Fidelity Roth: Index Funds And Auto-Investing Strategies

Investing in index funds is a great way to invest in a broad range of stocks or bonds with just one fund, often at a lower cost. Fidelity offers a variety of investment accounts, such as brokerage accounts, IRAs, health savings accounts (HSAs), or 401(k)s, where you can purchase index funds.

To make your Fidelity Roth IRA invest in index funds automatically, you can set up automatic investments by logging into your Fidelity account and going to https://www.fidelity.com/cash-management/automatic-investments. From there, you can select the account you wish to set up automatic investing for and choose from various options, including transferring funds from an external bank account or investing funds from your core position.

Fidelity also offers a range of tools and resources to help you choose the right investments and manage your portfolio.

Dollar-cost averaging: A strategy to reduce market timing risk by investing equal portions at regular intervals

Dollar-cost averaging is a strategy that makes investing easier by making purchases automatic and supporting regular investing. It involves investing equal portions of money in a target security at regular intervals over a certain period, regardless of price. This strategy eliminates the need to time the market to buy at the best prices.

Dollar-cost averaging, also known as the constant dollar plan, is a simple tool that helps build savings and wealth over the long term. It is a way for investors to ignore short-term volatility in the broader markets. A prime example of dollar-cost averaging is its use in 401(k) plans, where employees invest regularly, regardless of the investment's price. With a 401(k) plan, employees can choose the amount they wish to contribute and the investments offered by the plan. Investments are then made automatically every pay period.

Dollar-cost averaging can also be used outside of 401(k) plans, such as for regular purchases of mutual or index funds. It is a beneficial strategy for beginning investors looking to trade ETFs. Dividend reinvestment plans also allow investors to dollar-cost average by making regular purchases.

The benefits of dollar-cost averaging include:

• Lowering the average amount spent on investments
• Reinforcing the practice of investing regularly to build wealth over time
• Being automatic, taking concerns about when to invest out of the investor's hands
• Removing the pitfalls of market timing, such as buying only when prices have risen
• Ensuring the investor is already in the market and ready to buy when events send prices higher
• Taking emotion out of investing, preventing potential damage to the portfolio's returns

Dollar-cost averaging is a good strategy for investors with a lower risk tolerance. It helps lower the risk of investing a lump sum at a peak, which can be unsettling if prices fall. By investing smaller amounts over time, dollar-cost averaging lowers the risk and effects of a single market move.

For example, an investor who puts in $1,000 each month for four months, with prices at $45, $35, $35, and $40 at the end of each month, will have an average cost of $38.75. If they had invested the entire amount at the start, the price would have been $45 per share.

However, investors who engage in dollar-cost averaging may forfeit potentially higher returns. With this strategy, money is held onto for longer, which often produces lower returns than lump-sum investing, especially over longer periods. Additionally, there may be more brokerage fees, which could erode returns.

Automating investments: Setting up automatic transfers from your paycheck or bank account into your Roth IRA

Automating your investments is a great way to save time, reduce stress, and ensure you're putting money away for your future. Here are the steps to set up automatic transfers from your paycheck or bank account into your Roth IRA:

Option 1: Setting Up Automatic Paycheck Contributions

The first option is to set up automatic paycheck contributions to your Roth IRA. Most employers offer direct deposit, and you can set up multiple accounts to deposit money into. You'll need your bank's Routing Number and Account Number, as well as your Roth IRA's Routing Number and your Account Number. Once you have this information, you can set up automatic paycheck contributions through your employer.

Option 2: Setting Up Automatic Withdrawals

If your employer doesn't offer direct deposit or you're unable to set up multiple accounts, you can set up automatic withdrawals from your bank account to your Roth IRA. Simply go to your Roth IRA account, select "transfers," and set up a bi-weekly or monthly transfer to take place after you get paid. This option isn't based on your paycheck, so you'll need to be careful if your income varies or you take an unpaid vacation, as the automatic withdrawal will still process and could impact your checking account balance.

Determining the Contribution Amount

To make the most of your Roth IRA, you'll want to contribute the maximum amount possible each year. For the 2023 tax year, the contribution limits are $6,500 for individuals under 50 and $7,500 for individuals aged 50 and older. Here are the recommended contribution amounts per pay period to stay within these limits:

• Age 49 and Under:
• Weekly Paycheck Contributions: $125
• Bi-Weekly Paycheck Contributions: $250
• Monthly Paycheck Contributions: $541.66
• Age 50 and Older:
• Weekly Paycheck Contributions: $144.23
• Bi-Weekly Paycheck Contributions: $288.46
• Monthly Paycheck Contributions: $625

By setting up automatic contributions to your Roth IRA, you can make investing easy and ensure you're consistently working towards your financial goals.

