Is an IRA Considered a Mutual Fund?
An Individual Retirement Account, or IRA, is a tax-advantaged retirement account that allows investors to hold various investments tax-free. An IRA can be opened at banks, brokerage firms and other financial institutions.
Mutual and exchange-traded funds offer investors several distinct advantages over regular taxable brokerage accounts. The primary benefits include diversification, professional management and tax-advantaged status.
1. Diversification
Investment diversification can help mitigate risk by decreasing the chance that one investment will perform poorly and negatively affect your entire portfolio value. Furthermore, diversifying allows you to capture gains of high-performing assets more readily.
Asset allocation refers to the proportion of stocks, bonds and other investments you hold in your portfolio. It can be determined based on factors like your investment goals, retirement age and overall personal finances.
Your IRA allows you to develop its asset allocation by investing in different categories of funds, including market capitalization (small-, mid- and large-cap stocks), sectors such as technology, energy, health care and finance or geographical regions. Target-date retirement funds offer low cost broad based diversification tailored to your time horizon and risk tolerance while direct stock and bond investments or self directed IRA (SDIRA) accounts allow you to make all investing decisions yourself.
2. Tax-advantaged
IRAs provide attractive tax advantages, making them an attractive way to invest. Contributions may be tax deductible (traditional IRAs) or tax-free (Roth IRAs). Investment gains don’t become taxable until they’re withdrawn in retirement.
IRAs give you access to a broad array of investments, from mutual funds and exchange-traded funds (ETFs) to exchange-traded derivatives (ETTs). ETFs often boast lower expense ratios than mutual funds due to their passive management approach which follows indexes instead of trying to beat them.
Target-date funds can also be held in an IRA. As you near retirement, these investments transition from more aggressive to less risky investments as your withdrawal age approaches. But if you withdraw before age 59 1/2, any withdrawal will incur both ordinary income tax and a 10% federal penalty tax, so it’s essential that you consider all tax implications of any withdrawal decisions before taking them.
3. Tax-free
Individual Retirement Accounts, or IRAs, allow you to invest pre-tax and after-tax dollars for retirement savings purposes. Annual contribution limits are set by Congress; you can open one with banks, mutual fund companies, brokerage firms or even robo-advisors.
An IRA provides investors with an effective means of diversifying and accessing market segments at reduced fees than those charged by mutual funds. Exchange-traded funds (ETFs), which trade like stocks throughout the day and often carry lower fees than mutual funds.
Be mindful that withdrawing funds before the age of 59 1/2 incurs income tax and a 10% penalty, with certain exceptions including first-time home purchases or paying health insurance premiums. This rule applies even for Roth IRAs opened through banks or brokers while savings IRAs feature FDIC-insured certificates of deposit and money market savings accounts as their holders’ savings accounts.
4. Easier to manage
Many retirement accounts provide access to an array of investment options, from mutual funds and exchange-traded funds (ETFs) to annuities. It’s easy to research these investments and understand them; they could make up an integral component of your portfolio.
However, IRA investment fees may not be as cost-effective as those found in workplace plans. On average, institutional share classes found within employer-sponsored plans typically incur lower annual expenses than retail share classes of the same fund.
As illustrated by the hypothetical example below, differences in annual fees can be significant and could cost tens of thousands over your lifetime.
Providers of Individual Retirement Accounts can help mitigate fees by offering affordable options like index funds and ETFs. Another cost-cutting measure would be using an inexpensive robo-advisor, which automates the selection and monitoring process for investments – this service may be ideal for people who wish to manage their portfolio themselves but prefer not having the burden of conducting individual stock and bond research.
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