Every small business owner should regularly set aside some money for retirement. However, many people find it difficult to start saving. Any excess cash is quickly spent or deployed back into the business. If this is the situation in which you find yourself, consider opening an IRA account and allocating the money in the stock market. A relatively small investment made year after year, can grow into a large amount.
What is IRA? What’s an IRA Account?
IRA is an acronym for individual retirement account or individual retirement arrangement. This account helps you to accumulate funds for your retirement while also providing you with tax benefits.
You can open an IRA account with a bank, an insurance company, or with certain financial institutions.
If you start making your IRA contributions early, you can accumulate a surprisingly big sum. Fidelity Investments, a financial services corporation, estimates that $6,000 invested in an IRA account can grow to $64,059 over 35 years.
Hypothetical pretax growth of one IRA contribution
Of course, this calculation makes some assumptions. The annual rate of return is considered at a consistent 7% over 35 years. Additionally, taxes on earnings within the IRA are ignored. So are fees and inflation. However, the return indicated by Fidelity is achievable if you invest your IRA funds in the stock market. The S&P 500, a stock market index that measures the stock performance of 500 large US companies, has provided a return of almost 9.5% over the last 35 years.
Types of IRA Accounts
It’s important to know that there are two basic types of IRA accounts in which individuals can invest:
Traditional IRAs generally allow you to deduct the amount that you contribute on your tax return. But the withdrawals you make in retirement are taxed at ordinary income tax rates.
Roth IRAs, on the other hand, work differently. You pay taxes on contributions, but withdrawals are tax-free.
Which should you choose? If you expect your tax rate to be lower in retirement, a traditional IRA could be a better choice. However, if you think that you will pay tax at a higher rate when you start withdrawals, a Roth IRA could be the right choice.
Keep reading Roth Ira vs Traditional IRA to decide which option suits you better.
Pros and Cons of an IRA Account
Now, let’s review the pros and cons of opening an IRA account:
- The possibility of earning high returns on your investment – if you deploy your funds carefully, you have a good chance of accumulating a substantial amount. Your investment options include stocks, bonds, certificates of deposit, and exchange-traded funds.
- Save on taxes – this is a crucial benefit of putting money into an IRA account. Once you have made the investment, taxes are not levied on the dividends and capital gains that you earn.
- Get a tax deduction – as explained earlier in this post, a contribution made in a traditional IRA account permits an upfront deduction. In a Roth IRA, withdrawals are tax-free.
- Contributions are limited – the most that you can invest every year is $6,000. The limit for savers over the age of 50, is a little higher at $7,000.
- Your money could be locked up for years – if you have invested in a traditional IRA, and you want to make a withdrawal before the age of 59 ½, you could have to pay a withdrawal penalty of 10%. However, you won’t have to pay a penalty on an early withdrawal from a Roth IRA.
- You’ll have less money to invest in your business – there would likely be times when you will need funds for your business. You may need cash to buy new machinery or repair old equipment. A new marketing campaign may require additional funds. Should you use your excess cash to save for your retirement? Or is it better to reinvest it in your business? Keep reading to get the best solution.
What Can I Do If I Also Need Funds for My Business?
Fortunately, you can do both things. You can make contributions to your IRA account and also have the capital you need to invest in your business right when you need it most.
Go ahead make the $6,000 contribution (or $7,000, depending on your age) to your IRA. Your company’s cash needs can be taken care of with a small business loan from Camino Financial.
These are the main features of Camino Financial small business loans:
- You can submit an online application to know instantly if you prequalify.
- We stand by our motto, “No business left behind.” To be eligible for a loan from us, you need to have been in business for only 9 months and have gross annual sales of $30,000. We don’t need a minimum FICO score. Even applicants without a credit history could get a loan.
- We offer loans up to $400,000.
- Loan payback periods range from 24 to 60 months.
- We offer small business loans at an annual interest rate of 19% to 24.75%. There’s also an origination fee of 5% to 6.99% of the total loan amount.
