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Where to Open Your First IRA

I recently received this question from a reader:

“I’m about to get started investing, and I’m trying to figure out where to open my first Roth IRA. I know that you like Vanguard, but I don’t have the $3,000 that it takes to invest in any of their funds. What’s your suggestion for a new investor?”

My answer: It depends. Specifically, it depends on how much money you do have. But first, we need to back up a step.

Do You Have an Emergency Fund?

For most investors, building an “emergency fund” is a higher priority than saving for retirement. Unexpected expenses (car repairs, medical expenses, etc.) come along often enough that it’s important to plan for them. You don’t want to end up in debt just because you were eager to get started investing and your investments declined in value right before you needed to access them.

So if the cash in question is nearly all of your money, keep it in something safe (a savings or money market account, for instance), and continue working on saving. Eventually, you’ll get to the point where you can invest while still maintaining an emergency fund.

$1,000-$3,000: Vanguard STAR Fund

For investors with between $1,000 and $3,000 (outside of their emergency fund), I’d usually suggest opening an IRA at Vanguard and investing in the STAR Fund. Unlike other Vanguard funds, the STAR fund’s minimum investment is $1,000 rather than $3,000.

With a 0.34% expense ratio, it’s slightly more expensive than a low-cost index fund. But with $2,000 in the STAR fund, you’re still only paying $6.80 per year in expenses–hardly a catastrophe for your long-term investment success. And if you keep socking money away, you’ll soon be able to move it over to your favorite index fund(s) of choice.

Note: If you expect to spend the money within the next few years (on a first-time home purchase, for instance), the STAR fund’s ~62% stock allocation is too risky. CDs would likely be more appropriate. (Many brokerages and banks offer CDs inside an IRA account.)

$0-$1,000: Savings or Money Market

For new investors who haven’t yet managed to come up with the $1,000 necessary for the STAR fund, I would usually suggest just sticking with a plain-old savings or money market account–for now, anyway.

The first step to becoming a successful investor is to be a successful saver. So focus on saving until you’ve got it down to a science. If you can save just $20 each week, in less than a year you’ll have that $1,000.

(Just to be clear for any new readers: Vanguard is not the only good place to invest. There are plenty of other brokerage firms where you can build a low-cost diversified portfolio using index funds or ETFs. I’m just particularly keen on Vanguard because of their unique ownership structure.)

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Comments

  1. According to the yahoo fund profile on Vanguard Star, the fund may allocate up to 60 to 70% on stocks. For a young investor with 40 to 50 years to retirement, that is too low an allocation.

    T Rowe Price might a good alternative in the short to medium term.

    Cons:
    – They are an actively managed shop.

    Pros:
    – Very friendly to the small investor. (I wouldn’t be writing this post otherwise. This is the biggest value ad, otherwise go with Vanguard.) You can get started with $0 down as long as you commit to investing $75 a month.
    – For an actively managed shop, they aren’t price gougers. Most of their funds have an expense ratio under 1%.
    – They also a very conservative and boring shop. (ie not Janus) No star manager emphasis.
    – They have several fund with wide latitude (investing a broad array of asset classes) which give the small investor wide diversification in one fund. Spectrum Growth, Intl Spectrum Growth, Target Retirement funds, etc.

  2. Hi Schmoe.

    I agree that there are other perfectly-good alternatives to Vanguard.

    But I do not agree that one should avoid Vanguard solely to opt for a higher stock allocation than ~60%. For the short time that it will take to reach $3,000 in the account, the forgone return from having~60% in stocks as opposed to any higher percentage will be slim.

    For example, if an investor puts $2,000 into STAR when they wanted 100% in stocks, even if the market doubles and bonds earn nothing at all (an extreme scenario), the difference in account value is measured in hundreds of dollars, not thousands. (And the investor can now switch over to a different fund.)

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