Individual retirement accounts (IRAs) are a popular way to save for retirement because they offer tax advantages and the ability to invest in a wide range of assets with varying degrees of risk. Let's take a look at the most commonly held investments in IRAs.
- Low-risk investments commonly found in IRAs include CDs, Treasury bills, U.S. savings bonds, and money market funds.
- Higher-risk investments include mutual funds, exchange-traded funds (ETFs), stocks, and bonds.
- Mutual funds, in particular, are a popular choice for IRAs because of the diversification they offer.
Savings Accounts and CDs
Savings accounts are the safest and most liquid investment next to cash. They currently pay very little interest—on average, only 0.06% in April 2021. Most, but not all, are protected by the Federal Deposit Insurance Corporation (FDIC).
Certificates of deposit (CDs) are also very safe and, like savings accounts, are protected by the FDIC up to $250,000 as long as the financial institution is a member firm. Funds in CDs are usually locked in for an amount of time ranging from three months to several years. CDs typically pay higher interest than a savings account.
Treasury Bills and U.S. Savings Bonds
Next to cash, U.S. Treasury bills are the world standard for liquidity and safety. Their biggest drawback for individuals is their high cost to purchase individually.
U.S. savings bonds are also considered to be low-risk investments. They are offered directly from the U.S. Treasury, but they are not FDIC insured because they are owned directly and backed by the full financial strength of the U.S. government.
Money Market Funds and Accounts
Money market funds and accounts are also very low risk. Money market funds invest in low-risk, liquid securities, such as cash, cash equivalent securities, CDs, and U.S. Treasuries.
Money market accounts typically pay higher interest rates than regular savings accounts. Unlike savings accounts, they often include check-writing privileges and a debit card. Some, but not all, are protected by the FDIC.
Mutual Funds and ETFs
Mutual funds and, increasingly, exchange-traded funds (ETFs) are popular investments found in IRAs and other retirement accounts. This is due in large part to the diversification they provide. These funds also offer the potential for higher returns than CDs, Treasury bills, U.S. savings bonds, and money market funds. The trade-off is that they also come with higher risk.
Actively managed mutual funds pool investors' capital and hire professional managers to invest in stocks, bonds, and other investments. Index funds are a type of mutual fund that aims to replicate the performance of stock indices, such as the Standard & Poor's 500, and are passively managed.
Investments in funds, bonds, and stocks are not insured by the FDIC.
ETFs are similar to index funds in that they can track an underlying index. They can also track a commodity, sector, or other assets. But unlike mutual funds, ETFs trade like stocks. Shares trade on a stock exchange, and investors can buy and sell them throughout the trading day.
A bond is a debt obligation that matures on a certain date. Corporate bonds represent a loan made by the investor to a corporation. They also pay interest in the form of coupon payments at a stipulated rate. Agencies, such as Moody's and Standard & Poor's, provide ratings on bonds. Bonds are traded worldwide, and it is possible to lose money in them.
Stocks (also known as equities) are risky and require research, but may offer the most potential reward. They are bought and sold on stock exchanges and represent the investor's ownership of a fraction of a company. Corporations sell stocks to investors in order to raise money to fund their operations. By purchasing stocks, investors may be eligible for a portion of the company's earnings if and when the company issues dividends. Investors can also opt to sell their stocks for a profit should the price of the stock increase.
Dean St. Marie, CFP®, AAMS
St. Marie Financial Advisors LLC, Brevard, N.C.
The most common IRA investments tend to be mutual funds, which are popular for the broad diversification benefits they offer. For example, buying a mutual fund invested in Brazilian stocks would allow you to own just about every listed company in Brazil, which would be difficult to do otherwise.
Another common investment is individual stocks, which offer greater returns than mutual funds if the investment does well, but at the expense of higher risks and lower diversification. Individual stocks usually make more sense as an IRA investment when you have a larger account and can buy shares in many different companies.
Other investment choices can include rental real estate, precious metals, and private placements, but these are typically for more sophisticated investors.