Today I’m answering a question that was submitted by a reader of mine. It’s a pretty straightforward question actually:
“What is the best investment for me? And what is the best investment to put in my IRA?
Great question. So the first step in answering this question is to understand one simple fact: There is no single best investment out there that is suitable for everybody.
Watch video to learn more…
Risk Tolerance Plays a Huge Role
The reason this is so is because we are all different. So, one individual may feel completely comfortable having an investment with high volatility. What I mean by that is it has big upswings and downswings. But the individual is okay with that because he figures in the long-run it may grow very well for him.
However, another person may not like the volatility and couldn’t sleep at night with that kind of large gyrations in her portfolio. That individual may be much more comfortable with an investment that is less volatile with more steady growth and lower downside potential.
So the first thing to recognize is that everyone has a different level of risk tolerance. And the investments that are right for one individual’s portfolio may not be suitable for a different investor’s portfolio.
Time Horizon Must Be Considered
Secondly, we have to look at time horizon. If you don’t plan on touching the investment for a long time, then you can ride the ups and downs. If you know that you will need to spend the funds rather quickly, say in a year or two, then you probably don’t want to take too much risk and be exposed to all the potential volatility that goes along with it.
This is very important, especially if you are investing in the stock market. Consider just how far the S&P 500 can fall during a 12-month period. In fact from October 9th 2007 the S&P 500 sat at 1,565.15. By October 9th of 2008 it had fallen to 909.92. That’s a drop of 41% over a span of 12 months! So if you are investing in the stock market understand what your time horizon is on your investments. The sooner you need access to the funds the less risk you need to expose yourself to.
Lifetime Income Sources Cannot Be Ignored
Also, when determining the best ways to invest money, you must consider your income sources. Let’s look at 3 examples:
- The Pre-Retiree – If you are currently working, the money you live on is probably coming from your income. That means you are probably not relying on pulling funds from your portfolio to cover your living expense. Considering that, (and all other things being equal of course) you would probably feel more comfortable taking on more risk in your portfolio because you are not reliant on pulling money out of it to live on at the moment.
- The Retiree With Lots of Income – Let’s now picture a person who is retired but has plenty of lifetime income. This income could be in the form of Social Security benefits, a pension, or maybe an annuity. In short, this person is not relying on pulling money out of their investment portfolio to live on. Then, all other things being equal, that person would be in a better position to take more risk in their portfolio. And you know if you take more risk you do so because you are hoping to get a higher return on your portfolio.
- The Retiree With Limited Income – This is the category that most people fall in to. They are retired and have some lifetime income sources, like Social Security, pension, or maybe even an annuity. But the lifetime sources are not enough to cover their living expenses. That means they will probably pull money from their assets (such as an investment portfolio) on a regular basis to cover their expenses. Then all other things being equal, that person will want to be more conservative with her investments because she will have to sell them periodically to use the funds for her retirement needs.
What About The IRA?
Now we’ve laid that ground work, I will address the question with the IRA.
“What is the best investment to put in my IRA?”
Again, the best way to invest with your IRA is going to be dependent on a lot of the issues I mentioned above: What’s your risk tolerance, time horizon, income sources.
However, there is something to keep in mind with IRA’s. When an investment is inside an IRA it is tax deferred. You don’t pay taxes on it until you pull the funds out. So if you sell some shares of stock or perhaps of a mutual fund you may experience a capital gain. Well, you won’t have to pay capital gains taxes on that as long as you keep the funds inside the IRA.
So you could sell some shares of one stock and buy some shares of a different stock. If you had a capital gain you don’t have to worry about paying the capital gains tax. If you did this with a non-qualified money account (in other words, funds that are not tax sheltered), you may have to pay the capital gains tax. That would reduce the amount in that non-qualified account by whatever the tax was.
So if you pursue an investment strategy that involves a heavy amount of trading, you may want to reserve that strategy for your funds that sheltered in your IRA. This doesn’t mean you necessarily need to be trading all the time. And especially don’t day trade! Just because you have the benefit of tax deferral doesn’t mean you want to just trade without a strategy in mind.
But it is good to keep in mind this advantage with funds that are sitting in an IRA.
I hope that answers the question. Do you have a question about what is the best investment for yourself? Well, feel free to call me and I will help point you in the right direction.
Best of luck