It just makes sense to start planning for your retirement while you are still early in your career, in your late 20s and early 30s. Most of your income is subject to federal income taxes, but one place where you get a break is on investments in your Roth IRA. Internal Revenue Service regulations allow you to put a wide range of investments for your Roth IRA, including stocks, without paying taxes on any income those investments produce. Which stocks you pick for your Roth IRA depends on your investment temperament and the amount and type of your other investments.
The stock market has a long-term history of outperforming bonds and other savings instruments as a protection against inflation. How you pick stocks for your Roth IRA may vary based on how many years you have left before your retire. Traditional formulas advised determining the percentage of stocks in your investments portfolio by subtracting your age from an arbitrary number, such as 120 or 100, and keeping the rest in fixed-income securities such as investment-grade corporate bonds. Regardless of the percentage of your portfolio you have in stock, time is your best friend. The longer you have until you retire, the more aggressive you can typically afford to be. Investors in their 20s and early 30s may be able to afford to assume the risk of buying high-quality aggressive growth stocks during their peak earning years. If a particular stock of yours goes south, there is still time to overcome the loss.
You should take into account your investment temperament before buying any stocks for your Roth IRA. Your investment temperament reflects your aversion to risk. If you lay awake at night worrying about whether the money in your passbook savings account is safe, you have a high aversion to risk. Stocks of blue chip companies that have a long history of paying regular quarterly dividends in both good and bad economic times may be your best bet. If getting a quarterly dividend check from your stock in the local utility company bores you to tears and you'd rather roll the dice in Vegas, you probably have a high tolerance for risk. You will likely be more satisfied investing in a young, high-tech company that has the potential to take off like a rocket.
Your Roth IRA may be only one portion of your total retirement portfolio. You are probably covered by Social Security and you may have a 401(k) or pension plan at work in addition to a whole life insurance policy. You may have additional investments outside of qualified retirement plans that you can also draw on during your golden years. You should periodically reallocate the stocks in your Roth IRA based on your total investment portfolio, your years to retirement and your investment temperament. As you get closer to retirement, you'll probably want to focus more on stocks that preserve your capital and provide a steady stream of income, and less on stocks that offer potential growth down the road.
A Roth IRA offers benefits that are similar to a traditional IRA, but with some significant differences. You can't deduct your contributions to your Roth IRA. Investment growth in your Roth IRA, such as dividends and capital gains from stock trades, does not incur a current tax obligation. Qualified withdrawals from your Roth IRA, those made after you have had your Roth account for at least five years and once you reach age 59 1/2, are completely free from federal income taxes. On top of that, you can withdraw amounts up to 100 percent of your contributions at any time without owing any federal income taxes, because you've already paid taxes on those funds.
Mike Parker is a full-time writer, publisher and independent businessman. His background includes a career as an investments broker with such NYSE member firms as Edward Jones & Company, AG Edwards & Sons and Dean Witter. He helped launch DiscoverCard as one of the company's first merchant sales reps.