After talking to that one friend who knows finance or doing a little googling, much of the financial advice seems to point you in one direction — open an IRA. Congrats! You made a significant step forward in your financial journey. Unfortunately, most of this discussion stops short of the next step — Which company offers the best IRA account for your situation? We are in the age of WAY TOO MANY OPTIONS, so of course there are dozens of brokerages offering IRAs. Before you enter this rabbit hole, you may find solace in the fact that choosing any brokerage company results in a net positive for your long term net worth over choosing not to open an IRA (all things otherwise, equal). I needed to add that last assumption to appease the math nerds.
When deciding between brokerages for your IRA, the most important variables can be divided into the following factors:
- The Company
Factor #1: Effort
How lazy are you? Be honest with yourself, because this is an important question in finance. There is no wrong answer. Laziness can be optimal if it prevents you from trying to time the market or gamble with options like some of my Robinhood friends. An increase in investing activity is typically associated with an increase in risk.
Laziness might be a little harsh. The true question is how much time do you want to devote to maintaining your IRA. With the recent advances in machine learning and narrow artificial intelligence, a new hands-off approach to IRAs has become available to the public. Investors now have the option to have their contributions automatically sorted into various funds. You can simply choose the level of risk you desire and with the click (or swipe) of a screen, the brokerage company will allocate your money accordingly. This is a blessing for those who want to spend as little time as possible dealing with their investments. The automation saves time and takes advantage of tax-loss harvesting. However, this approach is not without it’s drawbacks. The investor loses some control over their investment choices and the service will cost more than the standard IRA offerings*.
Factor #2: Cost
Over the last century, expenses for investing have continued to decrease. This includes the noteworthy event in 2013 when Robinhood announced zero-commission trades. This event was the catalyst that lead to most competitors following the same path towards zero-commission trades. While costs have declined, the difference between two funds or two IRA providers can still net a huge difference in your returns. Typically, the cost of an IRA shows up in two different places, the IRA management fee and the cost of the funds. Some brokerages, like Charles Schwab or Fidelity, will not charge an IRA management fee for their standard offering*, but most of their funds have a management expense. The management expense of a fund is noted as the “expense ratio” for the fund. You will see it noted in a fund’s fact sheet or prospectus. Expense ratios range from 0 to 1.5 percent for most funds. This range appears trivial, but the difference between a 0.05 percent fee versus a 1.5 percent can be significant over the long term. In the below visualization, you will see the difference in your account’s value (net of fees) over a 20 year period for various expense ratios. The assumption here is one initial contribution of 10,000 dollars and an annual growth rate of 10 percent for that fund.
After 20 years, the difference in your account balance between a 0.05 percent fund versus a 1.5 percent fund is a staggering 15,546 dollars ($66,666 — $51,120). Imagine one day having an extra 15,546 dollars. Now imagine that you contributed more than 10,000 dollars to your IRA over these 20 years. The savings from fees would be MUCH HIGHER than 15,546 dollars. Here is a good mutual fund calculator to compare your returns (net of fees) with various assumptions.
There is one more major cost to worry about when deciding between IRA providers. This cost is not quite as obvious. Some providers, such as Vanguard, have required minimum investments for their mutual funds. Here is a direct statement from Vanguard’s website:
“You can now own lower-cost Admiral Shares for 43 of our index mutual funds for a minimum of just $3,000 each”
If you don’t have 3,000 dollars to contribute to an IRA, then your money will sit in a low-interest savings account until you save up enough for the required minimum. That could mean years of missed gains in the stock market. Nowadays, most IRA providers permit partial shares or much smaller denomination contributions.
One final note on costs.
IRA account management fees can vary based on your account balance at a brokerage company. As your balance increases, the benefits for your account tend to increase. This might include reduced fees or free access to professional advice. Some brokerages will incentivize investors to sign up through incentives, such as free management for the first 5,000 dollars contributed to their account.
Factor #3: Service
How self-sufficient are you with your financial decisions? Some brokerage companies offer access to financial professionals. Betterment offers various packages to meet with Certified Financial Planners, while other providers like Wealthfront only offer a free financial planning app. The former works better for those who desire advice from an actual person, while the latter suits the more tech-savvy and self-sufficient investors. If your IRA provider does not have an option for advice from financial experts, there are plenty of financial advisors out there who would be willing to take your call. The other day I met with a financial advisor through JP Morgan who was happy to walk me through some specific financial questions.
When choosing a brokerage company, financial assistance is not the only help you might require. Trying to understand the complicated financial jargon while using unfamiliar apps or websites can be challenging. You should consider how good the customer service is for an IRA provider. The more mature firms probably have more robust systems set up than a start up company.
Factor #4: The Company
Something that often gets missed in these discussions is analyzing the company itself. Choosing an IRA provider is often a decision that lasts a lifetime because of inertia and the annoying requirements to transfer assets. Therefore, your goal is to choose a brokerage that is most likely to satisfy your needs over a lifetime. Although you cannot predict your future or the future of a company, you can make an educated guess. Older and more mature companies, like Vanguard, will likely be around in thirty years, given the popularity of some of their funds. Meanwhile, a crypto exchange, like Kingdom Trust, might offer an IRA, but will crypto assets still be around in twenty years?
Safety might not be the only benefit for larger companies. The more mature companies tend to offer more variety and cheaper, possibly even free, ETFs and mutual funds. With more options comes the potential for higher returns and a higher Sharpe ratio, but that also comes with more responsibility.
On the other side, choosing a start up, or younger company comes with its advantages as well. Have you ever tried using the Fidelity mobile app? I work in tech, but it still gives me a headache trying to figure things out. Fin-tech companies, like Betterment and Wealthfront, will likely have more user friendly apps and are quicker to offer new innovations, such as automated investment accounts. If you are interested in owning crypto assets in your IRA, the early adapters in this space will likely be younger companies.
Give yourself a pat on the back. Making financial decisions can be a stressful and challenging process. Choosing the appropriate IRA account will help you maximize your long term objectives, whether that is free time or net worth. I believe that these factors provide a valuable framework for facilitating the decision process.
Note: If you want to sign up with Wealthfront, please use my referral link so your first 5,000 dollars will be managed for free.
*Standard offering refers to IRAs that are not autonomous. Autonomous IRA accounts typically have additional management fees.
Disclosure: The commentary above reflects my personal opinion, consolidated from a variety of sources. My views are subject to change at any time without notice. Nothing in this article constitutes investment advice, performance data or any recommendation that any particular security, portfolio of securities, transaction or investment strategy is suitable for any specific person.