Contributing to Roth IRA - Tax-deferred growth

I have been lacking contributions to my tax-advantaged space and missing out on the benefits of tax-deferred growth. I would like to diversify my portfolio by adding some retirement assets to it.

I have two choices (1) Traditional IRA or (2) Roth IRA. There used to be another option called MyRA. MyRA is a lot like Roth IRA except the initial minimum is $25. Although limited, I would have preferred MyRA as it would have allowed me to grow my portfolio with lower capital infusion. Unfortunately, this option is no longer available.

Now coming to the question of Roth vs Traditional IRA? I am eligible for both based on our income criteria. Given our current income, I would prefer making tax deducted contributions. Today’s tax rates are at historical low (Thanks in part to Tax Cuts and Jobs Act). With the burgeoning deficit and interest rate increases, I expect the tax rates to go up in the future.

The biggest plus for Roth IRA is the withdrawal rules. Unlike Traditional IRA, Roth does not require any required minimum distributions (RMD) in our life time. Beneficiaries of Roth IRAs don’t owe income tax on withdrawals and can stretch out distributions over many years. This would provide me an ideal vehicle to build wealth for my future generations. Although, I strongly feel education is the most valued asset I would like to pass on.

Secondly, Roth IRA contributions can be withdrawn tax and penalty free (as we have already paid taxes on it). The same does not apply to the earnings though. This gives me an opportunity to withdraw a portion or all of my Roth IRA contribution if needed.

I opened my Roth IRA in 2017 (April) with Vanguard. I have not ended up funding this account. In 2018, I plan to start funding it. The next step was to choose a mutual fund for my portfolio. Since, this would be a tax advantaged account I wanted to pick an asset with a broad mix of bonds in it. My portfolio is exclusively invested in equities. So, I decided to pick a mutual fund which had at least 30% bond allocation.

I did not want to pick a target date fund for two reasons. (1) The dividends are on an annual basis and as such I thought it would not be conducive for dollar cost averaging. (2) It has exposure to international equities and bonds. I have exposure to international equities in my taxable account and I wanted to avoid exposure to international bonds all together.

I ended up shortlisting (3) funds,

1. Wellesley Income Fund (VWINX)
2. Wellington Fund (VWELX)
3. Balanced Index Fund (VBINX)

I like the Wellesley Income fund. But, it is a bit too conservative. It allocates 60% to bonds and 40% to stocks. This fund is run by Wellington Management Company, which has a decent track record.

VWELX on the other allocates 65% to stocks and 35% to bonds. VWELX is one of the oldest funds and has been around since 1929. VBINX allocates 60% to stocks and 40% to bonds. VWELX is an actively managed fund and VBINX is an index fund. In my original post I mentioned VWELX as my final choice. I was probably driven by the fact that it was the oldest Vanguard fund and has had good returns over the last 10 years.

In terms of diversification VBINX is better. VBINX holds 3,344 stocks and 7,160 bonds. VWELX on the other has only 101 stocks and 888 bonds. This exposes me to diversification risk.

Neither of these funds have an ETF version. In the long run to reduce my ER I would need to switch to a lower-cost admiral fund. To switch VWELX to its admiral version I need $50,000. In comparison I need only $10,000 to get the admiral version of VBINX. Being an actively managed fund VWELX is slightly more expensive (0.26%). VBINX has an ER of 0.19%, with a yield of 1.91%.

I ended up funding my Roth IRA with $3,000.00 invested in VBINX. I will be reporting these additional dividends starting next quarter (March 2018). My goal is to rapidly reach $10,000 to switch to admiral funds and thus reducing my ER to 0.07%. I will keep these dividends separate from my FIRE dividends as (1) they are not readily available to me and (2) I would like to use it to build wealth for future generations.