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By Sam Swenson, CFA, CPA | The Motley Fool
Investing in an IRA is one of the most basic things you can do to ensure a comfortable retirement, but it's also one of the easiest to mess up if you aren't aware of the underlying mechanics. You have many options when it comes to IRAs, so it's a good idea to create a plan in advance and carry out the plan as intended.
Here, we'll discuss four scary IRA mistakes you're liable to make - especially if you're just starting out.
1. Failing to invest the money
Investing in an IRA involves two steps: contributing money and then investing it. As a fee-only financial planner, I commonly see investors contribute money to an IRA and then move on with their lives. Having IRA money sitting in cash does nothing to further your retirement goals, so it's imperative that you take the time to ensure it's properly invested in accordance with your overall asset allocation.
This all goes to say that an IRA is an account, or a "bucket"; it's not an investment in and of itself. The investments come after you've contributed money. Be sure to always complete both steps -- contribute and invest -- before moving on to other accounts.
2. Missing out on Roth contributions
Roth IRAs stand to be one of the most -- if not the most -- effective retirement planning tools that most investors can access. If you fall within the income eligibility limits, which in 2021 end at just over $200,000 of annual household income, you'll be eligible to contribute directly to a Roth IRA.
Roth IRAs are unique in that they're the only tax-exempt retirement vehicle available outside common employment relationships. You'll have to have some earned income to contribute, but if you do, you'll be able to invest, earn investment income, and withdraw money tax-free.
While the financial benefits of the Roth IRA are apparent, there is also a substantial psychological benefit to owning a Roth IRA throughout your working life. Roth money (assuming the account has been open for five years) is entirely tax-free for the rest of your life. This, combined with the looming threat of higher future tax rates, makes the Roth IRA a no-brainer for anyone who is eligible.
3. Forgetting to look at costs
Keeping your IRA -- as well as the investments within your IRA -- as inexpensive as possible is a crucial element to long-term investing success. Many companies charge unnecessary administrative fees, trading commissions, and management expenses. As an astute investor, it's in your best interests to avoid these fees, particularly if they're small and recurring. These are the ones that tend to get lost in the shuffle but end up having an outsized effect on your long-term returns.
Costs also tend to bite the hardest within actively managed mutual funds or other frivolously expensive investments. This is why it's absolutely imperative that you check the expense ratio for any investment product you hold. Costs and quality most certainly do not go hand-in-hand when it comes to picking investment products, so be diligent to reduce your investment costs to only the bare minimum.
4. Not seeing the bigger picture
Remember: Your IRA, Roth, or other retirement account is a slice of your financial pie. It's best to view your retirement accounts as pieces of a wider puzzle as opposed to single accounts on their own. This will help you manage the amount of total risk you're taking as well as assist you in the tax management of your portfolio.
Many investors want to know how they should invest their IRAs. This is of course a valid question, but it has to come against the background of their total financial picture. A person who has an asset allocation of 100% stocks might invest their IRA differently from someone holding 100% cash.
No two people are exactly the same, so no one-size-fits-all answer will suffice. Take the time to figure out the best solution for your particular situation.
Read more: How many IRA accounts can you have?
Fright is unnecessary
The beauty of sound IRA investing is that it's really very simple, but it requires that you get the fundamentals right. Always ensure that you're investing the money you contribute, taking advantage of a Roth IRA if it's available to you, monitoring costs, and seeing the big picture. By checking off these steps, you'll be putting yourself on a path to a financially successful retirement.
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