IRA Investments: Stocks, Bonds, and Mutual Funds

Choosing which type of investment to place your IRA funds into can be overwhelming, especially with all the different options, rules, and risks out there. Most of the time, you will spread your annual contribution between two or more investments, or “buckets” if you will. This way if one sector does poorly, you lessen your chance of taking a huge hit to your retirement as a whole. The most common forms of IRA investments are stocks, bonds, and mutual funds. These three investment opportunities are explained below.

  1. Stocks.  A stock is a purchased part ownership of a company. You can buy your way into this system by purchasing shares; and depending on how many shares you own and how many shares the company allocates, you will own a certain percentage of that company. If your shares fall under the category of “common stock”, you will have a vote in annual shareholder meetings and be rewarded dividends on company profits. If your stock is “preferred stock”, you won’t get a vote in shareholder meetings, but you will have first priority in dividend distribution and asset liquidation should the company go bankrupt.

Some stocks are riskier than others, and the safer ones tend to be the more expensive stocks. You will be completely at the mercy of the market with this type of investment, so you could gain or lose money in any given year. Even if you lose money, you can wait for an upswing in the market to gain back your losses, but it may take time. The amount of funds you contribute toward stock will depend on your age and your long-term retirement goals. They can be high risk, but they can also be high reward the longer you stick with them. The percentage you contribute to your stock fund will typically decrease as you age since you’ll want more secure and dependable assets in your portfolio the closer you are to retirement.

  1. Bonds. While bonds can be a safer investment than stocks, they can also yield smaller returns. Therefore, they are a low risk, low reward investment. You’ll want to include at least a small percentage of lower risk investments in your portfolio starting out, and increase the safe to risky ratio the closer you get to retirement. There are several types of bonds available, each with their own associated rules, taxation, and risk.

Bonds are basically tools for companies or governments to raise money quickly by issuing promissory notes to people who lend a certain amount of money to them in exchange for payback with interest, but no ownership in the entity. For instance, a company could issue 100 $1,000 bonds to people with a promise of paying them back at face value by a certain date, say two years later. Meanwhile, the company pays a pre-determined amount of interest to each bond holder in increments over those two years. With government bonds, you may have to pay federal and/or state tax on the interest accumulated and the value of the bond may not keep up with inflation. No tax on the interest usually means the interest percentage will be lower. Bonds can also be bought, sold, and traded since their value can fluctuate just like a stock.

  1. Mutual Funds. Mutual funds are most easily described as a bundle of different stocks and investments from different companies, niches, and assets. Rather than investing a large amount into one company’s stocks, you can use the same amount to buy a fraction of, say, ten different company stocks. Some mutual funds will be offered in a certain industry such as technology, while others may offer only large cap or small cap stocks. Because your investment is spread out in a mutual fund, the risk is generally less than with a single stock. In the same way, the reward is also smaller. Mutual funds can be a complicated investment to research and find the right one for you, so you may need the assistance of a broker with these investments.

Saving for retirement through an IRA is a smart decision, but it can be tricky with all of the options, risks, and rewards out there. While the above mentioned vehicles are only a few of the many ways to invest with an IRA, only you and your financial advisor will know which investments are right for you, your portfolio, and your retirement goals.

How a Change of Career Can Impact Your Self-Directed IRA

The process of building up a retirement nest egg doesn’t occur in a vacuum. You can come up with a savings plan and investment plan, but if the other financial elements of your life undergo significant changes, you might have to adjust those plans. One thing that can impact your self-directed IRA in several important ways is changing your job or career.

New Income Levels

As you are likely already aware, your ability to contribute to a traditional self-directed IRA or a Roth self-directed will depend on your modified adjusted gross income, as well as whether you’re participating in an employer-sponsored retirement plan such as a 401(k).

