Make the right investments in your IRA.
Choosing investments for your Individual Retirement Account (IRA) depends on your financial goals, risk tolerance, and time horizon. For beginners, investing in diversified, low-cost index funds and Exchange-Traded Funds (ETFs) is often the simplest and most effective strategy. In general, the IRA allows for a wide range of investment options, including stocks, bonds, mutual funds, and ETFs
Before you choose: Define your strategy
Before you begin selecting specific investments, you need to define your overall strategy.
- Determine your risk tolerance: This is how comfortable you are with fluctuations in your investments. With a long time horizon (decades until retirement), you can afford to take on more risk with stocks for higher growth potential. If you are closer to retirement, you might prefer more conservative investments like bonds for stability.
- Decide on your time horizon: This is the length of time you have until you plan to use the money. Because an IRA is a long-term retirement account, it’s generally best suited for long-term, buy-and-hold strategies.
- Balance growth and income: Most IRA portfolios require a mix of growth-oriented assets (like stocks) and income-generating assets (like bonds) to provide both long-term growth and stability.
Investment options for your IRA
Mutual Funds and ETFs
For most IRA investors, especially beginners, mutual funds and ETFs are the best way to get started. They allow you to hold a diverse portfolio of hundreds or thousands of stocks or bonds with a single purchase.
| Investment Type | How it Works | Pros | Cons |
|---|---|---|---|
| Mutual Fund | Pools money from many investors to invest in a professionally managed portfolio. | Provides instant diversification and professional management. Some funds automatically rebalance your portfolio for you, like target-date funds. | Can have higher expense ratios (fees) and often underperform market-tracking funds. |
| Index Fund | A type of mutual fund that passively tracks a specific market index, such as the S&P 500. | Extremely low costs because it doesn’t require active management. Offers broad market diversification. | Performance is limited to that of the index it tracks. |
| Exchange-Traded Fund (ETF) | Similar to a mutual fund, but it trades on an exchange throughout the day like a stock. Most are passively managed to track an index. | Generally has very low expense ratios and can be more tax-efficient in taxable accounts (though this is less of a factor in a tax-advantaged IRA). | Can have trading commissions, though many brokerages have eliminated this. |
Individual Stocks and Bonds
For more experienced investors, holding individual stocks and bonds can also be an option within an IRA.
- Individual Stocks: Offer potentially higher returns but with greater volatility and risk, as your money is concentrated in a single company. Requires more active research and management.
- Bonds: Generally less volatile than stocks, providing a more stable source of income. Lower-risk investments like bonds are often better for goals with a shorter time horizon.
Building a diversified portfolio
The “three-fund portfolio” is a popular and straightforward approach for IRA investing. It uses just three core index funds or ETFs to create a globally diversified portfolio:
- A U.S. total stock market fund.
- An international total stock market fund.
- A U.S. total bond market fund.
The “Rule of 110” is a general guideline for determining your asset allocation. Subtract your age from 110 to get the approximate percentage of your portfolio that should be invested in stocks, with the rest in bonds. For example, if you’re 30, you might aim for 80% stocks and 20% bonds.
Next steps to get started
- Choose a brokerage: Decide where to open your IRA (e.g., Fidelity, Schwab, Vanguard).
- Define your allocation: Decide on your ideal mix of stocks and bonds based on your risk tolerance and time horizon.
- Choose your investments: Select your funds or ETFs, focusing on low-cost index funds for broad diversification.
- Start investing: Begin making regular contributions. You can set up automatic investments to maintain a consistent savings schedule.
