If you've read The College Student's Guide to Investing, you know that an IRA is a great way to get started investing. And, you may have seen the 5 Worst IRA Mistakes Made Everyday. Today, I want to talk about the best ways to maximize your potential return in your IRA.
First, it is important to remember that an IRA is tax deferred. As such, any growth or income you have in the account is tax free until you take it out of the account. And, in the case of a Roth IRA, it is tax free upon withdraw as well.
Remember Your Time Frame
The first thing to consider with your IRA (and all investment accounts) is your time frame. If you have more than 10 years to go, you may want to consider investing in high growth investments such as stocks. If you don't have much time until retirement, you should stick with bonds.
What is the Best Investment Choice for an IRA?
Given that IRAs are tax deferred, you may think investments such as bonds would be the best choice because they pay regular dividends (which would normally be taxable). However, dividend paying stocks are actually the best choice for an IRA. Why? Because not only do these stocks pay regular dividends that would normally be taxed, they also have a history of growth. Thanks to the power of compounding, the return from dividend investing can actually generate a much higher tax burden over longer terms.
You Can Also Go With More Aggressive Funds
If you are investing for the long haul, you can also invest in more aggressive funds. These could be domestic or international stock funds, or even emerging market funds. These types of aggressive funds tend to buy and sell a lot of stocks throughout the year (measured by turnover). In fact, some of the most aggressive funds have turnover in excess of 250%. If you owned this type of high-turnover fund outside of a tax sheltered account, you could face a high tax bill. However, gains for this fund in an IRA would be tax deferred.
Some other types of aggressive investments that make good IRA candidates include REITs (Real-Estate Investment Trusts) and commodity funds.
Keep The Tax Deferred Out Of Your IRA
Finally, keep the tax deferred investments out of your IRA – save those for your regular account. Some examples of tax deferred investments are municipal bonds and annuities. Since the IRA itself is tax deferred, there is no reason to double-up on the tax deferral.
Readers: Do you have any other tips to maximize your IRA potential?