"What is the best IRA rate out there?" is a question I hear frequently.
"There is no such thing as an IRA rate," I reply.
"What? What are you talking about?"
No Such Thing As An IRA Rate
It's true. There is no such thing as an IRA rate. It is a term that is commonly misunderstood.
An IRA, or Individual Retirement Account, is just that - an account. Think of it like a bucket.
Suppose I was holding a bucket, and I asked you to tell me how much it weighed. In order to answer that you would need to know what was in the bucket; air, water, sand, or bricks, for example.
Just like determining how much the bucket weighs, in order to determine an IRA rate, you have to decide what type of investments will be inside that IRA.
IRA Rates Are Determined By the Underlying Investments Such As:
- An IRA can own CDs (certificates of deposit) in which case you would look for the best CD rates.
- An IRA can invest in a fixed annuity, in which case you would look for the best fixed annuity rates.
- An IRA can own treasury securities, or government bonds, in which case the IRA rate will be a combination of the interest rates paid by the underlying bonds that it owns.
- An IRA can own mutual funds, in which case you would have to decide whether to own stock, bond, or balanced mutual funds, and look at the performance history to determine their past rate of return. And of course last year's return does not mean that it is what it will earn this year.
- An IRA can own individual stocks, and if structured properly, an IRA can even own real estate, as well as just about any other type of investment you can think of.
So, before you search for the best IRA rate, remember that the term IRA is just a title that describes the tax treatment that applies to the investments inside of that IRA.
To determine the best IRA rate, first, you have to decide how much investment risk you are comfortable taking. Most investment choices that have the potential to pay a higher rate of return over the long run offer less stability over the short term.
Once you've chosen the investments you think you want your IRA to hold you can then look at the performance history of those investments, which would only be called a "rate" if it was an interest paying investment like a CD, fixed annuity, or bond.
What to Watch Out For
If an investment firm seems to be offering a much higher rate than you can find anywhere else, you need to be cautious. No one gives money away.
Many advertisements I see lure someone in with a promise of a high rate, but when you read the fine print and see how the investment is actually structured it is usually not nearly as attractive as the advertising makes it appear. Often these advertisements are sponsored by firms that receive a commission to sell you their investment products. If something seems to good to be true have someone independent help you evaluate the investment before you buy. I've watched far too many people lose money all in the hopes of earning a slightly higher rate of return.