3 IRA Investing Tips That Could Earn You Thousands
Whether you're just getting started with IRA investing or you've been investing in an IRA for decades, there's always more you can learn and incorporate into your strategy. With that in mind, here are four tips that can help you make the most of your IRA.
Image Source: Getty Images.
Traditional vs. Roth: Which is right for you?
The first decision you'll need to make when starting to invest in an IRA is whether to use a traditional or Roth IRA. The basic difference is that traditional IRA contributions can be tax-deductible, while Roths are funded with after-tax money but they allow tax-free withdrawals in retirement.You can read more about both IRA types here, but here's a quick breakdown of why you might choose one over the other.
You might be better off with a traditional IRA if:
- You're in a higher tax bracket now than you expect to be in retirement.
- A tax break now sounds more appealing than tax savings in retirement.
- You don't have an employer-sponsored retirement plan, and you earn too much to contribute directly to a Roth IRA.
On the other hand, here are some reasons a Roth IRA might be the way to go:
- You want to "lock in" your current tax rate.
- Your other retirement assets are in a pre-tax account like a 401(k), and you want to diversify your retirement assets.
- You might not need the money in retirement and would prefer to leave it in the account to continue growing. (A Roth IRA doesn't require minimum distributions after a certain age.)
- You don't want all your money "tied up." (A Roth IRA allows you to withdraw your original contribution amounts at any time.)
Take full advantage of the tax benefits
One smart way to maximize the benefits of your IRA is to fill it with the right kind of stocks. Now, anystock that appreciates in value over time will produce better returns for you in an IRA than it will in a taxable brokerage account. However, dividend growth stocks can really harness the full compounding power of IRA investing, so they should be the main focus of your IRA if you choose to buy individual stocks.
To illustrate this, consider two of my personal favorite stocks in my own portfolio: Apple and Berkshire Hathaway. We'll say that you must choose one to hold in your traditional IRA, while the other will be held in a taxable brokerage account, and you're buying $5,000 worth of each one.
Apple pays a 1.9% dividend yield as of this writing, so your $5,000 investment would generate about $95 this year. In a taxable brokerage account, this dividend would be subject to tax (15% for most people), so it would effectively be cut down to about $81. In a traditional IRA, no dividend tax would be due. Here's the important point: In your IRA, you now have the full $95 to reinvest in more shares, while less of your dividend could be put back to work in a taxable account. Sure, this $14 difference doesn't sound like much, but this compounding effect can be larger than you think over a long period of time.
For simplicity, let's say that Apple's dividend yield remains 1.9% and the stock rises by 8% per year. Here's the difference over time in the value of a $5,000 initial investment:
|
Time Period |
Taxable Account |
Traditional IRA |
|---|---|---|
|
1 Year |
$5,481 |
$5,495 |
|
5 Years |
$8,673 |
$8,810 |
|
10 Years |
$13,726 |
$14,124 |
|
20 Years |
$34,348 |
$36,301 |
|
30 Years |
$78,536 |
$84,899 |
So, while it doesn't make a big difference over shorter periods of time, keeping your Apple investment in a traditional IRA would result in almost $6,400 higher returns over 30 years in this simplified example.
On the other hand, a $5,000 investment in Berkshire Hathaway would only benefit from the initial tax deduction on your IRA contribution. Since Berkshire doesn't pay a dividend, your investment would grow by the same amount over time in both account types.
If you're young, now is when you need to be aggressive
One of the biggest mistakes people make when investing in IRAs is allocating too little of their money to stocks or avoiding them altogether. This is especially true for younger investors.
Now, it makes perfect sense that millennials might be scared to invest in stocks. After all, this generation's early observations of the market included the tech crash of the early 2000s and the Great Recession. Many millennial investors saw their parents lose lots of money in the market.
However, as a general rule of thumb, if you subtract your age from the number 110, that's the percentage of your portfolio that should be in stocks. For example, I'm 35, so this implies that about 75% of my investment dollars should be in stocks. If you follow this guideline, then your portfolio will grow more conservative as you approach retirement. It's also important to mention that stock-based mutual funds and ETFs are totally fine if you don't feel comfortable picking individual stocks.
The point is that when investing in stocks, volatility is to be expected. In any given year, it wouldn't be out of the ordinary for the stock market to drop by 10% or more. However, over long periods of time, stocks have delivered better returns than any other asset class.
Finally, it's important to remember that your investment dollars will never have more long-term growth potential than they do right now, regardless of what the market does this month or year. If you're 25, based on a historically conservative 7% annual growth rate, you only need to invest $5,000 per year ($417 per month) to retire as a millionaire at age 65. If you wait until 35, then you'll have to save $15,800 per year, or $1,318 per month, to retire in the millionaire club.
The best IRA investing advice I can give you is to invest as much as you can, as early as you can. Time is the most powerful weapon in your investing arsenal.
The $15,834 Social Security bonus most retirees completely overlook If you're like most Americans, you're a few years (or more) behind on your retirement savings. But a handful of little-known "Social Security secrets" could help ensure a boost in your retirement income. For example: one easy trick could pay you as much as $15,834 more... each year! Once you learn how to maximize your Social Security benefits, we think you could retire confidently with the peace of mind we're all after.Simply click here to discover how to learn more about these strategies.
Matthew Frankel owns shares of Apple and Berkshire Hathaway (B shares). The Motley Fool owns shares of and recommends Apple and Berkshire Hathaway (B shares). The Motley Fool has the following options: long January 2018 $90 calls on Apple and short January 2018 $95 calls on Apple. The Motley Fool has a disclosure policy.