How to Choose IRA Investments: A Beginner's Guide

Individual retirement accounts, or IRAs, can play a powerful role in any retirement savings strategy. In addition to their tax benefits and accessibility, both traditional and Roth IRAs offer a great deal of flexibility.

However, knowing how to invest in an IRA requires a clear understanding of your personal risk tolerance and ideal asset allocation. Here's how to choose IRA investments that support your retirement savings goals.

Open an IRA

If you have a solid understanding of how IRAs work, your first step will be to open an account. Unlike employer-sponsored retirement plans, IRAs are available to virtually anyone, as long as you or your spouse has earned some amount of taxable income during the year.

The process of opening an IRA is relatively straightforward and you have the freedom to choose where you open your account. As you compare IRA providers, think carefully about how hands-on you'd like to be. Be sure to pay close attention to account minimums and fees.

Next, you'll need to choose between a traditional or Roth IRA. Each option offers unique tax benefits and has different IRS rules regarding eligibility. Learning more about the differences between a Roth versus traditional IRA can help you determine which option is right for you.

Once you've opened and funded your account, you'll need to develop an IRA investment strategy. If you have a professionally managed IRA, a financial advisor will personally select and manage investments on your behalf. However, if you're using a self-managed investing platform or robo-advisor, you'll have the freedom to select investments based on your personal risk tolerance and retirement goals.

Understand your risk tolerance

Investment risk tolerance refers to how willing you are to tolerate market fluctuations and potential losses in pursuit of higher returns. Factors that may influence your risk tolerance include your age, income level, financial obligations and overall financial stability.

Generally speaking, younger investors can afford to take on more risk, as they have more time to recover from market downturns before they reach retirement. Conversely, individuals who are closer to retirement may prefer a more conservative approach to protect their savings.

To assess your risk tolerance, reflect on how you view market fluctuations. Would you feel the urge to sell your investments when the market slumps, or are you comfortable giving your holdings time to recover any losses? Taking a risk-profiling evaluation or talking with a financial advisor may help clarify what level of risk you're willing to accept.

Determine your asset allocation

Asset allocation is another factor that may help determine the best investments for an IRA. It refers to the mix of investments—in other words, the percentage of stocks, bonds and other assets—you hold in your portfolio. This is important to your overall IRA investment strategy because some investments, like stocks, are considered riskier than others. Here are some investing options that may be available to you, depending on where you open your account.

Lower-risk investments

• IRA certificates of deposit, or CDs: Similar to regular CDs, these offer a fixed interest rate and FDIC insurance, making them a low-risk option.
• Treasury bills: Maturing in 1 year or less, these short-term government securities offer low-but-guaranteed returns.
• US savings bonds: Backed by the government, US savings bonds earn interest over a set period, typically 20 or 30 years.
• Money market funds: These mutual funds invest in short-term, low-risk securities like Treasury bills and commercial debt.

Higher-risk investments

• Mutual funds: These are professionally managed investments that combine money from many investors to buy a diversified mix of stocks, bonds or other securities. Mutual funds come in many shapes and sizes, which can help investors achieve various goals—such as growth, income or a combination of both—depending on the fund's investment strategy and the investor's risk tolerance.
• Exchange-traded funds, or ETFs: While similar to mutual funds, ETFs are traded on stock exchanges, offering greater flexibility and often lower fees. Several low-cost ETFs track various indexes like the S&P 500.
• Individual stocks and bonds: While these offer higher potential returns, they also carry more risk and may be appropriate for experienced investors who have the time and knowledge to research and monitor their investments.

How should I allocate my IRA?

A common guideline is to subtract your age from 100—or 110 for a more aggressive approach. That number represents the percentage of your portfolio you may want to invest in stocks, with the rest invested in less risky options like bonds and savings accounts.

For example, based on this calculation, a 30-year-old investor might allocate 70% of their IRA investments to stocks and 30% to bonds, whereas a 60-year-old investor may opt for a 40/60 stocks-to-bonds split. As you near retirement, gradually shifting toward a more conservative mix can help shield your savings from market volatility.

Target-date funds

For investors who prefer a more hands-off approach, target-date funds may be a good choice. These mutual funds automatically adjust their asset allocation over time, becoming more conservative as you near your target retirement date. However, while target-date funds may simplify the investment process, it's essential to review particular holdings and fees to ensure they align with your goals and preferences.

Finalizing your IRA allocation strategy

While general guidelines may help you choose IRA investments, the specific asset mix in your IRA should be tailored to your individual circumstances. For example, if you have a pension or another source of stable retirement income, you may be able to maintain a more aggressive investment mix. Conversely, if you have a lower risk tolerance or anticipate significant expenses in retirement, a more conservative approach may be appropriate.

Diversify your investments

No matter your risk tolerance, diversifying your IRA investments is essential. Allocating your investments across many different asset classes or sectors may help you reduce the overall volatility of your investments and stabilize your returns over time.

How do I diversify my IRA investments?

Diversifying your IRA investments is fairly straightforward—rather than putting all of your eggs into a single basket and investing in one stock, asset class, sector or geography, you spread your money across various investments. For example, a well-diversified IRA might include a mix of domestic and international stocks, bonds with varying maturities and credit qualities, and possibly even a small portion of alternative investments such as real estate or private equity. Regularly rebalancing your portfolio to maintain your target asset allocation can further enhance the benefits of diversification.

The bottom line

It's important to remember that investing always involves some level of risk, and past performance doesn't guarantee future results. However, by understanding the various IRA investment options available and the importance of diversification, you can build a portfolio that supports your long-term retirement savings objectives.

If you're new to investing in an IRA, you may find it helpful to work with a financial advisor to develop a personalized retirement strategy that's tailored to your goals and risk tolerance.