How Does an IRA Work and Why Isn't Mine Performing?
To understand why your IRA, 401(k), 403(b), or 457 isn’t performing, you need a little background on how these retirement products work. They are essentially just tax-deferred containers for your retirement portfolio, so they function differently than many other investment products.
To begin with, an IRA, 401(k), 403(b), or 457 is not a product. It is an account. When you invest in an IRA or a 401(k), you’re not really investing in the IRA or 401(k). You’re investing in the products held within your IRA or 401(k). They are tax-deferred investment accounts that are used to save for retirement, and they can be set up in a variety of ways. For instance:
- Your 401(k), 403(b), or 457 plan will be set up by your employer. Normally, you can choose from a variety of plans offering different levels of risk.
- If you set up an IRA at your local financial institution, your IRA will likely contain certificates of deposit and cash. Because these do not contain securities, they tend to offer a much lower return on investment than the type of IRA you would set up with an advisor/broker.
- If you set up an IRA with your advisor or broker, your IRA can include any number of investment securities including stocks, bonds, mutual funds, exchange traded funds, and more.
In simple terms, your IRA or 401(k) is simply the registered account and what you’re purchasing are the investments within the account.
Definition: a security is a certificate that indicates that you own a stock, bond, or another tradable derivative.
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Why is your account underperforming?
As mentioned above, the money you place in your retirement account is used to fund investment products within the account. How much goes to each investment within the account depends on what your risk tolerance, time horizon, and investment objectives are and what types of investments you hold in those accounts.
For example, if you put $150 into your account and you have a low risk tolerance, your advisor/broker may put half the money in cash and low-risk bonds and the rest in blue-chip stocks that tend to be reliable. If you had a higher risk tolerance, they may put more money into tech stocks or other higher risk securities.
Once the securities have been purchased, their value fluctuates with the stock market. If you bought a stock at a high price and the value of the stock goes down, the value of your overall portfolio will go down and if you were to cash out your investments at that point in time, you may lose money.
The good news is that advisors/brokers help reduce your risk level by diversifying the investments in your retirement account. Through diversification, they are able to create a portfolio that includes securities that react in very different ways to any given stock market scenario. For instance, a bond may become more valuable as the values of stocks go down or foreign securities may hold steady as US securities tank. Diversification does not ensure a profit or guarantee against a loss.
How do you improve your account’s performance?
The tricky thing about investing is that it is uncertain. You can look back in history and see that over time, stock market returns have consistently increased, but the values of securities are constantly moving up and down. It is the nature of the markets to be in flux, so if you want to invest, you will have to be comfortable with some level of risk.
If you don’t have experience with investing, the best thing to do is speak with your advisor to make sure that your portfolio is balanced and diversified for your risk tolerance. When it comes to your IRA or 401(k), your advisor/broker will help take care of the investment choices. You can speak with them to make sure that your portfolio is properly diversified and balanced for your risk tolerance and ask them if you should change course depending on the market environment.
Many people practice dollar-cost averaging to reduce their risk. This technique is simple and, if you have a 401(k), you probably already use this technique, even if you’re not aware of it. Dollar-cost averaging is a strategy in which an investor purchases securities at regular intervals over time. So, instead of buying $3,000 in stock at one point in time and then waiting a year before investing again, someone who engages in dollar-cost averaging may split that amount up and invest $250 per month over the course of the year.
With dollar-cost averaging, the investor is not buying a lot of stock at one price but rather small amounts of stock at different prices. Sometimes they’ll pay a high price for the stock because the market is up. Sometimes they’ll pay a low price because values have fallen. This practice reduces the investor’s vulnerability to market volatility by spreading their risk over a variety of market conditions over the course of time.
Dollar-cost averaging does not assure a profit and does not protect against loss in declining markets. Since dollar-cost averaging involves continued investing regardless of fluctuating securities prices, you should consider the ability to continue purchases over an extended period of time.
Where do I start?
As with all investment matters, most people are best served by working with their financial advisor or broker. Even if you are concerned about your employer-sponsored 401(k), 403(b), or 457 plan, your advisor can help you determine which portfolio makes the most sense given your life circumstances and risk tolerance.
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The views and opinions expressed in this blog are those of the authors and do not necessarily reflect those of VSECU.
Representatives are registered, securities sold, advisory services offered through CUNA Brokerage Services, Inc. (CBSI), member FINRA/SIPC, a registered broker/dealer and investment advisor, which is not an affiliate of the credit union. CBSI is under contract with the financial institution to make securities available to members. Not NCUA/NCUSIF/FDIC insured, May Lose Value, No Financial Institution Guarantee. Not a deposit of any financial institution. FR-3468086.1-0221-0323