on your state of residence (if you have high state income tax as well), any tax deferral is a big help...between state and fed tax, some folks are paying 30-40% of income in taxes...so that is 30-40% that Uncle Sam/state gives you to put in your IRA by not taxing you now...and if you live in a no tax state when you retire, you NEVER pay that state income tax....on the tax deferred accounts.

t.


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Author: 2old4bs Big red star, 1000 posts 10+ Year Anniversary! Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 39128 of 76237
Subject: Re: Buying funds straight or through IRA Date: 2/10/2004 7:06 PM
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in looking at the index funds(such as vanguards s&p 500 and total mkt indx) it has 2 options. One is to buy each fund for 3k, the other is to start an IRA and you get it for 1k.

If you go with the Total Market Index there is no reason to also invest in the S&P 500, since the Total Market is heavily weighted toward the S&P 500 anyway. IOW, you really only have to buy one fund if it's the Total Market Index.

If you are not in a very high tax bracket now, I would opt for a Roth IRA over a deductible traditional IRA. A Roth doesn't have restrictions and penalties on withdrawals like a TIRA does, and all withdrawals are non-taxable. In either case, I would choose an IRA over a taxable account at your age, to get you off on the right foot.

2old


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Author: kp0023 Two stars, 250 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 39154 of 76237
Subject: Re: Buying funds straight or through IRA Date: 2/11/2004 10:19 AM
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I agree with rookieJoe. Put 3K in before April 15th as 2003 contributions. Then put the other 2K in at the same time for 2004 contributions.

Personally we use Scottrade to purchase our IRA's but go out and research what is best for your situation.

If you do a search on VTSMX and VFINX on the boards, you will see many here recommend these index funds for new investors. My family owns both.

MinKim


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Author: dsemmler Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 39172 of 76237
Subject: Re: Buying funds straight or through IRA Date: 2/11/2004 3:39 PM
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In a ROTH, only the gains are taxed when you take the money out....at regular income tax rates (up to 33%)

The Roth IRA is tax-free for qualified distributions. For definition of qualified distributions, please see page 59 of the IRS Publication 590.

dt

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Author: pmmcateer One star, 50 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 39233 of 76237
Subject: Re: Buying funds straight or through IRA Date: 2/15/2004 12:54 PM
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Thank you all for your reply! I will probably go with the Roth IRA with VTSMX, it seems to be the premier "buy and hold" type index fund. Thank you for all your insight...glad I joined!

Patrick

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