Want to be a smart investor? The Investment Company Institute’s recently released The IRA Investor Profile might show the way. It shows that Roth IRA investors in particular are doing a great job – it seems that they focus on all the right things.
Possibly the most important factor in your retirement is behavior: what you do (and possibly more importantly, what you don’t do). For whatever reason, the study shows that Roth IRA investors have the right behaviors that are helping them reach their goals. Another takeaway is that Roth IRA assets are currently relatively small, and it might mean we’re less likely to see unpleasant changes in tax treatment down the road.
Viewing things from 35,000 ft. helps you make better decisions
The study does not even mention “flashy” investment topics (which are less important than your behavior). For example, you won’t hear about any particular strategies, fund choices (active or passive, ETF’s, or sector funds – although asset allocation funds are mentioned), or market timing successes. That’s because a few simple behaviors are really all it takes.
Note that a Roth IRA might or might not make sense for you based on your tax situation. Either way, you can learn a lot from those who are successfully building assets in Roth IRAs.
They Take an Active Role
Roth IRA investors are proactive about building their retirement income. Instead of leaving things to their employer, these people set up their own accounts, and actually make contributions to the accounts. The vast majority of assets in those accounts are the result of somebody writing a check, or setting up an automatic monthly contribution to the account. The study shows that “31.1 percent of Roth IRA investors aged 18 or older contributed to their Roth IRAs, and nearly four in 10 of these contributors did so at the legal limit” and “only 18 percent of Roth IRA-owning households in 2014 report that their Roth IRAs contain amounts that were initially rolled over from employer-sponsored retirement plans.”
They Leave It Alone
Money in your retirement account does you no good unless it’s still there when you actually retire. 401(k) plans notoriously get raided through loans and hardship withdrawals, but Roth IRA investors seem to have an amazing resistance to temptation. Especially when you consider that it’s easier to pull your contributed funds out of a Roth IRA at any time without tax consequences, that’s impressive.
The study reports that “fewer than 4 percent of Roth IRA investors aged 25 or older made withdrawals, compared with nearly 23 percent of traditional IRA investors.” You might argue that this is because Roth IRA investors are on the younger side, and traditional IRA account holders have to deal with required minimum distributions. But that’s not the case: for Roth accountholders between the ages of 25 and 59 (and therefore presumably not yet retired, and certainly not yet required to take distributions), only 3.4% made withdrawals in 2013 vs. 9.1% of traditional IRA users.
They Think Long-Term
Roth IRA investors seem to use investments that (hopefully) will offer better returns over long time periods. Again, the specific investments you use are far less important than your behavior – and the study only looks at how accounts are invested in very general terms (stocks versus bonds versus cash).
Again, you could argue that this is due to age, and there’s probably some truth to that. But avoiding market risk altogether can expose you to other types of risk (like the risk of losing purchasing power due to inflation – in other words, not being able to afford stuff when you get to retirement). For many people who will have money invested for over 10 years or so, having at least some exposure to stocks is a good idea. But almost a quarter of all traditional IRA investors have shunned stocks: “10 percent of Roth IRA investors had no equity holdings (equities, equity funds, and the equity portion of balanced funds), while 23 percent of traditional IRA investors held none.”
Will It Pay Off?
The behaviors above go a really long way towards retirement success. Unfortunately, it’s the simple but difficult things that matter (like making contributions, not reacting in rash ways to scary events, and taking a big picture view). Watching the market every day and reading a list of the “Top 10 Funds for the Next Year” might feel satisfying, but the results are questionable.
These investors are controlling what they can control, and that’s the best you can do.
Some people question the wisdom of trusting the government to give you tax-free distributions from Roth IRAs in retirement. It is certainly true that the laws can change, especially in light of huge deficits and demographic changes. Hopefully that won’t happen, but it’s worth acknowledging the risks of any strategy. At just 7% of all IRA assets, Roth IRA holdings are hopefully not a juicy-looking target.
Photo credit: Daily Sublime