Step-by-step Guide on How to Invest your IRA in the Stock Market
The stock market offers the greatest potential to maximize your returns on the contributions that you make into your IRA account. Here’s a step-by-step guide that you could use:
Step1- Decide how much you want to invest in stocks
The stock market offers an excellent option for savers. Look at this illustration prepared by Fidelity. It shows that stocks provide a far higher return than other financial instruments.
What $100 would be worth over the history of the stock market
It seems unbelievable, but $100 invested in the stock market in 1926 would have grown to $587,000 by 2016. Of course, the timeframe for your IRA account would be much shorter.
However, if you have ten years or more for retirement, consider investing in the stock market. If you do, there’s a strong possibility of earning far more than you would in bonds or other short-term financial instruments.
Is it a good idea to invest in the stock market? Examine the performance of the company that you are planning to invest in carefully. Individual stocks can pose high risks. It’s essential to learn how to invest in the stock market before you begin the process of allocating funds to your IRA.
Step 2 – Consider your other options
If you have a low-risk tolerance, investing in individual stocks may not be a good idea. The share price of a company can fall rapidly if investors think that the stock is overvalued. Consider Pfizer, a pharmaceutical company headquartered in New York. In 2019, it has lost about 14% of its value. Meanwhile, the Dow Index, which includes Pfizer, has gained 15%.
Individual stocks can lose value even as the stock market rises
|Change in the period January 1, 2019, to September 9, 2019|
|Dow Jones Industrial Average||+15%|
What should you do if you don’t want to invest in individual shares but would like to gain from the increase in stock market valuations? Think about putting your money in mutual funds or ETFs. These invest in the shares of dozens of companies and help to reduce the level of risk you are exposed to.
Step 3 – Select an IRA account
When you start the process of choosing an IRA account provider, remember to ask the following questions:
- Fees and charges – how much will you have to pay the financial institution?
- Investment advice – will you be charged extra for financial advice?
- Types of investments – what are your investment options with the IRA provider?
- Which are the companies that you should consider opening an account with? Merrill Edge, TD Ameritrade, and Fidelity can be good options.
Pros and Cons of Investing Your IRA in the Stock Market
Allocating your retirement money in the stock market has its pluses and minuses. Evaluate these points before you decide:
- Potential for earning high returns on your retirement savings.
- Stock market investments can help you to beat inflation.
- If you are risk-averse, you have the option of investing in mutual funds or ETFs.
- It may not be advisable to put your money into the stock market if your time horizon is less than ten years.
- The stock market is not for those who have low-risk tolerance.
- If you are not familiar with the stock market, you could make a purchase that could lead to losses.
Useful Tips to Invest Your IRA in the Stock Market in the Right Way
- Don’t delay opening your IRA account. An early start gives you the advantage of the power of compounding.
- If your retirement is many years away, put a higher proportion of your money into stocks.
- Don’t forget that the stock market is volatile. You should be willing to bear the risk of seeing a decline in the value of your portfolio. There’s no guarantee that the stocks you have chosen will increase in value over time.
- Consider diversifying your portfolio. Instead of putting all your money into the shares of one company, spread it across several. Try and buy stocks in firms in different industries.
- If you’re not familiar with how the stock market works, take the help of a financial advisor.
Other Strategies to Invest Your IRA
It’s important to remember that the investments you make in your IRA are for the long term. You need to understand your financial needs and decide on an investment strategy.
If you’re the type who likes to minimize risks, you could consider a conservative investment portfolio that allocates 50% to bonds and another 30% to short-term investments. The remaining 20% could be invested in stocks.
Investors looking for high growth could reverse this allocation. Deploy 85% of your IRA funds in stocks and the remaining in bonds. But if you do this, you should be prepared for the possibility of losing money.
Here’s a chart that illustrates how you can split your investments across different options based on your investment approach.
Investment mix options for your IRA funds
The Bottom Line
Opening an IRA account and deploying your savings in stocks can be an excellent way to build your retirement nest egg. If you want to learn more about stock market investing, read our post Stock Market 101.
At Camino Financial, we do our best to provide you with the information and tools to help you make the decisions that can grow your sales and boost your profitability. We encourage you to access our free business resources. Camino Financial members are also entitled to free 1-on-1 business consultation.