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How to Invest Your IRA

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Have you been endlessly Googling “How to invest in my IRA?” Are you concerned about the amount of money you have saved for retirement? 

An individual retirement account (IRA) is a type of retirement account that can help you save money toward retirement. You can use an IRA to fill in the gaps left by your employer-sponsored 401(k) or SEP 401(k) or as your sole source of retirement savings. There are a number of IRA investing options you can use to maximize your contribution and put more money away before you reach retirement age.

We’ll take a closer look at how you can start investing in an IRA.

Investment Options for an IRA

You can choose between 3 major account types when you’re on the hunt for an IRA:

  • Traditional IRA: You get a tax break when you file your federal income taxes with a traditional IRA. You can deduct any contributions you make from your income tax the year that you make them. However, when you withdraw money in retirement, you’ll need to pay taxes on the money as you take disbursements. By law, you must start taking distributions when you turn 72.
  • Roth IRA: When you make contributions to a Roth IRA, you cannot claim a tax deduction on any money you put into your account. However, when you retire, you won’t pay taxes on your disbursements. This means your money grows tax-free. You can’t make withdrawals before age 59 ½ without a penalty, but you can take disbursements after this age. A Roth IRA can be more advantageous if you’re making less money now than you believe you will in the future.
  • Simplified employee pension (SEP) IRA: A SEP IRA is a special type of IRA for those who are self-employed. A SEP IRA allows you to save more money toward retirement compared to a traditional or Roth IRA. Like a traditional IRA, SEP IRA contributions aren’t taxed the year you contribute to them. If you have employees, you may need to make contributions to your employees’ retirement account if you open a SEP IRA.

Unlike brokerage accounts, there are limits to the amount of money you can contribute to an IRA in a single year. In 2020, you can contribute up to $6,000 to a traditional or Roth IRA if you’re under the age of 50 and $7,000 if you’re over the age of 50. If you open a SEP IRA, you can contribute up to $56,000 each year or 25% of your annual income.

The specific funds and financial products you can invest in will depend on the IRA type you choose. As a general rule, IRA investing is much more self-directed than investing in an employer-sponsored fund. This means that you’ll need to do more independent research on what you’re investing in before you make a purchase. If you already have an IRA account or another type of retirement account, you can also choose to roll over your account to a new provider. 

Steps to Maximizing Your IRA Investments 

You can maximize your savings for retirement by investing both in an IRA and an employer-sponsored 401(k). Here are some tips for using an IRA account:

  • Diversify your investments. From REITs to index funds, you’ll have access to a wide variety of investment choices through your IRA provider. You can split your money between a few different industries and investments to diversify.
  • Set a monthly savings goal. You may not have $6,000 lying around to save at the beginning of the year. Instead of saving for a lump-sum contribution, set a goal to save a set amount each month. If you save $500 per month toward retirement, you could max out your IRA before the year ends.
  • Look at your budget. A better IRA contribution schedule begins with a well-balanced budget. Take a look at your monthly budget and search for areas you can cut back and save more.
  • Compare providers. There are lots of different banks, brokerage firms and investment companies that offer IRA accounts. Research your options before you choose where to open an account. This can help you minimize fees and allow you to save more. 
  • Avoid taking money out before your retirement age. Though it’s important to contribute to retirement, don’t overexert yourself financially. You’ll pay a whopping 10% penalty if you withdraw money from an IRA before retirement. 

IRA Investment Strategy by Age 

IRA investing is much more self-directed than investing in a 401(k). This means that it might be more difficult to choose the best IRA investment strategy.

IRAs are made up of stocks and bonds as a general rule. Stocks are shares of a corporation that increase or decrease in value based on the performance of the company and the economy as a whole. Bonds are a type of agreement between you and a company or the federal government that you loan money to for a set period of years. Stocks are riskier investments than bonds but have much more growth potential.

As a general rule, the best strategy for IRA investing depends on your age and risk tolerance. You have more time until retirement as a younger investor. This means that you can withstand market fluctuations and take more risks with your money. As you grow older, you’ll probably want to shift more of your money toward bonds. Bonds are insured by the company or government that issues them. This means that they’re less likely to plunge in value — but they also won’t grow as quickly.

Looking for a set-it-and-forget-it solution for your IRA? Look for target retirement date funds from your IRA provider. Target retirement date funds automatically readjust as you age to keep you on track toward retirement with your preferred risk level. Choose target retirement funds that align with the year you aim to retire. For example, if you plan to retire in the year 2055, you’ll want to choose a target retirement fund with a name like “Target Retirement 2055.” 

Should You Use a Financial Advisor for Your IRA?

With so many rules, regulations and products you can choose from, investing in an IRA can be overwhelming. You might consider hiring a financial advisor to help you manage your IRA. On the other hand, you might be wondering if it’s even worth it to work with a financial advisor — are the returns you’re seeing higher than they would be if you didn’t spend the money on an advisor?

There is data that supports the idea that working with a financial advisor does improve your portfolio’s performance. According to a survey from Vanguard, one of the largest IRA providers in the world, you can expect about 3% more returns each year by working with an advisor.

Most financial advisors charge you a percentage of your net assets they manage. This means that advisors have incentives to keep their minimum account balances high. Considering the relatively low contribution limits that control the size of your traditional or Roth IRA, you might have a hard time finding a financial advisor who will agree to work with you.

It’s typically better and more cost-effective to work with a robo-advising service instead of a human financial advisor. If you have a SEP IRA with a larger dollar amount of assets, you may want to hire a financial advisor to assist you to make sure your money is protected.

What if another Recession hits?  

You might be worried about another recession and what it will do to your investments. However, the truth is that recession is a natural part of the economic cycle — it’s not something you should fear. You’ll set your risk tolerance to match the number of years before you retire If you readjust your portfolio as you age. If you’re an older investor, most of your money will be in stable assets like bonds. This means that the effect you’ll feel during a recession will be minimal. On the other hand, if you’re a younger investor, your portfolio may significantly change in value. But as a younger investor, you have time to ride out the ups and downs in the stock market.

The most important thing to remember during a recession is that all economic downturns are temporary. Avoid the urge to stop contributing to your IRA during a recession or selling your funds to “stop the bleeding.” You’re much more likely to lose money than gain it by attempting to time the market. Instead, stay consistent and buy stocks and bonds when they’re lower in value. This can leave you with a larger return when the recession does end. 

Should You Focus on an IRA or 401(k)? 

If your employer offers a 401(k) match program, focus on contributing to your 401(k) over your IRA until you reach your max. 401(k) match programs are free money that you can put toward your retirement. There’s no downside to taking full advantage of your employer’s program.

If you’ve already maxed out your 401(k) match contribution, you may want to consider diverting funds away from your 401(k) to a Roth IRA. Roth IRAs use post-tax dollars to grow over time. This means that, unlike your 401(k) disbursements, you don’t need to pay tax on your Roth IRA funds when you reach retirement. If you’re a younger investor who believes that you’ll be making more money later in life, you can potentially save thousands of dollars by investing in a Roth IRA over your 401(k). 

The Best Way to Invest in Your IRA

IRAs are much more self-directed than 401(k) plans and other employer-sponsored retirement options. This means that you’ll need to spend more time researching your investment options to choose the right funds, bonds and stocks you need to complement your primary savings. Don’t be afraid to leave yourself plenty of time to read about the fund options your IRA provider offers. If you don’t max out your contribution this year, you’ll have a few months during the beginning of next year to contribute towards last year’s maximum.  

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