For 2014, for example, if you’re a single taxpayer and you’re covered by a retirement plan at work, you can only deduct the full amount of any contributions you make to a traditional self-directed IRA if your modified gross income is $60,000 or less. If you’re not covered by a retirement plan at work then your contributions to a traditional self-directed IRA will be fully deductible regardless of your income. With respect to a Roth self-directed IRA it is irrelevant whether or not you participate in an employer-sponsored retirement plan, but you can only make the maximum contribution to your Roth account if your modified adjusted gross income is less than $181,000.

Clearly there are several moving parts here, but the bottom line is that whenever you switch to a new career or job, the optimal contribution strategy you used in past years may not be the best one in your new position. You may find that you’re much better off making contributions to a traditional account than a Roth account, or vice versa. (And some individuals maintain both Roth and traditional IRAs throughout their saving years for just this reason.)

Ability to Rollover Your 401(k) Account

Whenever you change jobs, you have the ability to roll over your account balance to your new 401(k) account at your new employer (assuming that your new employer offers such a plan). That has certainly been a common approach among many individuals who find themselves moving to a new job or new career.

But that change in job or career gives an opportunity to rollover the balance that’s in your 401(k) account into your self-directed IRA. Not only will this give you the opportunity to reduce your administrative burden by having fewer accounts to manage, but you’ll also have a larger pool of capital that you can use to make some of the less common retirement investments that you can only do with a self-directed IRA.

It’s true that you can generally leave your 401(k) account with your old employer, but if you choose that path you won’t be able to make new contributions to your account, and you’ll be stuck with whatever limited investment options that particular plan happens to offer.

Make sure that you structure this as a direct rollover, not as a distribution and contribution of funds. The negative tax implications of taking a distribution from your 401(k) could be significant.

Using Your Self-Directed IRA to Invest in Illiquid Assets

When most investors think of investments they tend to focus on assets and asset classes that are relatively liquid. We’re talking about investments that you can trade in and out of relatively easily and at relatively low cost – things like stocks, mutual funds, banks CDs and the like. Liquidity means that your money is always available if you have an emergency or other pressing expense. (While it’s true that you may have to forfeit some of the interest you earned in order to liquidate a bank CD before maturation, the money is still there for you to use.)

For this reason, there’s sometimes a tendency to avoid investments that are illiquid. These investments include assets like real estate and investments in private companies. If you ever need to sell these investments, you might find that it takes a bit of time to actually “cash out.” Some investors are reluctant to have their funds tied up in this way.

Fortunately this type of illiquidity is perfectly consistent with the long-term investment timeframe of the self-directed IRA. Withdrawing money from a self-directed IRA before retirement generally incurs penalties (and in the case of a traditional account, taxes as well), so account holders are generally more comfortable with holding illiquid investments because they wouldn’t easily be able to use the underlying funds outside of the account anyway.

Real Estate. Real estate is a popular illiquid investment to hold in a self-directed IRA. Given the costs that are generally imposed on both the sellers and the buyers of any real estate transaction, most real estate investors tend to have a medium-term to long-term outlook, and rightly consider these investments to be illiquid.

Private Mortgages. Owning a piece of property outright is not the only way to invest in real estate. With a self-directed IRA you can lend money to others to enable them to purchase real estate. Many investors find that they can generate healthy returns by becoming active in lending markets that their local banks and mortgage companies don’t participate in.

This might mean commercial lending, or lending to first-time or high-risk lenders that may find difficulty in obtaining financing through traditional means. As you might expect, with higher risk comes a higher interest rate that you can charge.

Remember that as the originator of the private mortgage, you have to be prepared to carry the note to maturity. While a borrower can always choose to pay down their mortgage early, there’s no way for the lender to force early repayment. It’s possible to sell your mortgage note to another investor, but this secondary market is probably quite thin and potentially expensive to take advantage of.

Private Equity. By the same token, private equity investments are also highly illiquid, and therefore are well-suited for self-directed IRAs. It’s important to understand that the investment documents themselves may prohibit transferring the interest to third parties, so these may be the least liquid of any of the investment types we’ve discussed.

If you find an investment opportunity that’s going to tie up your money for a number of years, consider participating in it within your self-directed IRA.