Once you open an IRA, you start down the path of tax-advantaged investing that can help you get to, and through, a successful retirement. Opening that IRA is a great first step, but by itself, it's not enough. You also need to contribute to the IRA and then invest the money you contribute. In addition, while one year's IRA contribution is nice to have, the true power from your IRA comes when you repeat the contribution and investment steps over time to really build up its balance.
Over the course of a career, those investments can add up. The money you sock away in an IRA can potentially grow to over $500,000 by the time you retire, assuming you start early enough, invest enough money consistently, and earn a high enough rate of return. To get to that level, though, you need to consistently care for and feed your IRA for a time span measured in decades.
First, feed your IRA by contributing to it
You likely are able to contribute to your IRA if you earn "taxable compensation" such as a salary or contractor income, or if you're married to someone who does and you file your taxes jointly. The major exception to that ability to contribute is if you'll reach age 70-1/2 or older during the year and have an income too high to contribute to a Roth-type IRA.
If you're under age 50, you can contribute up to $5,500 this year, with the amount occasionally adjusting upward for inflation. Once you reach age 50, the typical limit grows by $1,000 due to a "catch-up" rule, to a total of as much as $6,500 in 2017. No matter what your age, you cannot contribute more than your (or your spouse's) taxable compensation.
If you can't come up with that kind of cash right now, don't worry. You actually have until the tax-filing deadline to contribute to your IRA. So you can contribute to your IRA for 2016 until April 18, 2017, and your IRA for 2017 until April 17, 2018.
In addition, if you can't completely top off your IRA in a given year, you can always contribute less than your maximum allowed amount. And if you prefer, you can send in a little bit each paycheck instead of putting it all in the account at once.
Next, care for your IRA by investing the cash you contribute
Once you have money in your IRA, your next step is to put that money to work for you by investing it. The primary types of investments most people should concern themselves with are stocks, bonds, and cash. The table below shows general guidelines of how to think about using each of those investment types as part of your overall plan.
Investment Time Frame
Key Risks Investors Need to Consider
Short Term (a few months)
Loss of purchasing power over time to inflation
Mid Term (a few years)
Default risk of issuer, low potential returns after taxes and inflation
Long Term (several years out)
No guarantees of value, significant volatility
Table by author.
As you're looking to invest, you don't need to buy individual stocks or bonds. You can invest in mutual funds or exchange-traded funds that let you get small stakes in dozens -- or even hundreds -- of individual stocks or bonds with a single investment. By spreading your risks out in that manner, you'll reduce the impact that any individual failure of a given stock or bond would have on your account -- but you also reduce the benefit of any extraordinary winner you may own.
If you've got a long enough time frame ahead of you to be invested in stocks, here are three exchange-traded funds to consider:
- S&P Depository Receipts (NYSEMKT: SPY) . This fund tracks the S&P 500, which contains 500 of the largest U.S.-based companies. It's a great way to get exposure to large and well-known companies without having to buy their shares individually.
- Vanguard FTSE All World ex US (NYSEMKT: VEU) . This fund invests globally in large companies headquartered in 45 countries outside of the U.S. It offers you international investing without the headaches and costs of currency conversions, or finding a broker that will handle foreign investments for you.
- Vanguard Small Cap (NYSEMKT: VB) . This fund buys a broad array of smaller U.S.-based companies. Smaller companies frequently have better long-term growth prospects than larger ones do, but also face more risks because they don't tend to have the resources of their larger brethren. It's a trade-off of more volatility and potential risk for higher potential returns, but that's a trade-off that many investors are willing to make.
Finally, keep up the contributions and investments throughout your career
Opening, funding, and investing in an IRA can provide a great foundation for your financial future. What really turns that money into a significant retirement nest egg, however, is continuing the process of funding and investing in your IRA every year throughout your career. A little bit at a time invested regularly over the course of decades can turn those initial $5,500 per-year contributions into that $500,000 or more nest egg.
So, congratulations on taking the first step of opening your IRA. Get that IRA funded, invest those funds, and repeat the process every year for a few decades. Once you reach retirement, you likely will be very glad you did.
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