Would you think I was crazy if I told you that my Roth IRA (check out IRA Basics) is also the account that invest most aggressively? The word “retirement” is supposed to match up with “safe” or “secure”, right? A retirement account would never be the place to pick stocks or trade options.
What If The Opposite Were True?
We’ll ignore the fact that tons of financial advisers make their money by selling safer investments like mutual funds and focus on the numbers as always. Here is why I prefer aggressive investment in my Roth IRA.
Lets say you have two investment accounts
“Account A” is a Roth IRA where the investments grow tax-free and withdrawals at retirement are tax free.
“Account B” is a standard brokerage account and gains, dividends, and interest are all taxed.
You also have two investments.
“Investment A” is a risky or aggressive investment with an average expected return of 15%.
“Investment B” is a safe corporate bond yielding 5%.
Which return would you rather have taxed?
The only logical conclusion is to put the investment with the higher potential return into the tax-free vehicle.
I’m Not Telling You To Trade Options In Your Retirement Account
Don’t take this article as advice on what specifically to invest in. That’s not the purpose. You as your own individual must determine the level of risk that you are willing to take and go from there.
Once you figure that out though I am telling you to put the most aggressive piece of your diversified portfolio into a Roth IRA. For example if you diversify between stocks and bonds as part of your strategy, make sure the Roth IRA is filled with stocks. The most aggressive stocks that you own.
Amazon is up about 6000% from its IPO in 1994 at the time of writing this. If you bought $10,000 of Amazon in your Roth Account in 1994 you just made $600,000 tax free, whereas a traditional brokerage account would be hit with a capital gains tax of 20%, or $120,000 to cash out now. Ouch. Don’t let that be you.
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Interesting insight — You should do a post on what risk is. It’s often hard to look at the given information about different index funds and decipher the differences between target returns and average returns, or individual stocks and understand different factors that make them more or less risky than others. Do you have a framework for how an investor could decide 1) How much risk they are comfortable with, and 2) How to quantify the risk level of certain investment vehicles?