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 novice investors, as they don’t want to make a mistake that will cost them money.
But sometimes what seems like a “safe” option can be more expensive in the long run. If your goal is to maximize the growth of your nest egg, you definitely want to avoid the following mistake.
There is 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 prefer. Usually people do this through the use of an IRA money market account. This works similar to a traditional bank account and allows you to keep cash easily accessible and earn modest returns without risking your money in the stock market.
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For some people, it’s smart to keep some of their money here, especially if they’re about to retire or have 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 to go until retirement, an IRA money market account is not a good choice. These accounts have fairly low annual interest rates (APYs) and are often lower than inflation. That means your balance may grow over time, but your purchasing power will actually decrease because the cost of living increases faster than your savings.
You also won’t be able to count on as much income to grow your savings if you invest in an IRA money market account, so you’ll have to put more money aside on your own to achieve your goal. But there is another way.
So what should you invest in?
Instead of keeping your money in cash, build a diversified portfolio of investments that fits your risk tolerance. An index fund is a good basis for many people. One of these gives you a stake in hundreds of companies, many of which are industry leaders. This spreads your money across many different stocks so that none impact 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 keeping your savings in cash. The general rule of thumb is to keep 110 minus your age in stocks and the rest in bonds.
You can also invest in a target date fund if you prefer a more hands-off approach. These are bundles of investments designed to become more conservative over time. You choose one that corresponds to your retirement year, which is often in the name of the fund itself. Then you don’t really need to do anything. 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 that hard to find. Index funds usually have the name of the index — like the S&P 500 — on behalf of the fund, while funds with a target date clearly state their target year.
All of these investments come with some risk, but don’t worry too much about short-term losses, especially if you have a long way to go before retirement. If you have invested in stable companies that you expect to do well over time, these dips are likely to be temporary.
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