Roth IRA for an 18 year old-- critique welcome

[VagabondMD]

As I construct a Roth IRA for my 18 year old, it occurs to me that such a portfolio construction (100% equity) might be appropriate for any uber aggressive investor, early in one's career (resident, new attending with a Backdoor Roth, etc.). I want it to make sense and be easy for my son to understand and maintain as he takes over his finances in the coming years. I also am encouraging to learn and understand why one should want more than the S&P 500 (why international?, why small value?, why emerging markets?).

So here's what I have planned and implemented:

70% US (split between total stock market and small value) and 30% international (split between total developed market and emerging market)

We are a Fidelity family family , so I am using ishares ETFs (that trade free at Fidelity) in the following proportions:

itot (er 0.03) 50%

ijs (er 0.25) 20%

iefa (er 0.08) 20%

iemg (er 0.14) 10%

Thus far, the money that has seeded the account has been taken from his W-2 and 1099 earnings over the last two years as a lifeguard, camp counselor  and swim instructor, and he has a little north of $7000 in the account. I take 50% of his paycheck and match it with my money. (If he earns a few extra bucks as a tip or $20 cash from a private lesson, I do not include it.) When I add the money to the account and place the trade, I do so with him present and encourage him to ask questions and discuss.

[Sneezy]

If he is 18 maybe he should be the one deciding?  When I was young I did all kinds of crazy things like investing in technology funds.  With relatively little money it may be okay for him to make mistakes and learn on his own

 

For my own son who isn't too interested in investing, I advised him to put it all in a Vanguard Target fund which he did.

 

[Hatton]

both Sneezy and Vagabond are setting the bar high to raise financially literate kids.

[jfoxcpacfp]

Not sure I could have done it better myself. I know I've mentioned this before, but Simple Wealth, Inevitable Wealth would give him great perspective on the benefits of long-term investing and much clarity about the issues you're discussing. I realizes Nick Murray encourages the readers to use a financial planner, but he can ignore that and get a lot of meat out of the book that will serve him well for life. I'll even send him a copy if you feel comfortable enough to pm your mailing addy - would love to help a young man start out on the right foot.

[VagabondMD]

jfoxcpacfp wrote:

Not sure I could have done it better myself. I know I’ve mentioned this before, but Simple Wealth, Inevitable Wealth would give him great perspective on the benefits of long-term investing and much clarity about the issues you’re discussing. I realizes Nick Murray encourages the readers to use a financial planner, but he can ignore that and get a lot of meat out of the book that will serve him well for life. I’ll even send him a copy if you feel comfortable enough to pm your mailing addy – would love to help a young man start out on the right foot.

Click to expand...

Thank you! PM sent.

[FIREshrink]

Really seems like a rube goldberg solution to me.

There'll be at most $5500 in this Roth IRA this year, right? 10% of that is $550. What kind of bid-ask is your son going to spend to get into $550 of IEMG? How much of the $5500 will be leftover because he can only buy whole shares?

What I did for my kids is teach them a lesson about simplicity, low costs, and diversification. If they want to learn about factor investing later they can. So they are 100% invested in Vanguard target date retirement 2060 funds. One fund for life, if they want.

[Donnie]

I agree with letting the child make his own decisions at this point.  I would show him the merits of Roth versus taxable.  I think there is some benefit to having liquid investments in taxable accounts rather than in a Roth so that all of the value can be released penalty free if the child wants to buy a house, or a car, or something else down the line.  I think it is better not to ever have to withdraw from a Roth since it could lead to a pattern of behavior, which is ultimately more destructive to wealth creation.

 

[VagabondMD]

@FIREshrink (love the handle, BTW):

ishares are easy to trade for free at Fidelity, one share or more with minimal/negligible bid/ask spreads. One of the lessons in all of this is to not get too caught up in the details. For his purposes, anywhere between 5 and 15% is okay for emerging markets, as an example, but when you have new money and one of the positions is out of range (ie. emerging markets at 5%, instead of the target 10%), that is where you invest it. He already has $7000+ in the account from working the last two-plus years. There is usually a cash balance of under $50 or so.

I like the ease of the Vanguard Target Date funds, but I do not like the composition. I do not agree with the 10% bond allocation in the 2060 for an 18 year old, and, in general, I am not a big fan of international bonds for a basic portfolio. Thank you for your suggestions.

@Donnie

He already has a sizable taxable account (over $100k), started as a UTMA* account when he was born (and still registered as such) that is intended to be used if we run out of college funds and cannot otherwise cash flow it, he wants to go to grad school, or early adulthood seed money for a house, starting a business, moving, emergencies, etc. Or perhaps it will be the nidus of his nest egg. So, I guess I agree with you here.

As for decision making, I am using this as an opportunity to mentor him on saving and investing. I am also hoping that it encourages him to bring his own ideas to the table ("Hey, Dad, let's buy some Amazon in this account...) which would provide a learning laboratory for him on investing while the stakes were lower. Thank you for your comments.

(*Yes, I know that he is legally entitled to control this account, but he is not inclined to do so, and if he showed such inclinations, there could be other repercussions. )

[Craigy]

+1 for letting him handle the account.  If you want to keep an eye on it as a requisite for your matching his contributions, so be it, he should be fine with that.

What I learned investing by myself from age ~10-25, the mistakes I made, coming to realize that the big wins I had were mostly luck, the principles I learned along the way were invaluable.  Better to learn now on his own than when he's 30 or 40 or 50 years old and there's hundreds of thousands in the account.  Mistakes cost a lot less when you're young.

