Starting a Roth IRA When You Turn 18

There are few forces more powerful than compounding interest. When you’re getting started investing, especially at an early age, it can drive better long-run performance than you could ever achieve or catch up to in your 30’s. 40’s, 50’s or beyond. The markets, be they real-estate investment, bond markets, or the stock market can all drive you to long-run financial success. One of the most powerful investment vehicles behind you on this journey is a Roth IRA. Setting up a Roth IRA at 18 can help you drive long-run financial success above what you could ever expect storing your cash in a simple bank account.

One of the best things I’ve ever done was logging into E*TRADE and setting up my first IRA back at the ripe old age of 18 in 2006. I can’t say I did the research to find the best bank or platform to start investing, but I did know for sure that E*TRADE supported digital accounts and was cheaper than my bank at the time (Bank of America), so I opted for the cheaper option.

While your parents could have setup a Roth IRA for you before you turned 18, and they should have!, for most of us that simply isn’t and wasn’t the case. This said, we need to get you moving to get started investing as soon as possible because time is of the essence.

The reasons you want a Roth IRA are somewhat legendary. The best part of having a Roth IRA is that taxes do not have to be paid when you take money out of your account, avoiding capital gains tax. Though all your money is post-tax that is added to the account the benefits of a Roth IRA over the long-run you’ll usually end up with more after-tax money than you would through a Traditional IRA.

You can even avoid any tax issues by spending the earnings on your college or first home (where it’s legal). This isn’t recommended as there are other investment vehicles such as 529 plans that are designed for college savings. I can’t say I’ve ever taken advantage of these options as the best course is to usually not-touch your investments until you reach retirement age.

How to Setup Your Roth IRA

You can set up a Roth IRA almost anywhere banking is done in the US. However, we’re going to walk through the setup process with Vanguard, the leading financial institutions for low-fee fund investing.

If you’re impatient and want a quick video tutorial, check this out.

What you’re going to need to signup are the following initial documents:

  • Your email address and basic contact information
  • Your social security number
  • Your citizenship details

Once your account is setup and email verified, you’ll need a few more things such as:

  • Your banking information to transfer funds

That’s really it. It’s basically as simple as setting up a bank account for the first time. Things get a little more complicated if you’re moving your Roth IRA from bank to bank, but you shouldn’t be worried about this when you’re getting started. Just search around for a good provider (we cover this below) and stick with one for a while until you feel comfortable enough to move (but only if you need to).

Hidden Costs

Roth IRAs can be setup a wide variety of financial institutions, but not all are the best places to store your cash. We’ll cover some of the fees and issues that you can run into when you start investing in another post, but the main thing you need to watch out when choosing where to invest are the following fees and barriers to entry:

  • Upfront minimum contribution limits on certain funds – for instance, the wildly popular fund from Vanguard VATSX has a $3,000 minimum investment contribution. Funds like SPY, or one of popular the S&P 500 Index Funds, however, does not have such minimum investment requirements
  • Trading Fees are collected when you buy or sell assets within your portfolio so shop around for the lowest fees. Just know these can change regularly and we still recommend Vanguard as they are the “Everyday Low Price” version of investing funds
  • Advisory Fees a lot of people early on may opt for advisory services but over time these can be substantially detrimental to your long-run returns. It can always be good to talk to an advisor, but if you do make sure they have a fiduciary responsibility to your investment outcomes so that they’re not leading you astray.

What to Look For in a Provider

I’ve used a bunch of providers for my investment accounts over the years including E*TRADE, Betterment, and Vanguard. I strongly recommend you shop around to determine what fits right for you. Some things to consider are:

  • Online experience
  • Customer service
  • Advisory services
  • Trading Fees (mentioned above)

We cover a lot of our favorite providers in our lengthy post here.

Making Your First Investments

It is really important to setup an automated process for investing over time. The impact, mainly to your behavior, can be enormous as a result of consistent and steady contributions over the course of your lifetime until you reach the age you can take money out for retirement.

There is a huge amount of research and opinions that show and confirm that if you are consistent with your contributions – even if it’s as small as $10 a month to start when you’re just getting started in your career or working through college – the long-run benefits can be enormous.

Some Hard Requirements

Sorry if you don’t work and you’re 18 but you’re going to need to get a 1099 or W2 to prove that you make some kind of money to invest in Roth IRAs. If you’re investing your parent’s money or a gift, that is okay, but you still have to make the income minimum requirements, which are basically $1.

There are many income restrictions once you start earning a serious six figure salary however. We don’t want to get overly in depth on these limitations as we know that when you get started investing at 18, it’s highly unlikely you’ll be making this kind of money (but amazing if you are).

Here are the income maximum restrictions from the IRS website as of May 20th, 2020:

A Review Of Investing Mistakes

My early days of investing weren’t that great. I definitely didn’t listen to a lot of the advice that was out there from the Bogleheads or the ETF/index-fund crowd and toiled away trading individual stocks that ended up providing me negative returns. I did do a few things right, however.

I stayed focused on diversification, or never holding too much of my money in one stock or market sector at a time. And, despite my occasional day-trading, I did maintain some portion of my stock in the S&P 500 ETF, SPY. When the 2008 downturn came, this was a lifeline, while I watched virtually all my individual stock holdings tanked. Thankfully though, I didn’t sell everything on the ride down in the markets, and I didn’t sell at the bottom either!

Holding the S&P 500 for the long-term gave me significant returns that paid off throughout my 20’s. I continued to invest there over

One thing I didn’t do however was to automate my investing into my funds. I had cash being dumped into my accounts each month, but I had to manually go in and make my contributions. I would often end up with a bunch of cash sitting in my account not working, or compounding, for me in the market. This is not a great idea. Maybe it was the type of account I had early on with E*TRADE or it could have been my lack of knowing how to set this up on the platform, but there are many new investment platforms that do this auto-buying for you now. That’s a huge leg up.

Summary

If you’re getting started investing for the long-run at 18 with a Roth IRA, you’re not alone, but you’re definitely ahead of the pack. The earlier you get started the better. Compounding interest is on your side and can have huge impacts on how much money you’ll end up with by retirement.

Just to recap the advantages of starting a Roth IRA at 18:

  • Tax advantages when you take money out of your IRA at retirement
  • The power of compounding interest on your side over your life until retirement
  • The ability, though not advised, to take out money for qualified expenses such as college or your first home purchase
  • You can use your Roth IRA to invest in many investment vehicles outside stocks and bonds such as real-estate

Getting a Roth IRA at 18 is one of the smarted financial moves I have ever made and I think you’ll agree once you have a decade or two of consistent investing history behind you in the market.