About a week ago, I decided it was time to open a Roth IRA. For context, I am a 22-year-old who graduated college in May 2020. My full-time employment has been delayed until January 2021. I have been filling my time with various side hustles and have actually started to make some money. I’ve decided that the postponement of my employment should not preclude me from starting to invest for retirement, so I decided that opening a Roth IRA is my best bet.
The first step in my process to opening my Roth IRA was to pick a method of investing. There were three types of methods I was interested in because they are all commonly recommended by other personal finance creators and the finance world in general. They are investing with a robo-advisor, investing in a target-date fund, and DIY investing. If you aren’t familiar with the first two, you may want to google it and come back. I think I explain the third one pretty well later on.
Many people fret over which broker to choose, but I believe that after determining your investment method, the choice of broker is trivial. Robo-advisor services are offered by brokerages such as Wealthfront and Betterment whereas you can invest in a target date fund or do DIY investing at what are called “discount brokerages” like Vanguard, Fidelity and Charles Schwab. There are many more options out there, and I encourage you to do your research, but definitley don’t stress too much about comparing brokerages in the same category. In the long run, it won’t matter too much.
I have outlined the pros and cons of each method below:
Robo-advisor
- Pros
- Convenient– generally hosted on really user-friendly websites and apps that don’t require a lot of effort to learn how to use
- Fool proof– your entire investing strategy will be determined after answering a few questions about how much risk you wish to take on and how long you want to be in the market
- Tax-loss harvesting– although this may be a great benefit that is hard to replicate on your own as a beginner investor, it doesn’t apply to my situation because IRA’s are tax-sheltered and capital gains aren’t taxed
- Cons
- Robo-advisor fee– Although the fee is generally low (below 1%) compared to a human advisor, this fee gets stacked on top of the fees to invest in the investments themselves. These are two places where your investments can be degraded.
- Not much evidence that returns are significantly higher than a DIY fully diversified portfolio of index funds
- This is because a robo-advisor portfolio essentially invests in the same or similar index funds that you can buy from other brokerages.
Target Date Fund
- Pros
- One and done– It’s not too good to be true when I say that you can buy a target date fund and have as diversified and robust a portfolio as you would ever need
- Low cost- when compared to a robo-advisor, a target date fund is generally cheaper because you’re only paying for the fund part.
- Buy it and forget it- When you buy a target date fund, the best practice is to buy it, make your monthly/yearly contributions, and let it sit. You don’t want to play around with buying more index funds in addition to it because you could end up more exposed to certain parts of the market than you would like!
- Cons
- Asset allocation is one size fits all– buying a 2060 target date fund shackles me to the asset allocation of that fund. That means if I want to put more money into stocks, for example, than the fund allows, I can’t.
- Target-date funds may not have the most efficient strategies- usually a target date fund invests in an array of other index or mutual funds. The managers of the fund may have incentives to invest in a higher cost mutual fund than you could buy if you created your portfolio on your own. This will ultimately degrade your return on investment.
DIY Investing
- Pros
- Cheapest Option– I am especially interested in Fidelity which offers 0% fee funds!
- Great way to learn about investing by doing– creating and maintaining my own portfolio will force me to learn how to form beliefs about my asset allocation (i.e. what % should be in stocks, bonds, international, etc) and rebalance it every year
- Flexibility to add special funds– although I’m not looking to do this in the very beginning, I’m definitely interested in the possibility of adding funds that invest in sustainability, women-owned businesses, or specific sectors that I want weighted more heavily in my portfolio
- Cons
- More room for error– DIY investing takes a bit more research to make sure that the investments you pick are properly diverse and that you aren’t too exposed to one area of the market
- Requires more research to feel fully informed and ready to go– If you are going to invest in more than one fund, you should learn about each one so that you don’t buy something that you don’t understand. This naturally requires some time and effort
- Abundance of options leads to paralysis– if you are unable to break free of analysis paralysis, I suggest you defer to the robo-advisor option
My Choice: DIY investing
There are a few main considerations that drove my decision to pick DIY investing. Please keep in mind these are personal considerations that will vary for everyone. What I choose is not necessarily the best choice!
My profile: risk averse, above-average investment competence, high price sensitivity
1. I am generally a risk averse person. You won’t find me riding my bike without a helmet or using my phone without a phone case. Once you read my investing strategy, you might question its aggressiveness given this fact, but the next point will help you understand why I’m comfortable taking more risk when it comes to investing.
2. At 22, I have taken about 3-4 courses on financial and investing concepts, done a four-week investing bootcamp, and completed two full-time internships in the investing space (in equities and in bonds). This gives me a great foundational knowledge in investing and it’s the reason I know how to compute compound interest, what diversification is, and what the implications of cyclicality are on long-term returns. I have great confidence in the market’s ability to grow over the long-term because I have studied this stuff. Most people enter personal investing afraid of the market and having to overcome this fear. If anything, I am coming in too confident in the market and will have to compensate for my bullishness.
3. When I talk about price sensitivity, I am talking about the cost of investing. This means all those fees that I mentioned above. For example, there is a fee to invest with a robo-advisor. There is also a fee to hold individual investments. I am price sensitive in all areas of my life (this is why 80% of my wardrobe is thrifted). Holding all other factors equal, I would prefer to invest in the lowest cost option.
When I combined all the aspects of my profile: risk adversity, investing competence, and price sensitivity, it made sense for me to go for DIY index investing. Index investing, when done right, can be low risk, high return. Although all the options I listed are technically index investing (since robo-advisors and target date funds all invest in some mix of index funds), DIY investing makes sense for me because I can utilize my investing competence to create a portfolio that is tailored to my own ideas, risk profile, and time horizon. It also allows me to gain all the benefits of index investing at the cheapest price.
What My Choice Means for You:
So, I know that I emphasized the fact that I am very comfortable with investing terms and ideas. Does this mean you can’t do DIY investing yourself if you don’t have the same level of comfort? No! DIY investing is super attainable for everyone. You don’t even need to do extensive learning and research. There’s plenty of articles online and books that detail sample portfolios that you can recreate.
This is a great place to start: https://www.moneyunder30.com/portfolios-for-diy-index-investors
However, the fact that I’m very risk averse may have precluded me from doing DIY investing if I didn’t have the level of knowledge that I have. You do introduce a small amount of risk when you decide to create your own allocations and rely on yourself to rebalance your portfolio.
On the subject of fees, although I mentioned that robo-advisors and target-date funds are generally more expensive than DIY investing, this should not prevent you from picking them. In the long run how much you contribute to your account will matter much much more than the amount that you lose in fees. Don’t get me wrong, fees can add up to a considerable amount, especially when you consider the opportunity you are losing to earn compound interest on them, but if trying to DIY invest is going to prevent you from opening your account due to analysis paralysis, then you’re better off just going for a robo-advisor.
For an awesome analysis of how robo-advisor and target-date fund fees affect your return, please see this article: https://www.moneyunder30.com/are-robo-advisors-worth-it
Next Steps
The next steps for me are to create my portfolio of investments and then take the leap and actually invest my money. I will be detailing this process in future articles so stay tuned!
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