As far as allocation, my 1yr old has a Roth and an UTMA, with a handful of Vanguard ETFs in each.  I'll probably let him have some say in how they're invested when he becomes interested, but they'll be his when he turns 18.

[FIREshrink]

Vagabond MD wrote:

@fireshrink (love the handle, BTW):

ishares are easy to trade for free at Fidelity, one share or more with minimal/negligible bid/ask spreads. One of the lessons in all of this is to not get too caught up in the details. For his purposes, anywhere between 5 and 15% is okay for emerging markets, as an example, but when you have new money and one of the positions is out of range (ie. emerging markets at 5%, instead of the target 10%), that is where you invest it. He already has $7000+ in the account from working the last two-plus years. There is usually a cash balance of under $50 or so.

I like the ease of the Vanguard Target Date funds, but I do not like the composition. I do not agree with the 10% bond allocation in the 2060 for an 18 year old, and, in general, I am not a big fan of international bonds for a basic portfolio. Thank you for your suggestions.

@donnie

He already has a sizable taxable account (over $100k), started as a UTMA* account when he was born (and still registered as such) that is intended to be used if we run out of college funds and cannot otherwise cash flow it, he wants to go to grad school, or early adulthood seed money for a house, starting a business, moving, emergencies, etc. Or perhaps it will be the nidus of his nest egg. So, I guess I agree with you here.

As for decision making, I am using this as an opportunity to mentor him on saving and investing. I am also hoping that it encourages him to bring his own ideas to the table (“Hey, Dad, let’s buy some Amazon in this account…) which would provide a learning laboratory for him on investing while the stakes were lower. Thank you for your comments.

(*Yes, I know that he is legally entitled to control this account, but he is not inclined to do so, and if he showed such inclinations, there could be other repercussions. )

Click to expand...

I agree with you on international bonds, but fortunately since only 10% of the fund is in bonds of any kind, the international quotient on a $7000 investment comes to around Two hundred bucks. In my view the simplicity of this approach is worth the imperfections. You can teach someone to be too clever by half.

Obviously this is a personal choice.

[yountville]

I like the Indexed Target Date Retirement Funds for my Teenagers Roth Accounts and use the Fidelity 2065 Fund for them which is a little more aggressive early and has a slower glide path than I saw at Vanguard or Schwab.

[jz]

Over the course of your son's lifetime, I am more excited about the prospects of EM than old developed internationals.  Demography is destiny. Europe's white population is contracting and repopulating with nonassimulating Muslims; lots of cultural and business upheaval to come.  India, China, Poland, Mexico, and Thailand inspire more optimism for rapid growth.

[spiritrider]

I take a completely contrarian view to the aggressive age-based asset allocation proposed.

The amount of investment assets such a young person will have, means that the asset allocation they have initially will have minimal impact on their long-term portfolio returns.

The proper asset allocation should be based on the individual's ability, willingness and need to take risk. I propose that an 18-year-old:

• Does not know what their ability to take risk is.


• Does not know what their willingness to take is.


• Does not need to take an extreme risk given the size of their portfolio.

I started my girls at age 16 with a UTMA Roth IRA at 60:40 and increased equities by 5% to 80:20 by age 20. At age 21 it was their choice. My oldest started investing in 2007 and totally freaked out in 2008-2009, but stayed the course. I doubt she would have done so at 90:10 or 100:0.

I saw a lot of people insisting that 100:0 was the only option in 2000 and then again in 2008. I also saw a lot of them sell at the bottom. Here we are again after a prolonged bull market with a lot of 100:0 proponents. What could possibly go wrong???

Studies have shown that investment trauma (significant losses) can have a lifetime effect on an investor's future ability and willingness to take risk even when they have a significant need to do so.

I just caution that you are training a new investor here and not just trying to maximize their return.

[Peds]

Vagabond MD wrote:

As I construct a Roth IRA for my 18 year old,

Click to expand...

that sentence seems to be the problem.....

my parents let me manage my rIRA at 16. why dont you teach him as well?

[VagabondMD]

spiritrider wrote:

I take a completely contrarian view to the aggressive age-based asset allocation proposed.

The amount of investment assets such a young person will have, means that the asset allocation they have initially will have minimal impact on their long-term portfolio returns.

The proper asset allocation should be based on the individual’s ability, willingness and need to take risk. I propose that an 18-year-old:

• Does not know what their ability to take risk is.


• Does not know what their willingness to take is.


• Does not need to take an extreme risk given the size of their portfolio.

I started my girls at age 16 with a UTMA Roth IRA at 60:40 and increased equities by 5% to 80:20 by age 20. At age 21 it was their choice. My oldest started investing in 2007 and totally freaked out in 2008-2009, but stayed the course. I doubt she would have done so at 90:10 or 100:0.

I saw a lot of people insisting that 100:0 was the only option in 2000 and then again in 2008. I also saw a lot of them sell at the bottom. Here we are again after a prolonged bull market with a lot of 100:0 proponents. What could possibly go wrong???

Studies have shown that investment trauma (significant losses) can have a lifetime effect on an investor’s future ability and willingness to take risk even when they have a significant need to do so.

I just caution that you are training a new investor here and not just trying to maximize their return.

Click to expand...

Peds wrote:

Vagabond MD wrote:

As I construct a Roth IRA for my 18 year old,

Click to expand…

that sentence seems to be the problem…..

my parents let me manage my rIRA at 16. why dont you team him as well?

Click to expand...

Reply to both, at this point, there is little or no engagement on his part, so little risk of permanently scarring him and no indication that he wants to manage it. I will continue to probe him on the matter, and I suspect that he will eventually come around.