An IRA can be a great retirement tool, but make sure you don't use it to take unnecessary risks
Unlike a 401(k), your IRA allows you to invest in any stock, bond, or mutual fund you want, which allows you to construct a retirement portfolio that meets your exact needs. While it can be fun to choose your own stocks as opposed to choosing investment funds in a 401(k), many investors make the mistake of taking on too much risk in their IRA. Here's a quick discussion of the risk (or lack thereof) that comes with choosing IRA stocks, and how much is too much.
Younger investors can afford to take more risk
It's a generally accepted rule that younger investors can take more risk than older investors. After all, if a recession takes a bite out of a 30 year old's portfolio, he or she has several decades to recoup those losses.
For this reason, older investors who rely on their portfolios for income should have more (but not all) of their portfolio in bonds, as these aren't as sensitive to economic issues as stocks and will produce a constant stream of income no matter what the market does. A good rule of thumb is to subtract your age from 110, and that is the percentage of your portfolio that should be in stocks. So, a 30 year old should have roughly 80% stocks and 20% bonds in their IRA. If you want to be a little more aggressive, subtract your age from 120.
And, the stocks in your IRA should meet some pretty distinct criteria, as I'll discuss a little later. However, older investors should stick to stocks that can perform well even if the market goes bad. For example, during 2008 the S&P lost nearly 38%. However, Wal-Martand Family Dollaractually gained for the year, as their business models allow them to thrive during difficult times.
Younger investors have a little bit of "wiggle room" here to invest in slightly riskier stocks that are vulnerable to recessions and crashes, but are generally considered to be good investments over the long run. However, in an IRA, "risk" is a relative term. Even the riskiest stocks that are appropriate for an IRA should look tame compared to stocks that are usually considered to be risky or speculative.
But, don't confuse "risk" with "gambling"
Even though younger investors can afford to take on more risk, there is a big difference between higher-risk investing and speculation or gambling.
As an example, let's look at the financial sector. Most would agree that an investment in US Bancorpis about as low-risk as it gets, as far as banks go. For those investors with a little more risk tolerance, investing in Bank of Americais a riskier investment than US Bancorp, but is still pretty safe. In other words, at least in my opinion, there is little chance of Bank of America going bankrupt or taking another massive hit, especially with the tougher bank regulations of today.
However, an investment in Fannie Mae is not much different than purchasing a lottery ticket. While it could pay off handsomely, there is an extremely high probability that Fannie Mae's shareholders will get wiped out completely. An investment like this is far too speculative to include in a retirement portfolio.
Just to give you a general idea of what I mean, here is an example of a low-risk stock from certain sectors, along with a riskier and a speculative example.
| Sector | Safe, low risk | Higher, but IRA-acceptable risk | Speculation/Gambling |
| Energy | ExxonMobil | BP | Petrobras |
| Healthcare | Johnson & Johnson | Celgene | Amarin |
| Consumer goods | Wal-Mart | Dick's Sporting Goods | Aeropostale |
| Technology | Microsoft | Facebook | Zynga |
| Industrials/Materials | Caterpillar | Alcoa | AK Steel |
Now, I'm not saying that you should never speculate. If you truly believe that Fannie Mae will eventually return 10 times your original investment, go for it. Just don't do it with money you can't afford to lose, and the savings in your IRA is definitely in this category.
The right kind of IRA stocks
To find stocks that can work great in an IRA, there are a few things you should look for
- It must have an acceptable track record of revenue growth and profitability
- It should not have any realistic chance of bankruptcy anytime in the foreseeable future
- The company shouldn't have a high debt load
- It should be in a business that works in both good times and bad. For example, manufacturers of luxury items tend to get crushed when the economy goes bad
This is by no means an exhaustive list, but a little research will show you that all of the stocks in the "safe" column above definitely meet all of these requirements. For more examples of great retirement stocks, you can read this article.
As a final thought, keep in mind that with an IRA, it's better to err on the side of caution. After all, it's better to end up with less money that you could have made than to end up with less than you started with as a result of taking on too much risk.
Matthew Frankel owns shares of Bank of America, Caterpillar,, and Petroleo Brasileiro S.A. (ADR). The Motley Fool recommends Bank of America, Celgene, Facebook, and Johnson & Johnson. The Motley Fool owns shares of Bank of America, ExxonMobil, Facebook, and Johnson & Johnson. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
FAQs
Younger investors can afford to take more risk
A good rule of thumb is to subtract your age from 110, and that is the percentage of your portfolio that should be in stocks. So, a 30 year old should have roughly 80% stocks and 20% bonds in their IRA.
What is the rule of 72 Motley Fool? ›
Let's say that you start with the time frame in mind, hoping an investment will double in value over the next 10 years. Applying the Rule of 72, you simply divide 72 by 10. This says the investment will need to go up 7.2% annually to double in 10 years. You could also start with your expected rate of return in mind.
