Choose investments wisely, and get help if you need it
- Roth IRAs offer more investment choices than employer-sponsored plans like 401(k)s.
- If you don’t want to choose individual investments, you can pick a target-date fund or use a robo-advisor.
- No matter what you pick, watch out for high fees—and avoid those investments.
One of the primary benefits of Roth IRAs is the tax-free income they provide at retirement. But they have another big advantage as well. They provide a great deal of flexibility when it comes to investment options. You can choose stocks, bonds, and mutual funds, to name a few. But most providers offer many more choices than that.
The scope of investment options makes Roth IRAs (and traditional ones, too) attractive vehicles for retirement savings. Still, all those choices can make it tricky to decide which investments will work best for you. To help you get started, here’s how to invest in your Roth IRA.
Decide on Asset Allocation
Asset allocation is how your money is divvied up among different assets, such as stocks, bonds, and cash. The main goal of allocating your assets is to minimize risk given an expected level of return.
Your ideal asset allocation depends largely on two things: your time horizon and risk tolerance. Time horizon refers to the number of months, years, or even decades you plan on investing to achieve a certain financial goal.
In the case of a Roth IRA, your time horizon can extend well beyond age 70 ½—the age you’d have to start taking required minimum distributions (RMDs) from a traditional IRA. That’s because you can keep adding money to a Roth IRA as long as you want, provided you have earned income for the year.
Your risk tolerance is also a factor in deciding your asset mix. You should take enough risk to build wealth, but not so much that you’ll lose sleep every time the market takes a dive. In general, the more time you have to save, the more risk you can take. The reason? You’ll have time to recover from any losses.
A popular rule of thumb is to subtract your age from 100 (or 110 if you use newer guidelines) to determine what percentage of your investments should be in stocks.
Guidelines aside, keep in mind that people are living longer—and are less prepared financially for retirement—which means you should still be building wealth well into your 60s and 70s. You have to take some risk to do that.
Choose Your Roth IRA Investments
In general, you should allocate more of the equities portion of your IRA to stable stocks (e.g., large-cap funds) and less to smaller, riskier classes—such as small-cap funds and emerging markets.
The same goes for bonds. Put most of your bond allocation into a total U.S. bond market fund and less into international bond funds. This strategy helps diversify your investments, while also managing risk.
Most online brokers and websites such as Morningstar and Yahoo have screeners that can help you sort funds by type, expense ratio, performance, and other factors.
Mutual funds, index funds, and ETFs are popular investments for IRA accounts because they allow you to buy a basket of investments simultaneously. This has a couple of advantages. One is that it provides a simple and effective way to diversify your investments.
It also makes your investing job a lot easier. You could build a portfolio of stocks and bonds from scratch, but most people don’t have the time, confidence, or experience to do it well. Funds are the “easy” button.
Get Help From the Pros
If you don’t have the time, interest, or expertise to shop for and select investments for your IRA, you have several other options.
One is to put all your IRA money into a single target-date fund. These are designed to work toward the year you plan to retire, automatically rebalancing along the way. They’re named by the year you expect to retire. If that’s 2040, for example, you would select a 2040 target-date fund, such as the Vanguard Target Retirement 2040 Fund (VFORX).
Another option is to use a robo-advisor. That’s a digital platform that builds and manages a portfolio or ETFs using algorithm-driven models. In most cases, you’ll pay a management fee of about 0.25% (some brokerages, including Schwab, provide this service for free).
You’ll fill out an initial questionnaire so the robo-advisor can select appropriate investments based on your age, risk tolerance, and other factors.
Finally, you can work with an investment professional who can manage your IRA for you. Many brokerages offer managed accounts. An annual advisory fee typically covers the ongoing management of your money, including investment selection, rebalancing, and personal service and support.
No matter which route you choose, find out ahead of time which fees you’ll have to pay—including expense ratios, commission fees, and account fees—and what they’ll cost you each year. Left unchecked, these fees can quickly erode your earnings, leaving your nest egg a lot lighter come retirement.