IRA Savers, Don’t Make This Costly Mistake With Your Retirement Nest | Smart Change: Personal Finances
Saving in an IRA gives you flexibility that a workplace retirement plan doesn’t, but it also puts a lot of pressure on you to choose the right investments. This can be stressful, especially for newbie investors, as they don’t want to make a mistake that will cost them money.
But sometimes what seems like a “safe” option might actually be more expensive in the long run. If your goal is to maximize your nest egg growth, you definitely want to avoid the following mistake.
There’s such a thing as being too conservative
You can invest your IRA funds in stocks, bonds, mutual funds, exchange-traded funds (ETFs) and more, but you can also leave your money in cash if you want. Most of the time, people do this using a money market IRA account. This acts like a traditional bank account and allows you to keep cash readily available and earn a modest return without risking your money in the stock market.
It makes sense for some people to keep some of their money here, especially if they are about to retire or are already retired. This way they can leave their investments alone and hopefully avoid having to sell them when they are down.
But for those who have decades before they retire, a money market IRA account isn’t a great choice. These accounts have fairly low annual percentage yields (APY), and often they are lower than the rate of inflation. This means that your balance may increase over time, but your purchasing power actually decreases because the cost of living increases faster than your savings.
You also won’t be able to rely on income as much to help you grow your savings if you invest in an IRA money market account, so you’ll have to set aside more money yourself to reach your goal. But there is another way.
So what should you invest in?
Rather than keeping your money in cash, build a diversified portfolio of investments that matches your risk tolerance. An index fund is a good base for many people. One of them gives you a stake in hundreds of companies, many of which are industry leaders. This spreads your money among many different stocks so that none affect your portfolio too much.
You can also keep some of your money in bonds. These don’t offer the same returns as stocks, but you can still do better with them than you can keep your savings in cash. The general rule is to keep 110 minus your age in stocks and keep the rest in bonds.
You can also invest in a target date fund if you prefer a more passive approach. These are sets of investments designed to become more conservative over time. You pick one that matches your retirement year, which is often in the name of the fund itself. Then you really don’t have to do anything else. The fund adjusts your asset allocation for you over time. The downside is that these funds can be expensive.
You can find all of these investment options with most major brokers. They are usually not too difficult to locate. Index funds are usually named after the index – like the S&P500 — in the name of the fund, whereas target date funds clearly state what their target year is.
All of these investments carry risk, but don’t worry too much about short-term losses, especially if you have a long way to go until retirement. If you have invested in stable companies that you believe will thrive over time, these declines are likely to be temporary.
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