How to diversify IRA portfolio given fund minimum investments and IRA contribution limits?

Question

I recently opened a Roth IRA. Most of the funds at the fund company (Vanguard) have a minimum initial investment of $3000. The IRA contribution limit is $5500. This means I can only buy into one fund per year.

It seems like this has to be awkward for anybody who has an IRA with any institution that has minimum buy-ins that high. I'm not planning on buying into a ton of funds, but even if you just want, say, a US stock fund, international stock, bond, and maybe REIT, you're already looking at four years just to get your portfolio set up.

Is there any way around this or do you just have to accept that diversifying your IRA is going to take years? Does the fund minimum apply across accounts, so that I could somehow buy $3000 worth of a certain fund, but only put $1500 of it into the IRA and the rest into a taxable account?

Answer 1

There are fund of funds,e.g. life cycle funds or target retirement funds, that could cover a lot of these with an initial investment that one could invest into for a few years and then after building up a balance large enough, then it may make sense to switch to having more control.

Answer 2

If you have other savings, the diversification occurs across the accounts. e.g. my 401(k) has access to the insanely low .02% fee VIIIX (Vanguard S&P fund) You can bet it's 100% in. My IRAs are the other assets that make the full picture look better allocated.

A new investor has the issue you suggest, although right now, you can deposit $5500 for 2013, and $5500 for 2014, so with $11K available, you can start with $6 or $9K and start with 2 or 3 funds. Or $9K now, but with $500 left over for the '14 deposit, you can deposit $6K in early '15.

The disparity of $3K min/$5500 annual limit is annoying, I agree, but shouldn't be a detriment to your planning.

Answer 3

Many mutual fund companies (including Vanguard when I checked many years ago) require smaller minimum investments (often $1000) for IRA and 401k accounts. Some also allow for smaller investments into their funds for IRA accounts if you set up an automatic investment plan that contributes a fixed amount of money each month or each quarter. On the other hand, many mutual fund companies charge an annual account maintenance fee ($10? $20? $25? more?) per fund for IRA investments unless the balance in the fund is above a certain amount (often $5K or $10K$). This fee can be paid in cash or deducted from the IRA investment, and the former option is vastly better.

So, diversification into multiple funds while starting out with an IRA is not that great an idea. It is far better to get diversification through investment in an S&P 500 Index fund (VFINX since you won't have access to @JoeTaxpayer's VIIIX) or a Total Market Index fund or, if you prefer, a Target Retirement Fund, and then branch out into other types of mutual funds as your investment grows through future contributions and dividends etc.

To answer your question about fund minimums, the IRA account is separate from a taxable investment account, and the minimum rule applies to each separately. But, as noted above, there often are smaller minimums for tax-deferred accounts.