For many people, an individual retirement account (IRA) is a cornerstone of their retirement plan. Like a 401(k), it allows people to save and invest their income to use as living expenses after they reach retirement age. IRAs can be funded directly. Alternatively, when you leave a job, you have the option of moving your 401(k) assets into an IRA, which is called a rollover.
An IRA is one important way to save for retirement, but you may have questions about how and where to invest your IRA assets. The IRA is a financial instrument, but you'll need to come up with an investment strategy on your own.
The first and biggest choice is whether to find a financial advisor to help manage those assets or to invest them yourself. Making that decision depends on many factors, such as your plans for retirement, your comfort level with making active investments, the types of investments you want to make and your outlook on the long-term impact of fees.
READ MORE: Personal Finance 101: IRAs
What Is a Self-Directed IRA?
A self-directed IRA (SDIRA) is an IRA that you're managing on your own: researching investments and choosing where your money goes. One reason to do this is that you have more investment choices in a self-directed IRA, such as being able to hold stocks and bonds, mutual funds and ETFs, real estate, precious metals, cryptocurrency and other alternative investments.
Some people also prefer self-directed IRAs because it gives them more control over their investments, though the downside is that a greater amount of knowledge and research is required, as well as extra time to manage your portfolio.
Technically, a self-directed IRA is administered by a custodian or trustee. But the day-to-day management—and the assumption of any risk—is entirely up to you.1
How To Plan Your Self-Directed IRA
When deciding whether to self-manage your retirement accounts or seek support, consider what you need to accomplish. The first step of any savings plan is to define your goals and timeline.
Know your financial goal
How much of your retirement income will your IRA eventually amount to? If it's your sole retirement account, you may want to contribute the maximum pretax dollars every year (more on that below). But if it's a supplemental account—to your 401(k), for example—you may not need to, especially if overcontributing would strain your budget.
Have a target retirement age
Are you planning to retire in five years? Ten years? Thirty years? The answer will help you decide on your investment strategy and risk tolerance. (You can take money out of your IRA at any time, but any withdrawals you make before age 59½ may result in additional taxes.2)
Your strategy is what will determine the types of investments you want to make in stocks, bonds and cash equivalents, such as certificates of deposit (CDs) and money market accounts. To decide how much of your IRA to place in each type of investment, conventional wisdom says you should invest more heavily in stocks and stock-based funds early on and gradually shift to less-risky investments (such as bonds and cash equivalents) as you get closer to retirement.3
If that already sounds too complicated, a financial advisor can help you flesh out your IRA strategy and implement it. But remember that financial advisors charge fees, which can reduce the amount of money in your account over time.
READ MORE: How an IRA Can Lower Your Taxes
Should You Manage an IRA Yourself?
There are a few advantages to having a self-directed IRA that you manage. The first is that you'll often pay lower fees, depending on your plan and the investments you choose. The second advantage of a DIY approach is control. With self-directed IRAs, you can invest when you want, how you want—and make changes on the fly.1
Here are some questions to ask yourself as you consider self-directing an IRA.
1. How much do you know about investing?
Just about anyone can buy stocks or bonds, but understanding investing terms and the mechanics aren't always enough to be a successful investor. It's important to understand what you're doing and why, and to have a strategy behind your decisions. For instance, do you know the difference between a traditional IRA and Roth IRA, and which is best to use when? If you are not confident in your investing know-how and not interested in learning, a self-directed IRA might not be the best choice for you.
READ MORE: 10 Lessons You Should Learn Before Investing
2. What do you want to invest in?
One advantage of self-directed IRAs is the ability to get tax advantages from alternative investments. If purchasing Bitcoin or private equity and holding it within your IRA is an appealing prospect, a self-directed account might be a good choice.
3. What fees are involved?
Some self-directed IRAs charge account maintenance fees or charge for trading costs, so you'll have to pay for every stock you buy or sell. Many investment options, such as mutual funds and exchange-traded funds, charge management fees. Those fees come out of your account regularly, regardless of how your investments perform, so it's important to read the fine print and see what you'll be paying.
If you have a simple strategy and you're comfortable setting up a self-directed IRA, then you will likely pay lower fees if you decide to manage your own IRA versus hiring an advisor—though specific costs depend on your choice of investments.
4. How much control do you need?
With an IRA, you can purchase investments using pretax dollars by contributing a little each pay period or each month until you either reach your annual savings goal or hit the IRA's annual investment maximum. This approach will help you slot your retirement savings into your monthly budget.
Take advantage of the different kinds of IRAs available. If you're worried about paying high income taxes in retirement, a Roth IRA may make sense. With a Roth, you buy investments using your posttax dollars but pay no income taxes on withdrawals when you cash out in retirement. If you own your business, you might want to look into a SEP IRA or a SIMPLE IRA.
READ MORE: 5 Ways It Pays to Fund Your IRA
When Should You Work With an Advisor or Broker?
Not everyone is comfortable investing. Most people are not good at choosing individual stocks, nor do they have the time to properly vet investments.4 But to save enough for a comfortable retirement, your money must grow over time. That's where an advisor can be helpful.
If you choose to work with a financial advisor, make sure it's someone you can trust. Talk to more than one candidate and get a referral from a trusted contact, if possible. Before you sign anything, ask a potential advisor about their fees and their fiduciary position, and check their credentials.
Depending on the assets you have to invest, you may not have enough money to work with a traditional financial advisor. But you can still get help. You may consider a low-cost financial advisor who will charge you by the hour for specific advice. This can be especially helpful when considering alternative investments.
Many online brokerages also offer so-called robo-advisor services. To work with one, you'll usually fill out a questionnaire about your goals, life stage and comfort level with investments and the risks that come with them. Using that information, the robo-advisor will set up an investment plan and automatically rebalance your IRA portfolio as the markets change and your time horizon to your goals decreases.
Self-Directed or Not, an IRA Is a Valuable Tool
The biggest advantage of a traditional IRA is that you can fund it with pretax dollars, allowing you to invest more money up front and reduce your taxable income for that year. So look closely at the tax advantages of the IRA you choose, whether it's a traditional or Roth IRA. The decision you make could have tax implications both this year and later on, in retirement.
The next step is to decide how you want to fund your IRA, whether it's monthly or annually. Having a financial plan will help you make the most out of your IRA over the long term. And when buying investments in your IRA, remember what you're investing for and stick to your strategy.
Whether you choose to self-direct your IRA or work with an advisor or institution to help guide your decision-making, putting the effort into setting up an IRA to save for retirement can pay dividends—literally. It's an investment of time that's an even bigger investment in your future.
How much should you have saved for retirement? Find out what the typical American has saved, at every age.
