Saving in an IRA gives you flexibility that a workplace retirement plan doesn't offer, but it also puts a lot of pressure on you to choose the right investments. This can be stressful, especially to beginning investors, because they don't want to make a mistake that will cost them money.
But sometimes, what seems like a “safe” option could actually be more costly in the long run. If your goal is to maximize your nest egg's growth, 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 a lot more, but you can also leave your money in cash if you want. Most of the time, people do this through the use of an IRA money market account. This acts similar to a traditional bank account and enables you to keep cash readily accessible and earn a modest return without risking your money in the stock market.
It's smart for some people to keep some of their money here, especially if they're on the verge of retirement or are already retired. This way, they can leave their investments alone and hopefully avoid having to sell them when they're down.
But for those with decades to go until retirement, an IRA money market account isn't a great choice. These accounts have pretty low annual percentage yields (APYs), and often they're lower than the rate of inflation. That means your balance might grow over time, but your buying power's actually decreasing because the cost of living is rising faster than your savings.
You also won't be able to count on earnings as much to help you grow your savings if you invest in an IRA money market account, so you'll have to set aside more money yourself to reach your target. But there is another way.
So what should you invest in?
Rather than keeping your money in cash, build a diversified portfolio of investments that matches your risk tolerance. An index fund is a good foundation for a lot of people. One of these gives you a stake in hundreds of companies, many of which are industry leaders. This spreads your money around between a lot of different stocks so no single one affects 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 you can keeping your savings in cash. The general rule of thumb is to keep 110 minus your age in stocks and keep the remainder in bonds.
You could also invest in a target-date fund if you prefer a more hands-off approach. These are bundles of investments that are designed to grow more conservative over time. You choose one that corresponds to your retirement year, which is often featured in the name of the fund itself. Then, you don't really have to do anything else. 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're usually not too difficult to locate. Index funds usually have the name of the index — like the S&P 500 — in the name of the fund, while target-date funds clearly advertise what their target year is.
All of these investments carry some risk, but don't get too worried about short-term losses, especially if you have a long way to go until retirement. If you've invested in stable companies you expect will do well over time, these dips will probably be temporary.
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