The Best Way to Invest in a Roth IRA
A Roth IRA is an easy way to save for retirement and have the withdrawals be tax free. The trade-off for having a tax-free withdrawals in retirement is that you have to pay taxes on your contributions to a Roth IRA. With a traditional IRA, your contributions are tax-deductible up to certain limits, but you pay taxes upon making withdrawals in retirement. Many people find the trade off worth it and open Roth IRAs.
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Low Maintenance
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Many people choose to have their Roth IRA invested in mutual funds. By doing so, the account is diversified and enjoys the benefits of professional management. The management comes with a fee, however, and fees are deducted from the mutual fund returns. The higher the maintenance fee, the higher the returns the fund needs to generate in order to make a good overall return.
Dollar-Cost Averaging
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Dollar-cost averaging investing buys more when the mutual fund is low and buys less when the fund is high. You simply set up your mutual funds to invest a set amount each month. If you are investing $300 a month when the mutual fund shares are $30, your purchase will get you 10 shares. When the fund is $40, you'll get 7.5 shares. However, at this point, you have 17.5 shares worth $35 a share or $612.50 instead of $600. Dollar-cost averaging averages out your risk and cost over time.
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Avoid Tax-Free Securities
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Investing in tax-free securities provides no benefit because your investment is already tax free. In fact, they can reduce your returns because tax-free securities typically have a lower rate of return than taxable securities.
Diversify
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Many mutual funds are designed to be diversified among stocks, bonds and cash, as well as the type of stocks they invest in. However, you are still putting all your eggs in one basket. You may want to add additional investments that support your main investment. IRAs allow you to invest in individual stocks, bonds and precious metals, too. You also can find mutual finds that target specific industries.
Shift to Cash Near Retirement
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You'll always want a portion of your portfolio in stocks as an inflation hedge, but to reduce risk you should begin shifting more of it into bonds and cash assets as you near retirement age. The rule of thumb is use your age as the percentage of your portfolio that should be in bonds and cash assets.
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