Savvy savers start putting aside money for their retirement years while still in the 20s, which is why you should deposit some of your spare cash in an individual retirement account. These tax-deferred vessels are available through banks and investment firms. However, IRAs come in many varieties so you need to understand the investment products before you sign away your future.
Bank IRAs normally take the form of savings accounts or certificates of deposit. Basically, you deposit your money in the bank and receive a certain amount of interest on it for a period of time. If your bank goes bankrupt, the Federal Deposit Insurance Corp. insures your IRA up to $250,000, per bank. You can maximize your coverage by spreading your cash out among several banks and making sure you do not exceed $250,000, at any one institution. In contrast, investment IRAs take the form of stocks, bonds or mutual funds and the FDIC offers you no protection if these securities lose value. However, the Securities Investor Protection Corp. covers losses stemming from your broker going bankrupt but only if you broker is an SIPC member.
Your investment timeline and risk tolerance should govern your investment decision. If you are wary of seeing your account drop in value then you should invest in bank IRAs because the account value cannot drop below your original investment. In contrast, stocks and mutual funds have no price limits, which means your investment has unlimited growth potential but you could lose it all as a result of one bad day on the stock market. If you do not plan to retire for a few decades, then you can withstand a few downturns on the markets but while time can be a healer there are no principal guarantees with investment IRAs.
Banks IRAs tend to pay low interest rates that just about keep up with inflation. This means that when you retire and cash in your nest egg that you have about as much spending power as you did when you invested the money. If inflation spirals out of control you will lose spending power during the IRA term. In contrast, stocks and mutual fund shares often grow at a pace that exceeds inflation. The longer you plan to hold the IRA, the more daylight you can put between your investment and the ravages of inflation. However, a down market and a period of deflation could knock your IRA investment off the rails.
When you buy shares in a mutual fund you often have to pay a commission known as a load fee and this can amount to 4 percent of your investment. You also pay broker's fees to buy stocks and bonds and these expenses erode your earnings. In contrast, banks do not typically charge acquisition fees for CDs and savings accounts. Some banks charge an annual custodial fee but brokers also charge this fee. Therefore, bank CDs are generally cheaper to buy but you have to weigh the potential savings with the limited potential for growth. After all, you need to raise enough money so that you can enjoy retirement living.
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