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Never Too Early to Open a Roth IRA

You're young. You have a little extra cash this year, and you want to open a Roth retirement account. Go ahead, invest in a really risky mutual fund, your friends say. All the cool guys are doing it. You'll feel 10 feet tall.

Don't listen to them. You should invest like an old fogey when you're young. And if you do, you'll probably have more money when you retire than those other whippersnappers.

If you're thinking of starting a Roth, good for you. It's a great idea. When you open a Roth, the earnings on your investments are free from taxes when you start withdrawals at retirement age. (The fine print: Retirement age is the year in which you turn 59 1/2, and you have to have held your Roth for at least five years.)

If you're single and your modified adjusted gross income is less than $105,000, you can make a full Roth IRA contribution. If you're married and filing jointly, your modified adjusted gross income must be less than $166,000.

You can contribute up to $5,000 to a Roth for 2009 or 2010, and $6,000 if you're 50 or older. But that's the maximum: You can start a Roth with as little as $100 at many banks or mutual funds.

The next question is where to invest the money in your Roth. Planners usually tell you to take your biggest risks when you're young. After all, you'll have plenty of time to make up for your losses when you're in your 40s and boring everyone with the story about your iPod and that walrus.

But there are several holes in that line of reasoning. First, risky investments don't become less risky with age. The longer you hold a risky fund, the more likely you are to have a catastrophic loss. And in the long run, the big gains may not compensate for the huge losses.

Consider small-company stocks, which are riskier than their large-cap brethren but often produce sizzling returns. Those sizzling returns, however, often come with brain-numbing declines.

For example, compare the Russell 1000 index, which measures large-company stock performance, and the Russell 2000 index, which measures small-company stocks. The past 30 years, small-company stocks have gained 1,723 percent, which is pretty darn good. But the large-cap Russell 1000 has soared 2,127 percent.

This brings us to another point: There is no need to take more risk than you really need to. If you can reach your savings goal with a safe 6 percent investment, there's no reason to stretch with a risky 12 percent. And when you have time on your side, you also have the power of compounding. A $5,000 investment will grow to about $29,000 in 30 years at 6 percent a year. To get that same amount in 15 years, you'll have to earn about 12 percent annually, which is considerably trickier.

All of which brings us to old fogey funds. A truly stuffy stock fund will invest primarily in large-company stocks, which tend to be less volatile than small-company stocks. Furthermore, it will look for stocks of companies that pay dividends.

Dividends are cash payments to shareholders - typically, a way to retain shareholder loyalty and to share a company's profits with its owners.

Thanks to the wonders of compounding, dividends can turbocharge your returns. For example, the Standard&Poor's 500 has gained 872 percent the past 30 years. Toss in reinvested dividends, however, and the index has returned 2,179 percent.

Some of the fogiest of funds are equity-income funds, which look for stocks of large, stable companies with decent dividend payouts. If you're looking for an equity-income fund for the long term, you also need one that keeps its annual expenses low. Currently, the average S&P 500 dividend yield is about 2 percent; you don't want to give three-quarters of that to your mutual fund company. The funds in the chart are all no-load, which means there's not a brokerage fee to buy them. And they all charge annual expenses of less than 1 percent.

You might also consider a dividend-seeking index fund, which will have even lower expenses. The SPDR S&P Dividend fund (ticker: SDY), for example, is an exchange traded fund that invests in high-yielding stocks of companies that have consistently raised their dividends. Vanguard Dividend Appreciation fund (VIG), which has a similar objective, is another good choice.

You may, someday, want to shoot the moon with one of those risky funds that everyone else is talking about. But if you're just starting, start with one that would make your grandfather smile.

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