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.
- 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.
- 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.
- 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.