In Individual Retirement Account, or IRA, is a great way to save for retirement. Depending on your income, the type of IRA (Roth or traditional) and other factors, you can put in several thousand dollars each year and let it grow either tax-free or tax-deferred. It is also the place to put money from 401K plans as you leave jobs since you have a much bigger variety of investments and you won’t have a trail of partial plans as you move from job to job. (Just be sure you have HR do a direct roll-over or you’ll end up having taxes withheld, and maybe forget to put the funds in an IRA and pay taxes and a 10% penalty.)
There are certainly lots of people who would love to tell you how to invest your IRA once you roll over a 401K. Financial advisors often get higher fees from IRAs than they do from 401K’s. Many of the products they sell, however, generate fees for them but don’t do well relative to a lot of other investments in the market.
Learning to invest in an IRA isn’t really that difficult, however, and even if you don’t get the optimal return you’ll still be a lot better off than the average person who cashes out his 401K and never starts an IRA. Here are some pointers:
1. Buy low-costs, standard funds. There are a lot of exotic things you can buy, but few investments will do better than just plain vanilla, low-cost index funds or even better, Index ETFs. Because there is no active management, these funds have very low fees and low turn-over. This means that your money can grow without losing a big percentage each year, which really adds up over time. Diversify into a few Index Funds or ETFs that invest in different types of assets, such as a S&P500 fund, a small-cap or NASDAQ fund, and a bond and income fund. You might also consider a REIT fund, which invests in real estate and generates income from rents. ETFs can be purchased on the stock market from a brokerage firm. Funds are normally purchased through a mutual fund company. Avoid funds with loads (a percentage fee paid when you buy or sell the fund).
2. Buy for the long-term. Your IRA is not the place to try to time the market. Put your money into assets and then leave things alone. Your buying and selling will result in more fees and you risk being out of the market right before one of the big moves that means the difference between making a 15% and a 5% average return.
3. Consider adding a few individual stocks into the mix. Think about buying a few individual stocks to supplement your fund and ETF holdings. This should be a relatively small portion of your portfolio. Pick a few growth stocks that you think will do well over the longterm. Look for small, growing companies instead of large, established stocks and then give them the time to grow. You might also pick a larger stock that pays a good dividend and had steady returns such as Clorox, Procter and Gamble, Wal-Mart, or Home Depot.
4. Get more conservative as you approach retirement age. When you’re 45 and don’t plan to retire for 20 years, you can have a large portion of your money in stocks because you can afford to wait out a downturn in exchange for the better returns you’ll get over time. If you are planning to retire in the next five years, however, you could see half of your retirement savings disappear over a period of a month or even a week and really see your retirement income fall. As you get closer to retirement, shift more money into fixed-income assets and even start to pile up the cash you’ll need for the first few years of retirement (or the cash needed to pay off the house). The more money you have, the more risks you can take, but even a multi-millionaire should have a good cash hoard when going into retirement.
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Disclaimer: This blog is not meant to give financial planning or tax advice. It gives general information on investment strategy, picking stocks, and generally managing money to build wealth. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. Tax advice should be sought from a CPA. All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.