Choosing an investment mix: Selecting investments that align with your risk tolerance, investment goals, and time horizon

When choosing an investment mix, it's important to select investments that align with your risk tolerance, investment goals, and time horizon. Here are some factors to consider when making your decision:

• Risk tolerance: Consider how comfortable you are with market fluctuations and potential losses. If you have a low-risk tolerance, you may prefer a more conservative approach with a higher allocation to fixed-income securities such as bonds. On the other hand, if you have a higher-risk tolerance, you may opt for a larger allocation to equities.
• Investment goals: Clearly define your financial goals. Are you saving for retirement, a down payment on a house, or funding your child's education? Each goal may require a different approach to asset allocation. For example, long-term goals like retirement may allow for a higher allocation to growth-oriented assets, while short-term goals may require a more conservative strategy.
• Time horizon: This refers to the length of time you plan to hold your investments. If you have a long investment time horizon, you may be able to take on more risk in pursuit of higher returns. Generally, the longer the time horizon, the more aggressive you can be in choosing your investments.
• Diversification: Diversifying your portfolio across different asset classes, such as stocks, bonds, cash, real estate, and commodities, can help reduce risk and enhance returns.
• Rebalancing: Periodically review and rebalance your portfolio to ensure it remains aligned with your goals and risk tolerance.
• Professional advice: Consider seeking guidance from a financial advisor, especially if you are unsure about how to assess your investment goals and risk tolerance. They can provide tailored advice based on your unique circumstances.

Remember, choosing the right investment mix is a personalized process, and it's important to regularly review and adjust your strategy as market conditions and your circumstances change.

Compounding returns: The potential for your investments to generate returns that are reinvested to grow your portfolio over time

Compounding returns are a powerful mechanism that can supercharge your money and grow your portfolio over time. Compounding occurs when you earn returns not just on your original investment but also on the accumulated returns received over time. This concept, often referred to as "earning interest on interest," has the potential to significantly enhance your investment growth, especially when coupled with the benefits of automated investing.

Automated investing involves contributing to your investment accounts regularly through direct deposits or recurring transfers. This method removes the decision-making aspect from saving and investing, ensuring that you do so consistently. By automating your investments, you reduce the temptation to spend the money instead and free up your time and mental bandwidth.

Fidelity offers various options for automating your investments, such as recurring investments in stocks, mutual funds, ETFs, and Fidelity Basket Portfolios. You can set the amounts, frequency, and timing of these recurring transactions according to your preferences. Additionally, Fidelity provides managed account options, including robo-advisors and access to full-service investment professionals.

Compounding returns can be understood through the concept of compound interest. For example, consider a savings account with a starting balance of $100 that earns simple interest of 5% per year, resulting in $5 of interest each year. With compound interest, you would earn 10% interest on the accumulated balance, not just the original amount. Over time, this leads to more substantial gains.

The power of compounding is more noticeable over longer periods. For instance, after 10 years of compound interest at 10%, your total interest received would be $62.89, with an account balance of $162.89. In contrast, with simple interest, you would have earned $50 in interest with a balance of $150. After 20 years, the difference becomes more pronounced, with compound interest resulting in $163.33 of interest and a balance of $265.33, compared to $100 of interest and a balance of $200 with simple interest.

Compounding returns are a more accurate measure of investment performance than average returns because they account for volatility, ensuring that your investment calculations are not misstated due to fluctuating returns.

By combining automated investing with the power of compounding returns, you can maximize the growth potential of your portfolio over time.

Benefits of index funds: Broad market exposure, diversification, and lower costs compared to actively managed funds

Index funds are a popular investment choice for those seeking low-cost, diversified, and passively managed investments that often outperform many higher-fee, actively traded funds. They are ideal for long-term investing, such as retirement accounts, and offer several benefits, including:

Broad Market Exposure

Index funds provide investors with broad market exposure by tracking the performance of a specific financial market index, such as the S&P 500 or the Dow Jones Industrial Average. This means that investors gain access to a diversified portfolio of securities, including stocks or bonds, that mirror the composition of the chosen index. For example, an S&P 500 index fund will hold a representative sample of the 500 stocks included in the S&P 500 index, providing investors with exposure to a broad range of companies and sectors.

Diversification

Index funds offer built-in diversification across various sectors and asset classes, depending on the underlying index being tracked. This diversification helps to reduce specific risks associated with individual stocks or sectors. For instance, if a single company performs poorly, it will have a minimal impact on the overall performance of the index fund since it is only one of hundreds of companies included in the fund.

Lower Costs

Index funds typically have lower expense ratios and fees compared to actively managed funds. This is because index funds are passively managed, meaning they do not require a large staff of professional fund managers to actively trade securities, conduct extensive research, or make investment decisions. Instead, they simply replicate the performance of a chosen market index, trading as little as possible to keep costs low. As a result, index funds can charge lower fees, often as low as 0.04%, compared to the higher fees of actively managed funds, which typically range from 0.44% to over 1.00%.

In summary, index funds offer investors broad market exposure, diversification across various sectors and asset classes, and lower costs compared to actively managed funds. These benefits make index funds a popular choice for long-term, low-risk investment strategies, particularly for those seeking a simple, cost-effective way to gain exposure to a diversified portfolio.

Frequently asked questions