An individual retirement account can be an excellent way to boost your retirement savings, especially if you don't have a workplace retirement account or have already maxed out your employer-sponsored 401(k) plan. But there are so many options available that deciding where to open your first IRA can be overwhelming. You need to decide how you want to invest the money as well as where to open the IRA. Here's a guide to setting up your first IRA.
How to invest your IRA funds. Your first decision isn't where to invest, but how. There are many options available, depending on how safe or risky you want your investments to be and how involved you want to be in managing the account. Here are the main options for IRA investments, and the pros and cons of each:
- Stocks. Stocks are often what first comes to mind when people think of investing. These are an ownership stake in companies. Stocks are typically considered a high risk but high reward investment, and they're likely to be a large part of your investment plan until you near retirement and need more stability.
- Mutual funds. Mutual funds are basically "buckets" of stocks, bonds and other investments. Diversification can help protect you from investment losses, and when you invest in a mutual fund, you get built-in variety. Some mutual funds hold a single type of asset, such as a specific type of stocks, while others are a blend of various types of investments including many different industries.
- Exchange-traded funds. An ETF is sort of like a mutual fund, but instead of being a "basket" of various investments, it's an investment that tracks certain bonds, a commodity or an index.
- Certificates of deposit. If your main goal is to save and not lose money, a certificate of deposit may be your best bet. CDs are from banks, and they have a set interest rate for a certain amount of time (usually months or years). CDs are a very low risk investment, but also earn a very low interest rate.
- Bonds. When you buy a bond, you're basically making a loan to a government or corporation. Bonds can be high risk and high reward or relatively low risk and lower reward, and are rated according to the borrower's credit rating. Bonds from higher rated companies and governments typically have a lower interest rate but are less risky.
A diversified retirement plan could include a variety of these types of investments. Typically, you'll want to invest in more high risk and high reward investments, such as stocks, in your early investing days, and then you may want to shift into lower risk investments as you near retirement age.
What to look for in an IRA. Once you determine what type of investing you would like to do, then you can decide where to open an IRA. Not all investment firms are created equal. You should investigate several IRA options to determine which will work best for you.
The main things to consider when looking into IRAs are costs and investment options. Some IRAs are surprisingly costly, and high fees will steadily erode your savings and investment returns over the years. Paying high fees can put your retirement plans in jeopardy, because you miss out on the compounding interest that would otherwise work its magic on your retirement savings. So be sure that you understand all the fees associated with a potential IRA investment, and compare fees between companies before you decide.
Another important point to consider is the type of investments that will be available to you. Generally, brokers make it easy to invest in stocks and ETFs, while automated investing services will do most of the work of picking stocks and bonds for you. Other options include banks, where you will be able to invest in CDs, and mutual fund companies, which obviously specialize in mutual funds and, increasingly, ETFs. Here are seven options for your first IRA:
E*Trade. E*Trade is a brokerage service you can use to invest in stocks, bonds and mutual funds. Since it has no account minimum, you don't have to have a lot of cash on hand to open an account. E*Trade can be a good option if you want to invest on your own and have ultimate control over where your money is invested. However, E*Trade discourages short-term trading, and you could incur a $49.99 early redemption fee on funds held less than 90 days. This type of account may work best for long-term stock and mutual fund investors.
TD Ameritrade. This is an online broker with no account minimum, which you can use to access over a hundred commission-free ETFs. However, there are trading fees, so this account might be a good fit for low-frequency traders and long-term mutual fund investors.
Betterment. This is an online automated investment service with no minimum deposit. When you start an account with Betterment, you'll go through their quiz to determine your current risk tolerance. Betterment will automatically build a portfolio made up of ETFs. You can make your own choices, or rely on its software to balance your portfolio for you. They also offer lots of tools to track your investments.
Ally. This bank operates exclusively online, and is thus able to offer low fees and competitive interest rates. Ally's high-yield CD currently offers a 1.2 annual percentage yield on an 18-month investment of less than $5,000. And if you have $25,000 or more to invest, you can boost your interest rate to 1.3 percent. That's still not a huge return on your investment, but it's not bad for an 18-month certificate of deposit at the moment.
Wealthfront. This automated investing service determines your risk tolerance and then creates a balanced portfolio for you. It offers options in real estate investment trusts, ETFs and commodities. Wealthfront has a $500 minimum deposit requirement, so you will need some money saved up to use this option.
Vanguard. Vanguard is a huge mutual fund company, so it can offer low fees and easy investing options such as target-date funds, which automatically adjust your risk as you near retirement. For example, if you have at least $1,000 on hand to start with, you can invest in the STAR Fund, which has a relatively low expense ratio of 0.34 percent. The STAR Fund is invested in about 60 percent stocks, which can make it a good long-term, high-yield investment if the stocks do well.
TradeKing. If you're looking to do some high-frequency trading, check out an account with TradeKing. It has relatively low stock and options trading fees, making it an affordable option for those who want to trade on a regular basis without triggering high costs. TradeKing doesn't provide a lot of support, so plan to do research on your own. You can access their trader network to see what decisions others are making with their money, which may help guide your thinking. However, investing exclusively in a high-frequency trading option is risky, and there's a significant possibility that you will lose money, especially if you are not very experienced. But you could put some of your money into this type of account just to give it a try.
The first step in deciding between these options and others that you research online is to inform yourself about the types of investments that are available to you. Then, choose a place to open your first IRA and get started.
