Choosing a Roth IRA Strategy

Once you understand the basic fundamentals of Roth IRAs, you need to choose an investment strategy compatable with your personal financial situation as well as your personal risk tolerance. Make a mental note of that last last sentence...

"Compatable with your personal financial situation as well as your personal risk tolerance."

Don't choose an investment strategy in which you contribute $100 per month to your Roth IRA if you have delinquent bills or no savings.

Make sure you have at least six months of living expenses tucked away before you begin committing to a long-term Roth IRA investment strategy.

Also, don't make any long-term investments which will cause you to lose sleep at night. If you're scared silly by the prospect of losing everything in the stock market, avoid a lot of unwarranted stress by simply not investing in the stock market to begin with.

In this article, we'll cover three (3) primary, non-exclusive investment strategies:

1) Investing in your own area of expertise
2) Investing in managed funds
3) Investing in individual stocks

These strategies are non-exclusive because you can engage in one, all three, or any combination of the three as you see fit. But in most cases, at least one of these strategies will apply to you.

Choosing Your Roth IRA Investment Vehicle(s)

There's an almost countless array investment vehicles you can hold in your Roth IRA, such as:

a) Common Stocks
b) Bonds
c) Mutual Funds
d) Certificates of Deposit (CDs)
e) Exchange Traded Funds (ETFs)
f) Money Market Accounts
g) Savings Accounts
h) Treasury Inflation Protected Securities (TIPs)
i) Real Estate Investment Trusts (REITs)
j) Platinum, Gold, and Silver Coins

Some things you can't hold in a Roth IRA include:

a) Collectibles (Priceless art, classic autos, antiques, stamps, etc.)
b) Cash Value Life Insurance

In a nutshell, this covers your list of investment options for a Roth IRA. Take a good look, then continue reading.

Your Personal Comfort Level

To decide what to invest in and how, you should start by asking yourself a series of questions. For instance, are you already familiar with the stock market? Do you have a certain level of comfort investing in one asset class over another? Perhaps you have an intimate familiarity with commodities due to your current job and you think this gives you special insight into the world of commodity investing.

Whatever your reasons for being more comfortable with one asset class over another, it's generally a good idea to stick with what you know best.

Your Personal Financial Goals

Regardless of your familiarity with an asset class, you need to make sure the one you choose can realistically help you meet your financial goals. For instance, if a comfortable retirement requires that you receive a 6% annual compound rate of return on your investment portfolio, then you probably don't want to invest everything in U.S. Treasuries yielding 2% annually - even if you consider yourself an ultra-conservative investor. Take a look at some Roth IRA calculators to help determine the annual rate-of-return you need to achieve.

Remember, your Roth IRA is a long-term commitment. If you want to grow your savings into a large nest egg by retirement, you need to do more than simply receive a return of a few percentage points per year. You need to receive a return of a few percentage points per year plus inflation. This is a key point to remember, because if your investment returns can't outpace inflation, then your investment principal will become worth less and less over time. You want it to be more and more!

Historically, the best inflation-beating financial returns can be found in one place: the stock market.

Strategy #1 - Investing In Your Own Area Of Expertise

But if the stock market is not one of your desired investment vehicles, feel free to go about doing your own thing, make sure you keep an eye on fees and other costs which can eat into your Roth IRA returns.

For the rest of you who are still interested in investing in the stock market, we're just beginning, so keep on reading.

Investing In The Stock Market

As a general rule, you can only invest in the stock market in one of two ways:

1) You can pay someone to manage your stock market investments
2) You can choose your own individual stock market investments

You should only choose method #2 if you're dedicated to investing the time and energy necessary to properly inform yourself on your investment options. So let's take a look at those options.

Strategy #2 - Investing In Managed Funds

When it comes to paying someone to manage your stock market investments for you, you generally have two options - mutual funds and index funds.

Mutual Funds - Mutual funds are actively-managed investment pools with multiple investors which are managed by an investment professional. Most mutual funds have a stated goal or an investment theme denoting the focus of their investment strategy. For instance, a "large cap" mutual fund will focus its investments on the largest publicly traded companies as measured by market capitalization, while a "small cap" mutual fund will focus its investments on the smaller publicly traded companies as measured by market capitalization. Mutual funds charge management fees (and sometimes other fees) depending on the individual fund.

Index Funds - Index funds are non-actively managed investment pools which attempt to mimic the investment performance of a market index such as the Dow Jones Industrial Average or the S&P 500. By definition, index funds won't consistently beat the market averages they mirror, but they also shouldn't underperform them either. Another benefit of index funds is that the fees they charge are generally much lower than those of actively managed mutual funds.

Strategy #3 - Investing In Individual Stocks

For those who think they can select a stock portfolio which consistently beats the market averages as well as the returns of actively managed funds, investing in individual stocks may be the choice for you. Just remember, this is not a decision to be made lightly. Making your own individual investment decisions in regard to individual stocks takes a lot of time and effort and the returns you generate need to consistently beat the market averages for the invested time and effort to be worth your while.

Consistently beating the market averages is an elusive goal for mutual fund managers who must contend with numerous restrictions, such as government-enforced restrictions on portfolio diversification, institutional demands for short-term success, and untimely shareholder redemptions. But with the proper time, effort, and emotional control, beating the market averages is an obtainable goal for most individual investors.

Before choosing Strategy #3, make sure you can answer "yes" to each of the following questions:

Are you willing to invest the time and energy to research your own investments?

Do you understand, or are you willing to learn, the basic concepts of the stock market?

Do you understand, or are you willing to learn, the basic concepts of running a business?

Do you understand, or are you willing to learn, the basic concepts of evaluating the worth of a business?

Do you have the emotional control and power of conviction to follow through on your decisions?

Do you have the emotional control to do nothing when the situation demands it?

If you can answer "yes" to each of these questions, then you're ready to move on and learn more about making your own individual stock investment decisions.

Britt Gillette writes for Your Roth IRA, a site about self-directed Roth IRA information and tips.