If you have nothing closer to investing experience than watching financial shows on TV, opening an IRA can seem intimidating. Fortunately, it’s fairly easy for beginners to start investing in an IRA, whether through a bank, brokerage or online.
For the 2017 tax year, you can open an IRA right up to the April 17, 2018, tax deadline. You have more than 15 months every tax year to get on board the IRA train.
Here are six tips on how to open an IRA and start investing.
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Consider your risk tolerance
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Before plunging into investments, gaze deep into your soul and ask, “How will I feel when my account balance falls by 40 percent?”
Very generally, having more stocks than bonds means many exciting days of having no idea how much your account could be worth. But you shouldn’t be checking your balance every day anyway.
A portfolio full of stocks, or stock mutual funds, is likely to go up over time faster than a portfolio filled with bonds. But in the short term, the value will move around much more.
Bonds are less volatile than stocks and generally have a fixed rate of return. But expect the return on bonds to be lower than that of stocks over time.
So the first rule of IRA investing for beginners is to toughen up and ignore the market gyrations. Even though there may be periods of extreme volatility, the trend over long time periods is up, up and away.
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Think asset allocation and time horizon
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When pondering investing options, the first question is, “How much stock do I need?”
Your time horizon should influence your asset allocation, so think about when you plan to retire. The longer you have until retirement, the more risk you should be willing to take.
Typically, people with a couple of decades or more until retirement can afford to take on lots of risk. That means putting most of your money into stocks or, more likely, stock mutual funds or exchange-traded funds.
“If you have five years or more until you need the money, that would suggest a portfolio with higher return and more volatility,” says John Bradberry, CFP professional with SageCreek Planning & Investments in Roanoke, Virginia. “If you are closer to retirement — in less than five years — asset protection might be a higher priority.”
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Wary of stocks? Get over it!
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Stocks are vital to long-term success. Without the oomph provided by compounding stock-market returns, a saver would need to save much more money to reach his or her retirement goals.
Risk-averse investors may want to study the art of investing to feel more confident about their decisions, or simply hire a professional for guidance.
If you’re a new investor who’s decades away from retirement, “you want to allocate your assets into stocks, as stocks earn more than bonds over the long run,” says Robert Johnson, CFA, president and CEO of The American College of Financial Services in Bryn Mawr, Pennsylvania.
“Since 1926, large-capitalization stocks have, on average, advanced by 10 percent compounded annually,” he says.
Large-cap stocks are the behemoths of the business world — think Apple, Exxon Mobil, IBM and General Electric.
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Start with an index fund
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A beginner should consider an index fund that has low annual fees.
An investor could do worse than picking a solid index fund such as one tied to the S&P 500 index, says Eric Meermann, CFP professional and portfolio manager with Palisades Hudson Financial Group in Scarsdale, New York.
“For an initial contribution, buying a diversified, low-cost mutual fund that tracks an index is a good bet,” he says.
Large-cap stocks tend to be less volatile than smaller companies. As time goes on, a beginning investor could build out an asset allocation plan with index funds representing small- and mid-cap companies in addition to an international index fund.
Or, you could do something entirely different. The important thing is to have a plan and save consistently and invest systematically. This is merely a starting point.
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Don’t let your money just sit there
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Getting cash into the account before the April deadline is only part of the battle. Putting the money to work as soon as possible is the real goal.
Investors without a plan often make contributions to their IRA on time, but then they leave the contribution un-invested, a study by Vanguard found.
The mutual fund giant studied accounts and found that investors would make the contribution to their IRA close to the deadline and then leave the funds sitting in a money market fund for months on end.
CFP professional Maria Bruno, senior retirement strategist in Vanguard Investment Strategy Group, suggests picking a default fund to serve as a parking spot for unallocated contributions.
“Make a balanced fund the default instead of a money market fund,” she says. “A balanced fund or target-date fund is a very reasonable default.”
Make sure that the fund chosen has a low expense ratio. Use Morningstar to compare the cost of your fund with the category average.
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Avoid the procrastination penalty
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Here’s another simple reason to start putting the money to work for you: compounding.
There can be a big difference between making your contribution at your first opportunity in January versus butting up against the deadline 15 1/2 months later. Vanguard’s Bruno calls this phenomenon the “procrastination penalty.”
“We ran hypothetical models and had a chart showing the difference between making a contribution on Jan. 1 versus April 15” of the following year, says Bruno. “The give-up is about $15,000 over 30 years.
“It’s completely hypothetical, but it could potentially make a big difference,” she adds.
Contributions should be invested as soon as possible to make the most of compounding over time.