What Kind of Investments Should You Make in your IRA
Choosing investments for your retirement account such as a 401k or IRA can be a very stressful job for many people. People want to trust a financial advisor, but they don’t know if they are really looking out for their best interests. Your retirement plan at work may limit your investment options to a group of about 10-20 mutual funds, or you might have an IRA with no restrictions. So how do you invest your retirement account?
Define Your Goal
The first step to choosing your investments is to define your goal. Are you more concerned with not losing money than making money? Do you have a lot of money invested in different accounts and you are looking for the most tax advantaged strategy? Should you use your retirement account to diversify your holdings? Are you already retired or do you have a long time to save before you retire?
The answers to those questions will help you to determine how you should be investing your funds.
Step One, If you Have Other Investments You Can Increase your Long Term Returns Through Tax Savings with Smart Allocations
What does that mean? You may have money in a mix of qualified and non-qualified accounts. Non-qualified accounts are taxable (regular accounts using after tax money) and qualified accounts are not taxable until the money is withdrawn (funded with pre-tax dollars like a 401(k) or IRA. If you do have money in both kinds of accounts, you can increase your rate of return simply by looking at all the money as one big account and holding the right types of investments in each account.
Bonds, bond funds, and high dividend paying stocks or funds are not tax efficient. Every time they pay out a dividend, this is a taxable event. But, if you hold your bonds and high dividend payers in your retirement account, you don’t need to worry about that. The money can be reinvested tax free, and this increases your long term returns by a lot. According that this article, as much as 15% over 10 years.
If you have a lot of money outside of your IRA, you may want to seek a tax advantaged strategy by investing in things like growth stocks and municipal bonds outside your retirement account, but hold bonds and dividend paying funds in the IRA or 401(k).
Gold Also Saves on Taxes
Holding gold is also a good way to save money on taxes. Gold pays no dividends, so if you hold gold in a nonqualified account you will realize the appreciation in it’s value and only pay taxes when you sell the investment. Gold appreciates nice and quietly. It will never be taken over or merged like a stock, or go bankrupt. Over thousands of years gold has steadily appreciated in price.
Some people hold gold in a retirement account (a gold IRA) and some people just hold it outside of one. Some people claim sales on their taxes, and some people quietly exchange gold for cash or goods and don’t tell the IRS. The choice is yours, but physical gold can be held in your retirement account, or you can buy a gold fund or index, but you will pay fees.
Step Two- How Much Time Do you Have Until Retirement?
This is a question that annoys people because they want to make money no matter how old they are, but this question is important. If you are almost retired or you are in retirement, you do not want to hold risky investments. The time that your money is likely to stay invested is known as your investment horizon.
If You are At or Near Retirement Age
You will still want to participate in the upside of the market, but you want a conservative portfolio. You should be allocating your retirement account heavily with bond funds and high dividend paying funds. You want to use the cash that they throw off to live on without touching too much of the principal investment. You can diversify here with a small portion of international holdings or commodities such as gold or oil, but you should not have more than about 10% of your portfolio in this type of speculative investment.
If You are Not Near Retirement
If you still have a long time until retirement (more than 12 years) then you can safely invest in higher risk securities. You will want to hold growth stocks, growth stock funds, international debt and equity, and hard assets such as gold and silver.
There is an argument to be made to putting 100% of your funds in an S&P500 index fund with low fees such as Vanguard, but you can usually more alpha (risk adjusted return) by having a mixed allocation portfolio. You will want to maintain an aggressive mix of stocks and gold to bonds, in the range of about 70% and 30% respectively.
What you are Allowed to Hold
Many different types of investments are permissible to hold in an IRA. Here is a pretty complete but not exhaustive list of what you can buy:
Publicly Traded Stocks
You are allowed to own any publicly traded stocks in an IRA. These may trade on any exchange such as the New York Stock Exchange or NASDAQ, or they may even trade “over the counter”. The IRS does not limit your ability to buy stocks on the market, or trade them freely within the IRA without tax consequence. You can be a very active trader within a retirement account without paying a penalty.
Bonds
You can own individual bonds within a retirement account. It is rare for a retail investor to do this because they don’t have the same sort of access to bond markets that institutional investors do, but it is perfectly permissible per the IRS and many people own bonds within an IRA.
Stocks or Bond Mutual Funds
Mutual funds are investment collections that retail investors can buy into. Each fund has a “fund objective” which describes the types of investments and investing rules that the fund will observe. Each fund is actively managed by a fund manager or management team, and a fee is charged as a percentage of total assets for doing this.
Mutual funds may own bonds, treasury securities, international bonds including those issued by sovereign nations, commodities, and stocks both domestic of foreign. Some funds stick to one asset class and some blend together multiple types of investments.
Mutual funds are great for investors seeking diversification to minimize risk, as well as giving the average investor access to professional money management, and active management, as hypothetically the money managers who run the funds know much more than the average investor. Because the fund managers are paid based on their performance, the objectives of the investor and the manager are also typically aligned. All mutual funds are permissible investments in IRA accounts.
Privately Held Companies and other Unconventional Assets
The IRS does permit the holding of private companies, even LLCs, in an IRA. That being said, the companies can not themselves derive their income from nonpermitted IRA holdings such as collectibles or alcohol. If you want to hold an unconventional asset within an IRA you should see, guidance from a CPA or a financial advisor.
Gold Bullion
The IRS allows you to hold pure bullion in your IRA. It must be highly refined and pure, and it must be held by a bank or authorized trustee. You can not hold collectible gold coins unless the value of the coins is entirely derived from the value of the gold contained in the coin.
Gold is a fantastic investment for an IRA account because it provides diversification, and it gives a very strong hedge against a stock market decline. Typically when the stock market goes down, gold will go up. However, a rising stock market does not necessarily mean that gold will fall in value. Gold is one of the oldest investments still in existence and it has a centuries long track record of stellar performance. People who hold gold in their retirement accounts do not typically regret it.
Conclusion
You can hold many different types of investments in an IRA, but ultimately what you do hold should come down to your personal investment objective as well as your tolerance for risk and investment horizon.
