(PUB) Investing 2015

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Fund Family Shareholder Association

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his IRA and is funding a 401(k)

at work. My daughter’s IRA, smaller

because she’s younger, is also growing (I

matched her earnings too). And yes, after

a job change, she’s got a 401(k) as well.

Okay. That’s my kids. What about

yours? Let’s go back and review my

thinking on the teenage Roth IRA, so

you won’t put this off. It’s important and

especially timely given that the April

15 deadline for contributions seems to

sneak up quickly on those who’ve pro-

crastinated about making their deposits.

The Roth IRA is an excellent retire-

ment savings vehicle for younger peo-

ple. Since their introduction in 1998,

Roth IRAs have been garnering respect

(and dollars) from knowledgeable

investors for the advantages they have

over traditional IRAs.

While a traditional IRA allows you

to deduct your contributions pre-tax,

it also locks your money in until you

are 59½ years old (unless you feel like

paying a 10% fee on withdrawals, plus

income taxes), and forces you to take

distributions upon reaching the age

of 70½, paying income taxes at your

future—and possibly higher—tax rate.

In contrast, when contributing to a

Roth IRA, you invest with after-tax dol-

lars now and can withdraw funds tax-free

after the age of 59½ or if you meet other

IRS qualifications (for instance, if the

distributions will be used for a first-time

home purchase—something today’s kid

might appreciate tomorrow—or to help

with a disability). Once you do hit

retirement, there is no requirement on

distributions—if you don’t feel like tak-

ing money out or don’t need it, you can

leave it in there to continue growing.

Why do I continue to preach the

benefits of IRAs as great starter invest-

ments for teenagers or young adults?

Simple: Taxes and the power of com-

pounding. If your child is only working

for the summer, or just starting their

professional career, they will likely be

in one of the lowest tax brackets, mak-

ing it a fantastic deal to pay taxes on

their retirement savings now as opposed

to when they are older and in a higher

bracket. And, in this economy, many

first-time jobs don’t come with 401(k)

retirement plans attached, so there’s no

other available vehicle for forced retire-

ment saving. Plus, for most, an IRA

gives you more flexibility over where

and how to invest. 401(k)s often have

few, and sub-par, investment choices.

The power of compounding is what

really makes any kind of tax-deferred

investment smart. The definition of com-

pounding is “the act of generating earn-

ings from previous earnings.” While I

know you know what that means, here’s

how I’d think about explaining it to a

younger investor: Let’s say you make a

$100 investment in a fund that rises 20%

in a year. After that year, you’d have

$120. Instead of selling your shares,

you let them ride, and the fund gains

another 20% the next year, bringing your

investment value up to $144. That’s an

additional $4 in gains over the first year

(or 4% on the original $100 investment)

generated because you gained 20% not

only on your original investment, but

also 20% on all the money you earned

in the first year. While this may not

seem like an impressive amount, with

each passing year that earnings poten-

tial grows even higher, so long as the

investment prospers. If you start actively

investing a set amount each year, add-

ing to the amount generated by what the

investment earns on its own, you create

even larger potential earnings.

In the table above, I set up several

different savings scenarios for illustra-

tion. All of them assume a 6% annual

return, with the difference in scenarios

being the amount contributed per year,

increasing in increments from $1,000

to $5,500 (the maximum currently

allowed under IRS rules for investors

age 49 and younger for 2014 and 2015)

from the age of 15 to 70.

Finally, the sixth scenario attempts to

show a conservative, natural progression

a young person might follow as they age

and gain employment: Starting with

their first summer job at age 15, they

invest $1,000 a year until they gradu-

ate from college and get settled into a

career, bumping their contribution up

to $2,000 a year at 23. By age 30, they

will (hopefully) be well-established and

able to again bump their contribution up

to $4,000, and at 40 bump it up again

to $5,500, an amount they continue to

contribute up until retirement.

You can see that the greater the con-

tribution and the greater the time that’s

passed, the larger and faster the account

grows. That is the power of compound-

ing—by constantly adding to your

investment, you increase the potential

return, going from what seems like a

paltry $1,000 initial investment at age 15

to $225,000 by age 60, simply by adding

$1,000 a year to the account, achieving

a 6% annual return and paying no taxes

on your income and gains. With larger

initial (and subsequent) investments, you

get even more bang for your buck.

But I also put together another sce-

nario that may be more realistic, par-

ticularly when we’re talking about real

markets and real teenagers. First off,

few teenagers are going to be able to

earn $5,500 in a summer, though they

might be able to hit that number or high-

er if they work during the school year.

Also, as you know, markets don’t

compound in a straight line. They go

up and down. So, in the charts on the

next page, I’ve assumed that our teen (or

guardian angel) is not only socking away

more modest sums, but does so from the

age of 12 to the age of 25, when, presum-

ably, Junior will be out working, saving

and investing on his or her own.

In the three scenarios, I’ve assumed

the actual returns from

Total Stock

Market

Total Bond Market

and

Wellington

from 2001 through 2014.

Roth IRAs Age Well

Age

$1,000

A Year

$2,000

A Year

$3,000

A Year

$4,000

A Year

$5,500

A Year

Gradual

Increase

$1,000

$2,000

$3,000

$4,000

$5,500

$1,000

$24,673

$49,345

$74,018

$98,690

$135,699

$37,284

$225,508

$451,016

$676,524

$902,032

$1,240,295

$612,935

$417,822

$835,645

$1,253,467

$1,671,289

$2,298,023

$1,174,517

Assumes a 6% annual rate of return.