The individual retirement account (known as the IRA) was created to allow people to stash away money for retirement on a tax-favorable basis. There is a variety of IRA’s; some are specifically for individuals and others serve business owners. From banks to mutual fund companies to brokerage firms, numerous financial institutions will allow you to open such an account. Most people might not be aware of this but there is a huge difference between a bank IRA and a brokerage IRA.
Bank IRA’s are a great place to put your retirement dollars if you are looking for safety and security. Such accounts will utilize certificates of deposits (CD’s) or other safe options like money market funds to invest your dollars. You can be assured that by having your money here, you will not lose a cent. Plus, having your funds placed there allows them to be protected by the Federal Deposit Insurance Corporation (FDIC). Some banks may offer riskier options, like mutual funds (which are not covered by the FDIC), but the safe options are primarily what you will typically see. This doesn’t seem like a big deal on the surface; however, playing it too safe with your retirement dollars could hurt you in the long run. By their very nature, banking solutions are low-yielding; thus, this will subject you to purchasing power (your dollar today won’t be worth much in the future) risk over time due to inflation. IRA’s were designed to be utilized as a long-term financial instrument, which means it isn’t wise to use CDs or money markets (which are more geared towards short-term goals) to fund your retirement. A bank IRA makes perfect sense if you are within a couple of years of retirement because you can’t afford to be too risky only since you don’t have enough time to make up any losses. Or, if you don’t have the appetite to take any substantial risk with your money, this option is also appropriate.
The brokerage IRA enables you to purchase securities… stocks, bonds, mutual funds, exchange-traded funds (ETF’s), etc. However, by purchasing securities, you are adding more risk to the equation. Unlike the bank IRA, you could lose some of your initial investment and you will see your account balance fluctuate over time. This usually scares people but have you ever thought about your retirement account in this manner. What if retirement is 10/20/30 years away, and the market is down and as a result, so is your account balance. If you’re not at retirement age, meaning you do not need these funds, then you have only “lost” on paper. Why exactly are you worried? Most people don’t have an excellent response to that; thus, we need to change the way we think about short-term news concerning our long-term accounts.
No one individual has control over the stock market, but over the long-haul, having money in the stock market can be extremely rewarding for your brokerage IRA. The neat thing about the brokerage IRA is that you can invest in a money market type of fund, along with the other riskier solutions. The one thing you want to avoid is having a brokerage IRA open and ONLY having money market funds within it. This happens quite often because people will rollover funds from an old 401k or 403b and the money will sit in a money market fund (which is the default), not being invested. Or, they will open a brokerage IRA, fund it, and never make a decision on what to invest in. Take full advantage of all your options within the brokerage IRA.