How aggressive should I be with my IRA? ›
Being too aggressive could be risky as you have less time to recover from a market downturn. As a general rule, in the absence of changes to risk tolerance or financial situation, one's asset mix should become progressively more conservative as the investment horizon shortens.
How much of my portfolio should be risky? ›
Most sources cite a low-risk portfolio as being made up of 15-40% equities. Medium risk ranges from 40-60%. High risk is generally from 70% upwards. In all cases, the remainder of the portfolio is made up of lower-risk asset classes such as bonds, money market funds, property funds and cash.
Can I lose my IRA if the market crashes? ›
It is possible to lose money in a Roth IRA depending on the investments chosen. Roth IRAs are not 100% safe, but they offer the potential for growth over time. Market fluctuations and early withdrawal penalties can cause a Roth IRA to lose money.
How much investment risk should I take? ›
In general, the higher the return needed, the more potential risk you'll have to take. Sometimes there is a gap between how much risk you're comfortable taking and how much you may need to take to achieve your goals.
What is the 4% rule Motley Fool? ›
It states that you can comfortably withdraw 4% of your savings in your first year of retirement and adjust that amount for inflation for every subsequent year without risking running out of money for at least 30 years.
How to double your money in 3 years? ›
The classic approach to doubling your money is investing in a diversified portfolio of stocks and bonds, which is likely the best option for most investors. Investing to double your money can be done safely over several years, but there's a greater risk of losing most or all your money when you're impatient.
What will double my money in 10 years? ›
The formula for the rule of 72
This being a formula, it works in the opposite direction, too: You can figure the compound rate of return required to double your money in a certain time frame. For instance, to double your money in 10 years, the compound rate of return would have to be 7.2%.
At what age should you stop investing in an IRA? ›
Roth IRAs: Like their traditional counterpart, there is no age limit of Roth IRA contributions. So long as you or your spouse earns income, you can continue to make contributions indefinitely.
For tax year 2024, single and head-of-household filers with MAGIs of $146,000 to $161,000 can contribute only limited amounts. The income phaseout range for married couples filing jointly is $230,000 to $240,000. Taxpayers with incomes above those top numbers cannot contribute anything to a Roth IRA.
What is the downside of a IRA? ›
IRA drawbacks
One drawback of using IRAs to save for retirement is that the annual contribution limits are relatively low. In 2024, you can contribute up to $23,000 to a 401(k) plan, but you can only contribute $7,000 to an IRA in 2024 unless you're at least 50 years old, in which case the limit is $8,000.
What is the 5% portfolio rule? ›
This is a rule that aims to aid diversification in an investment portfolio. It states that one should not hold more than 5% of the total value of the portfolio in a single security.
At what age should you stop investing aggressively? ›
The 50s and 60s: Almost There
Those close to retirement may switch some of their investments from more aggressive stocks or funds to more stable, low-earning funds like bonds and money markets. Now is also the time to take note of all investments and estimate a timeline for retirement.
What is the 80 20 rule investment portfolio? ›
In investing, the 80-20 rule generally holds that 20% of the holdings in a portfolio are responsible for 80% of the portfolio's growth. On the flip side, 20% of a portfolio's holdings could be responsible for 80% of its losses.
How safe is your money in an IRA? ›
Safety and security
Also, like regular IRAs, IRA CDs are federally insured up to $250,000 per depositor, per institution as long as you open one with an FDIC-insured bank or NCUA-insured credit union. This means your money is safe in the unlikely event the financial institution goes under.
Is there a downside to an IRA? ›
IRA drawbacks
One drawback of using IRAs to save for retirement is that the annual contribution limits are relatively low. In 2024, you can contribute up to $23,000 to a 401(k) plan, but you can only contribute $7,000 to an IRA in 2024 unless you're at least 50 years old, in which case the limit is $8,000.
What is a good amount to have in your IRA? ›
By age 35, aim to save one to one-and-a-half times your current salary for retirement. By age 50, that goal is three-and-a-half to six times your salary. By age 60, your retirement savings goal may be six to 11-times your salary. Ranges increase with age to account for a wide variety of incomes and situations.
What is a good rate for an IRA? ›
Best IRA CD Rates
- Connexus Credit Union IRA Share Certificates: 3.41% to 5.15% APY.
- Lafayette Federal Credit Union IRA Fixed-Rate Certificate: 4.32% to 5.04% APY.
- Consumers Credit Union IRA CDs: 0.50% to 5.00% APY.
- NASA Federal Credit Union IRA CD: 3.75% to 4.99% APY.
- Delta Community Credit Union IRA CDs: 3.85% to 4.95% APY.
