I could make this a short post, and simply say that someone wiser than me said “You’re a fool if you don’t”, but I’ll try to give it more substance than that.
Bear in mind, there may be other tax-advantages to having a Traditional IRA as opposed to a Roth IRA that I’m not fully aware of. However, I chose the Roth and stuck with it.
Taxes are one of the two certain things in life; what’s almost as certain is the assumption is that they are going to rise. This is what makes the Traditional IRA and the Roth IRA different: when they are taxed. Money that is deposited into a Roth IRA is taxed as it is going in, so that when you finally are ready to retire the money is 100% yours. You won’t pay any taxes on them then.
The Traditional IRA is taxed-deferred, meaning that you don’t pay taxes until you withdraw from it. That means a portion of your returns will be to the benefit of the government, not you. This also leads you to believe that you have more wealth than you actually have, since you must pay that tax benefit back on withdrawal.
The gamble that I’m playing here is that I’m expecting taxes to be higher by the time I retire than they are now. But I feel the advantage is still with the Roth, because the money in that account is still completely mine, tax-free, even if taxes are lower during my later years.
Okay, I have an IRA. Now what?
Congrats! You’ve taken the first steps to take control of your own retirement!
Now, imagine your IRA as an empty container. Your goal is to pour some money into that container, then put that money to work to make more money. Rinse, lather, and repeat. To do that, you have several options. That container can be filled with a mix of cash, bonds, stock, and mutual funds.
Cash – Is simply that: Cash. If you just deposit cash into an IRA, it will simply sit there, and it will lose value due to inflation over time. Direct your cash to other means to make the most out of it.
Bonds – The “better safe than sorry” mentality. Buying a bond in your IRA will lock that money away for however long you set the bond to (an option of about one to twelve years with varying rates of return). Upon maturation, you will get that money back, plus interest. Typically, you may be given the option to reinvest dividends from a bond back into the bond, or just have any returns trickle in as cash. I recommend reinvesting, let compound interest work its magic. Bonds offer a low rate of return, but it’s guaranteed. There’s no realistic risk of losing money. However, if your bond cannot beat the rate of inflation, it’s hard to justify it.
Stocks – I see stocks as an Adventure (or anxiety) mode for an IRA. This is meant for the more active people who have the time to buy, watch, and sell quickly. Most people cannot stomach the volatile nature of stocks. It’s hard to keep emotions in check when you see a stock you’re invested in begin to plummet. However, if you keep abreast of the right stock, and can keep your wits about you, stocks can yield some of the more significant gains you’ll see in an IRA. Remember: buy low, sell high.
Mutual funds – Consider these a “pool of funds”. Mutual funds are professionally managed and typically invest in a particular need. There’s mutual funds that fund certain flavors of companies (like medical or technological, for instance), funds that are designed to match the gains in a market (these are called “Index funds”) or funds that are designed to shift from aggressive to conservative growth over a period of time (commonly known as “Target-date mutual funds”).
For the average Joe, I’d suggest Mutual Funds at the beginning. As you become more familiar with the market you may want to branch out and buy a stock in your favorite company or for purchase a bond for stability. No matter the situation, try to keep these principles in mind:
- Although possible, there are hefty penalties for withdrawing from your IRA early. There are also certain conditions in which you are allowed to withdraw without penalty (i.e. first time home buying). That said, taking money out of this account is only going to impoverish “Future You”.
- There is no perfect, one-size-fits-all portfolio, no matter what anyone says. Everyone has their own personal ratio of risk to reward that they are willing to deal with. Some like a real aggressive posture while others prefer consistent growth over time.
- Do your research! Before you invest in a fund or stock, look at its performance history. Also, see what fees are charged every time you want to buy into the fund. These eat away at your portfolio, and you miss out on the potential gains from that lost money.
- Once you buy into a fund, stick with it for a while. I personally give a fund two years of solid investing before I make a determination. If it is not performing well enough, or is flat-out doing poorly, sell it then and look for a better option.
- Remember: Retirement Accounts are about the LONG GAME. Growth over time and compound interest need time to work their magic. Don’t panic over every single dip in the market. Instead, view it as the perfect time to buy cheap.