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How to invest your IRA

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An IRA can help you amass a sizable nest egg, and it gives you a lot of flexibility, allowing you to invest in many kinds of high-return investments, such as stocks and stock funds. While those options are great, the central question for many investors is how to invest your IRA.

Here are some helpful tips and guidance for how to invest your IRA to best reach your retirement goals.

3 crucial questions to ask about how to invest your IRA

An IRA is one of the best retirement plans around, and workers can get attractive tax benefits by participating in one. For example, with a traditional IRA you can deduct any contributions from your taxable income and grow your assets on a tax-deferred basis, while a Roth IRA allows you to pay taxes now, grow your assets and then withdraw them tax-free at retirement.

But you’ll want to ask three questions to get the most out of your IRA:

  1. How long do you have until retirement? The longer you have until retirement, the more aggressively you can invest. That is, you can invest in assets that can produce higher long-term returns at the expense of greater short-term volatility.
  2. Do you want to manage a portfolio yourself? If you want to manage your own IRA , you’ll need to know how to invest. If you do, there are some relatively simple strategies that you can use to earn solid returns. Otherwise, you have a few resources that can manage the IRA for you.
  3. Do you have the temperament to invest? If you’re investing in more volatile assets such as stocks and stock funds, you need a temperament and mindset that allows you to ride out downturns and stick to your long-term plan.

Those three questions will help you assess how you should invest your IRA, so let’s break down these considerations.

How to invest your IRA: Your time until retirement

How long you have until you need to tap your retirement funds – what investors call your time horizon – is a key guide to the level of returns that you can earn. In general, the longer your time horizon, the higher your potential returns. If you have just a few years until retirement, you’ll likely have to accept lower returns in order to ensure that you have your money when you need it.

Here’s how you can think about your options depending on your time horizon:

If you have a decade or more until retirement

If you have a decade or more until retirement, you can afford to be aggressive with your investments, giving yourself the best chance to earn higher returns. That means you can take steps such as:

  • Investing in a basket of individual stocks if you understand how to analyze stocks.
  • Buying a broadly diversified stock fund such as a Standard & Poor’s 500 index fund.
  • Potentially investing in multiple index funds covering different areas of the market such as large stocks (an S&P 500 index fund) and small stocks (a Russell 2000 fund).
  • Potentially investing in a stock-heavy portfolio, with almost all your assets in stocks or actively managed stock funds.

A long time horizon and some tolerance for risk gives you the best chance for high returns. But you’ll need to ride out the ups and downs that a stock-heavy portfolio will inevitably hand you.

If you have fewer than five years until retirement

With fewer than five years until retirement or if you’re actually in retirement, you’ll probably want to ratchet down your exposure to stocks. Above all, you’ll want to avoid having to withdraw money from stocks when the market is down. Selling in a down market, especially as you first start retirement, can permanently affect how much you can withdraw in later years.

So as you approach the time when you need to tap your money, you can take steps such as:

  • Adding more bond exposure to your portfolio, putting less volatile (but lower-return) assets in your portfolio. You can do this by buying a bond ETF.
  • Following the rule of 100 to help guide how much you should keep in stocks. The idea here is to subtract your age from 100 to give you the percent that you should keep in stocks, with the remainder in bonds or money market funds. However, some advisors now use the rule of 120, so that you grow your stocks for longer periods of time.
  • Maintaining some exposure to stocks, since they can add some growth to the average portfolio, which you may be counting on to last 20-25 years or more after you retire.

With less time to ride out the ups and downs of the market and a clearer need for your money, you want to play things more conservatively so that your money is there when you need it.

And if you’re already in retirement, you may be forced to take required minimum distributions from a traditional IRA, something the Roth IRA doesn’t have. So you really don’t want to be forced to sell stocks to meet this annual requirement.

How to invest your IRA: Your desire to manage a portfolio

With an IRA you have to figure out how to invest your money or find someone who can do it for you. Investing your own money is a big responsibility since your retirement is on the line. You have a few different options here, depending on how much expertise you have and how much work you want to do:

  • If you want to do it all yourself, you have the option of analyzing and buying individual stocks and funds. This requires a lot of work and is fraught with peril. Your returns depend entirely on your picks. If you want to invest in stocks or funds, look for one of the best IRA brokers.
  • If you want to do some of it yourself, you could buy an index fund, such as an S&P 500 index fund, and add contributions to the fund over time. Your returns depend on the index’s performance. The S&P 500 has historically returned about 10 percent annually.
  • If you want someone else to do it for you, then you can select a human advisor to make the decisions. Your returns depend on the advisor’s investing acumen. Your cost for this service might be 1 percent annually. The real value of an advisor is keeping you on track with your long-term investing plan, especially during tough times.
  • If you want an automated app to do it for you, then you can choose one of the best robo-advisors. The best robo-advisors will create an investing plan for you based on your risk tolerance and time horizon. Then all you’ll need to do is add money to the account each year, and the robo-advisor does the rest.

You’ll need to decide how much you want to be involved with your investment decisions. This choice will shape what kind of account you should get – a brokerage account, a robo-advisor account or an account with a financial advisor.

How to invest your IRA: Your temperament

The hardest part of investing is not finding the right investment or buying at the right time – it’s actually sticking to your investment plan. So you’ll need to consider your temperament and whether you can hang on through thick and thin, and ideally continue to invest throughout.

It’s hard for many investors to keep investing in the face of a bear market, when stocks just seem to keep going down. Instead, many get scared and sell somewhere near the bottom, and then they miss the market rebounding. Maybe worse, they buy back into the market when it’s up and appears safe, only for it to fall again. So they end up buying high and selling low.

If you’re investing in stocks or stock funds – assets with high risk and high returns – you’ll need to ride out the ups and downs of the market in order to earn attractive long-term gains.

Having the right temperament is absolutely essential. You can do everything else right, but you may end up sabotaging your returns if you can’t stick to a good long-term investment plan. One of the biggest advantages of a human financial advisor is getting you to stick to your plan.

Bottom line

Investing in an IRA is a great way to set up your golden years, but you want to take maximum advantage of all its benefits. With an IRA, you can earn attractive returns in high-return assets and then opt for safer investments as you approach retirement. You’ll want to take a sensible approach to managing your IRA, even if that means paying a professional to manage it.

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Written by
James Royal
Senior investing and wealth management reporter
Bankrate senior reporter James F. Royal, Ph.D., covers investing and wealth management. His work has been cited by CNBC, the Washington Post, The New York Times and more.
Edited by
Banking editor
Reviewed by
Professor of finance, Creighton University