Shouldn't a Roth IRA accumulate more than 1 cent of interest per month?

Question

Ten months ago, I opened a Roth IRA with an initial principal of $1,000, invested in one of those "Target Date" retirement mutual funds. I also set up $100 automatic monthly contributions.

The account is currently valued at $1,926, being $1,900 principal from both my initial and monthly contributions, and the extra $26 because the mutual fund's share price has risen. It has also increased by another 8 cents because the fund has paid a $0.01 interest dividend each month, starting from the second month.

And yet, every basic "IRA Calculator" I have used says that after 9 months of contributing $100 per month, a Roth IRA that started at $1000 should be worth $2036 because of the "interest". $136 of interest. And yet I have accumulated a whopping 8 cents of interest in 10 months. What am I missing?

Answer 1

The term 'interest' tends to be used loosely when discussing valuation of stocks. Especially when referring to IRAs which are generally the purvey of common-folk who aren't in the finance industry. Often it is used colloquially to include:

1. The increase in the value of the stock.
2. Any dividends paid by the stock.

Using this definition (which is what I'm guessing your IRA Calculator is doing), your stock would have increased in value by a total of $26 over the course of 10 months. Still not terribly good (only a couple percent increase), but certainly not a couple cents.

Answer 2

There are a couple of misconceptions I think are present here:

Firstly, when people say "interest", usually that implies a lower-risk investment, like a government bond or a money market fund. Some interest-earning investments can be higher risk (like junk bonds offered by near-bankrupt companies), but for the most part, stocks are higher risk. With higher risk comes higher reward, but obviously also the chance for a bad year. A "bad year" can mean your fund actually goes down in value, because the companies you are invested in do poorly. So calling all value increases "interest" is not the correct way to think about things.

Secondly, remember that "Roth IRA fund" doesn't really tell you what's "inside" it. You could set up your fund to include only low-risk interest earning investments, or higher risk foreign stocks. From what you've said, your fund is a "target retirement date"-type fund. This typically means that it is a mix of stocks and bonds, weighted higher to bonds if you are older (on the theory of minimizing risk near retirement), and higher to stocks if you are younger (on the theory of accepting risk for higher average returns when you have time to overcome losses).

What this means is that assuming you're young and the fund you have is typical, you probably have ~50%+ of your money invested in stocks. Stocks don't pay interest, they give you value in two ways: they pay you dividends, and the companies that they are a share of increase in value (remember that a stock is literally a small % ownership of the company). So the value increase you see as the increase due to the increase in the mutual fund's share price, is part of the total "interest" amount you were expecting.

Finally, if you are reading about "standard growth" of an account using a given amount of contributions, someone somewhere is making an assumption about how much "growth" actually happens. Either you entered a number in the calculator ("How much do you expect growth to be per year?") or it made an assumption by default (probably something like 7% growth per year - I haven't checked the math on your number to see what the growth rate they used was). These types of assumptions can be helpful for general retirement planning, but they are not "rules" that your investments are required by law to follow. If you invest in something with risk, your return may be less than expected.

Answer 3

Terminology aside. Your gains for this year in a mutual fund do seem low. These are things that can be quickly, and precisely answered through a conversation with your broker.

You can request info on the performance of the fund you are invested in from the broker. They are required to disclose this information to you.

They can give you the performance of the fund overall, as well as break down for you the specific stocks and bonds that make up the fund, and how they are performing.

Talk about what kind of fund it is. If your projected retirement date is far in the future your fund should probably be on the aggressive side. Ask what the historic average is for the fund you're in. Ask about more aggressive funds, or less if you prefer a lower average but more stable performance. Your broker should be able to adequately, and in most cases accurately, set your expectation.

Also ask about fees. Good brokerages charge reasonable fees, that are typically based on the gains the fund makes, not your total investment. Make sure you understand what you are paying.

Even without knowing the management fees, your growth this year should be of concern. It is exceptionally low, in a year that showed good gains in many market sectors. Speak with your broker and decide if you will stick with this fund or have your IRA invest in a different fund.

Finally JW8 makes a great point, in that your fund may perform well or poorly over any given short term, but long term your average should fall within the expected range for the type of fund you're invested in (though, not guaranteed).

MOST importantly, actually talk to your broker. Get real answers, since they are as easy to come by as posting on stack.

Answer 4

Unfortunately for investors, returns for equity-based investments are not linear - you'll see (semi-random) rises and dips as you look at the charted per-share price.

Without knowing what the investments are in the target date retirement fund that you've invested in, you could see a wide range of returns (including losses!) for any given period of time. However, over the long term (usually 10+ years), you'll see the "average" return for your fund as your gains and losses accumulate/compound over that period.