An IRA can hold many types of investments, including stocks. Target-date funds based on your year of retirement offer targeted rebalancing and diversification as you get closer.
Bonds that generate regular cash flows such as interest payments or capital gains make an excellent addition to an IRA, although seven Morningstar categories of bonds have negative 10-year aftertax returns.
Stocks
IRAs provide tax-deferred growth of investments held within them, which means stocks can accumulate without incurring current taxes as long as their owner doesn’t withdraw them before reaching retirement age. Thus, stocks tend to be the preferred investment choice among IRA investors.
Mutual and exchange-traded funds (ETFs) that track broad market indexes can make excellent additions to IRA accounts, since they generate dividend income and capital gains throughout the year. Furthermore, such investments provide investors with additional core market exposure should their taxable accounts contain too many peripheral shares.
Young investors in particular may prefer focusing heavily on stock investments at first. With more time before retirement and market fluctuations to contend with, investing heavily could result in substantial investment gains. If seeking less risky and cost-efficient options instead, Vanguard Dividend Growth VDIGX and First Eagle Overseas SGOVX may provide suitable domestic equity strategies with reasonable costs and reasonable risk profiles.
Bonds
Bonds should not replace stocks in retirement accounts; rather, they should provide stability to a portfolio and act as an anchor against volatility.
Bond investments represent the promise of governments or companies to return any money you lend them with interest, typically offering lower long-term returns and less volatility than stocks while providing steady sources of income.
As an investor, you have several investment options for bonds: individual, mutual funds or exchange-traded funds (ETFs). The main difference between them is that funds pool together many individual bonds into a basket for tax purposes; this affects your cost basis when selling your bond holdings.
Some investors utilize bond funds as part of an asset allocation strategy, particularly as they near retirement. It is essential to carefully consider your investment goals and risk tolerance prior to making this decision.
Taxes
IRAs typically offer lower fees and expenses than brokerage accounts, as well as access to a wider variety of investment options than many workplace retirement plans. Furthermore, depending on which broker or robo-advisor manages your account, different advice programs might also be provided.
Contrary to brokerage accounts, which have no annual contribution limits or penalties associated with withdrawals prior to age 59 1/2, Individual Retirement Accounts (IRAs) impose strict limits on how much can be contributed each year. Withdrawals prior to age 59 1/2 may incur taxes and penalties on withdrawal.
Investment in taxable accounts allows investors to avoid dividend taxes for years or decades until selling the stock or fund that pays dividends – although some investors intentionally hold stocks or funds that pay dividends within these taxable accounts, so that they may take advantage of tax write-offs (and then possibly repurchase them after 30 days). This strategy is known as “tax loss harvesting”, and works best when holding investments over an extended period.
Asset Allocation
An individual retirement account (IRA) allows investors to customize their investments according to their investment goals, risk tolerance and financial situation. A professional financial advisor can assist in structuring an asset allocation that will achieve your objectives while minimizing Uncle Sam’s take.
Investors have various ways of creating their portfolio. Individual stocks and bond funds can be purchased directly, while target date or asset allocation mutual or exchange-traded funds (ETFs) provide the added advantage of being managed over time to ensure an appropriate mix.
Target date funds that invest in domestic and international large-cap stocks automatically diversify by industry, market capitalization and geography – offering access to the best opportunities while meeting your long-term financial goal.
