Once you've opened a traditional IRA or a Roth IRA to set yourself up for retirement, what's next?
Now it's time to figure out your asset allocation, or how the fund in your IRA portfolio is divided among different investment categories such as stocks, bonds, and cash.
To start, ask yourself a few key questions, says Maura Cassidy, vice president of retirement at Fidelity: How involved do you want to be in choosing and managing your IRA? How comfortable are you with risk? How long do you plan to wait before you retire and start using the money in your IRA?
Thinking about those answers makes it easier to figure out which assets are best suited for your savings goals.
You can invest in just about any asset using your IRA, with a few notable exceptions like life insurance and collectibles. Broadly speaking, most people include a mix of equities, which can offer both higher returns and higher risk, and bonds, which tend to have lower returns than stocks but help dampen the overall risk.
How you choose to balance the two categories will depend on factors like your age and your tolerance for risk, says Tim Casserly, a certified financial planner at Arista Wealth Advisors in Albany, New York. "I tell younger clients to put 100% to 90% of their money in stocks because the money is going to be there for 40 to 50 years," he says. "The markets will have some downs—but historically speaking, the ups outweigh the downs."
The money managers at T. Rowe Price suggest these guidelines, based on your age:
- In your 20s and 30s: Up to 90% in stocks (because of your long investment timeline), with up to 10% remaining in bonds.
- In your 40s: Up to 80% in stocks, with up to 20% remaining in bonds.
- In your 50s: 60% to 80% in stocks, 20% to 30% in bonds, and up to 10% in cash.
- In your 60s: 50% to 65% in stocks, 25% to 35% in bonds, and 5% to 15% in cash.
Once you've settled on how you'll mix equities and bonds, you still need to figure out what investments to make. You'll have a wide array of options at your disposal, including index funds, exchange-traded funds (ETFs), target-date funds, and other kinds of mutual funds, as well as individual stocks and bonds.
Here's how some of the options stack up:
- Index funds are a kind of mutual fund designed to track and match the performance of a specific index, such as the S&P 500. They're generally lower risk, with steady growth and low fees. But by nature they won't outpace the market.
- ETFs are a collection of investments like stocks, bonds, and commodities, or a combination. ETFs typically track an underlying index, such as the S&P 500 or the Dow Jones Industrial Average, and they're traded much like regular stocks on stock exchanges. Check out our guide on why ETFs are an increasingly popular way to invest.
- Target-date funds are mutual funds created to automatically shift your portfolio mix as you age, increasing the portion in conservative investments as you approach retirement. Although target-date funds tend to be an easy way to navigate risk, says Justin Halverson, a financial advisor at Great Waters Financial in Minnesota, many of them come with layers of expenses and fees.
After you pick your asset allocation, there are still a few things to keep in mind.
Calculate overall costs: It's important to look at the fees on the asset class you're choosing and to check the fund manager's track record before picking a fund. Even very small costs can add up over the course of your career. Consider two 25-year-olds who earn the same salary and put identical amounts into their retirement, the only difference being that one chooses a low-fee fund, and the other opts for a high-fee one. The investor with the low-fee fund will end up with a balance of $100,000 more at retirement, according to the Center for American Progress.
Take the long view: The biggest mistake Casserly sees IRA contributors make is checking their accounts too often: "When you check the market performance day-to-day, it's easy to forget you have a 40-year time horizon." Aim to check in on your investments no more than once per quarter.
Keep it up-to-date: Casserly says contributors tend to forget to update their beneficiary designations, which determine who gets your account when you die and override even what's written in your will. For example, you may have named your parents as your beneficiary instead of your current partner because you opened your IRA before getting married.
Taking these next steps to make the most of your IRA can help set you up for a secure retirement.
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