You might be scrambling right now to put together the money you need to make your IRA contribution for the year. There’s nothing wrong with that. In fact, there is a lot right with investing in your IRA. You get a sweet tax deduction, tax-deferred growth and a bigger nest egg to draw from when you retire.
But just because you contribute to your IRA doesn’t mean you can check that box and move on to your next task for the day. A lot of people do that and fail to take the extra steps that can amplify the true value of their IRA investments. Here are the top 5 mistakes investors make with their IRA accounts and how to avoid making them yourself:
1. Spreading It Out Too Much
Many investors have IRA accounts all over town. They do this in order to reduce risk and perhaps save on fees. There is some value in those arguments of course but the cost of doing this far outweighs the benefits.
First, by having IRA accounts all over the place, it’s very hard to keep track of your money. That means investments often go unchecked. The danger of not watching your money is that you can easily hold on to under performing investments for years and years and not even realize how poorly those accounts are doing.
The solution is to consolidate your investments. This is easy to do and very worthwhile as it makes it a snap to audit and upgrade your investments on a periodic basis. And if you are worried about having too many eggs in one basket, you can relax.
As long as your money is held at a bonafide custodian who offers SIPC coverage, your investments are insured up to $500,000 including $250,000 in cash. Many custodians offer much more coverage – some up to several million dollars’ worth – so ask about the coverage you have with the company you do business with.
(If you keep your IRA money in bank products rather than investments, SIPC won’t help you. To solve that problem, keep reading.)
2. Investing Too Conservatively
The next big error that people make with their IRA is that they put the money in lousy investments. Ultra-conservative people tend to keep retirement assets in bank products like CDs and this costs them a fortune. That’s because the rate of return on CDs barely keeps up with inflation if at all and this can be devastating over long periods of time. And since the greatest benefit of having an IRA is the ability to tap into years and years of tax-deferred growth, it costs you big if you park your money in low-return investments.
To give you a sense of this, let’s look at some numbers. Let’s say you invest your $5500 IRA contribution into a CD every year for 25 years and earn 3% on average compared to a conservative balanced fund that theoretically earns 6% on average. The person who invested in the balanced fund ends up with $100,000 more retirement money at the end of the period compared to the bank depositor.
Of course, the fund investor took on more risk and there are no guarantees of results. But because the nature of retirement accounts is long-term, the value fluctuations over the short run aren’t important. What counts is the value over the long-term. I urge you to learn about investing for growth and learn about dollar cost averaging.
3. Investing Too Aggressively
Of course there is a flip side to this issue and that is, investing too wildly. Some people feel that they can take all kinds of risk with their IRAs because they are such long-term arrangements. Well, you can certainly take some short-term risk, but it rarely pays to take on unwarranted risk.
Remember, your retirement money is very long-term. You don’t need to take tremendous risk in order to grow your money quickly. You need to get a good return over the long-run. Sadly, investors who buy super risky investments often end up underestimating just how much risk they really take on. This happens with DIY investors as well as those using advisors. In my experience, this leads to investors suffering huge losses in many cases.
4. Not checking beneficiaries periodically
Besides making investment mistakes with their IRA money, investors often make administrative errors which can be even more costly. And the biggest mistake in this category is failure to check your beneficiaries.
By law, your retirement money goes to the beneficiary you name in your retirement account documents. It doesn’t matter if you have a trust or a will. The people you name on the beneficiary document are the people who are going to inherit that money.
Picking your beneficiaries can be a tricky subject and you should only name them after careful deliberation – preferably with a qualified attorney who is expert in estate planning.
And don’t become complacent. Review your beneficiary selection every couple of years. I suggest this because things change; people get married, have kids, pass away, etc. It’s absolutely critical to review who your beneficiary designations are periodically. If you don’t your money could fall into the wrong hands and you won’t be able to do anything about it.
The trick here is knowing the best way to check on this. In my experience, there is only one way to do this and that is to get a copy of the beneficiary form your custodian has on record. You can’t just call the custodian or email. You need the actual form your custodian has on record. Here’s why this is so important.
First, when you pass away, that form is the document your custodian will follow. Second, this proves that the custodian hasn’t lost the document to begin with. Believe it or not, this happens all the time and if you die and there is no beneficiary document, your IRA money might go into probate which is a costly and time consuming exercise only popular among lawyers.
5. Putting Your IRA at Risk by Other Financial Behavior
The last mistake is I want to mention is having to deplete your retirement money as a result of spending. I know that sometimes you have no choice but to tap that IRA in order to keep the financial wolves at bay. But please understand that this is something you should avoid at almost all costs .If you tap into your IRA to pay off debts, you’ll have to pay a 10% penalty if you are under 59 ½ (unless you meet stringent requirements). And worse, you risk never being able to retire at all. That’s because once people start putting their fingers in their retirement cookie jar, they tend to keep doing so until all they have left is crumbs.
As you can see, these 5 mistakes are relatively easy to make – unless you are aware of them and take proper steps to avoid them. My suggestion is to take the time to ask yourself if you are at risk in any of these areas and if so, take corrective action immediately.
Neal Frankle, Certified Financial Planner ®, WealthPilgrim.com, CreditPilgrim.com