Naked Truth Investing: Go for the Roth IRA!

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This is the part of a new series of columns called "The Naked Truth," by retirement expert Dan Solin. Please bring him your questions, in the comments box, and he will answer as many as he can.

Question: What is better. Traditional or Roth IRA? I have my Roth IRA invested in the Vanguard Total International Stock Index Fund (VGSTX)? I am 38 years old.

Answer: While this subject is not free of doubt, I prefer the Roth IRA. Both the Roth and traditional IRA's are tax-deferred accounts. But, unlike a traditional IRA, Roth IRA contributions are made with already-taxed income.

Here is a summary of the benefits of the Roth IRA:
  • No mandatory withdrawals when you reach any age;
  • No penalty for early withdrawals;
  • No taxes on withdrawals up to the amount contributed;
  • No tax on investment earnings within the Roth IRA once you reach age 59 1/2 (or become disabled), provided that the account was in existence for five or more years.
With the Roth IRA, are trading the certainty of tax avoidance for the uncertainty of tax deferral. With a traditional IRA, you are forced to make assumptions about the ordinary income tax many years in the future when you start taking withdrawals. This strikes me as risky bet.

You should not have 100% of your money invested in an international stock index fund. Instead, you should:

First: Determine your asset allocation by taking an asset allocation questionnaire. You will find many on the internet, including one on my web site.

Second: Keep your account with Vanguard. There are other fund families you could consider, like Fidelity and T. Rowe Price. However, Vanguard has historically been the leader in offering an excellent choice of low cost index funds.

Third: Invest 70% of the amount of your funds allocated to stocks in the Vanguard Total Stock Market Index Fund (VTSMX), and the balance of 30% in the Vanguard Total International Stock Index Fund (VGTSX). Invest 100% of the funds allocated to bonds in the Vanguard Total Bond Market Index Fund (VBMFX).

Fourth: Once or twice a year, re-balance your portfolio to be sure that your asset allocation remains intact.

This plan gives you a globally diversified portfolio of stocks and a broadly diversified portfolio of bonds.

Dan Solin is the author of The Smartest Investment Book You'll Ever Read (Perigee Books 2006) and The Smartest 401(k) Book You'll Ever Read (Perigee Books, June 24, 2008). Visit his website at Smartestinvestmentbook.com.
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