In the battle for a comfortable retirement, you have to make sure you have the right weapon at your side. Although traditional IRAs have been around for a lot longer, a Roth IRA could do even more toward getting you the retirement of your dreams.
On Monday, I showed you how you could stiff-arm the IRS and save your way to a comfortable retirement. But as a number of readers pointed out, when it comes to picking retirement accounts, you have more than one type of IRA at your disposal. If you haven't already looked into opening a Roth IRA, there's no better time than now. Below, you'll find ideas on how to invest your money once you get it into a Roth account.
IRA benefits magnified
Opening an IRA can be the biggest step forward you'll ever take toward retiring rich. Traditional IRAs give you a nice combination of current and future benefits: You get an upfront deduction on your current-year tax return, and you also get tax deferral for as long as you can keep your money inside your IRA.
But Roth IRAs bring a benefit that's potentially worth a whole lot more. In exchange for giving up the upfront tax deduction you get with a traditional retirement account, Roth IRAs give you true tax-free growth. Even after you start taking money out of your Roth to use in retirement, you still don't have to include your withdrawals on your tax return -- and you'll never pay a penny of tax on the investment gains you earned along the way.
The right stocks for your Roth
Because of the right to take money out of your Roth IRA without paying tax, some of the concerns that exist with traditional IRAs don't apply to Roths. For instance, you don't have to worry about turning capital gains that would have qualified for a lower tax rate into higher-taxed income, as you do in a traditional IRA.
When it comes to your Roth, the optimal strategy is easy to figure out. Since Roths give you a unique opportunity to earn investment returns tax-free, the best way to make the most of your Roth is to buy investments that will produce the greatest returns. With that in mind, here are two strategies that work especially well in a Roth IRA.
Big risks, big rewards
One way to invest in a Roth is to seek out companies that are first to the punch in new industries. Often, those companies already have a history of strong share performance, which often tempts investors to conclude that their best days are behind them. Yet the combination of momentum, good management, and sustainable competitive advantages drives some stocks forward for explosive growth.
It's easy to find past examples of this. Baidu (Nasdaq: BIDU ) duplicated the experience of the U.S. tech boom long after the bubble had burst by demonstrating its dominance in China. Intuitive Surgical (Nasdaq: ISRG ) took a groundbreaking technology and built it into an effective monopoly with strong demographic trends supporting its industry. Even a concept as simple as Netflix's (Nasdaq: NFLX ) mail-order video business has spawned huge profits.
Tomorrow's blockbusters are harder to figure out, but you can still see signs. Ancestry.com (Nasdaq: ACOM ) , for example, has capitalized on a growing trend of interest in genealogy with its expertise and supporting programming.
You won't always hit the jackpot with picks like these, but when you do, the returns can be staggering. In a Roth, not paying any taxes makes those gains even more valuable.
Another angle for Roth investing is in special situations. These can produce quick profits that would ordinarily create a big tax headache in a taxable account, but they can be perfect for Roths. For instance, asset manager Affiliated Managers Group (NYSE: AMG ) got beaten down during the bear market, but when it survived the market meltdown, shares soared. Those who got in cheap were able to score big gains in a short time period.
Another example comes from spinoffs. About 10 years ago, Sara Lee (NYSE: SLE ) spun off its Coach (NYSE: COH ) division. The move made plenty of sense -- what do handbags have to do with dessert, after all? But while Sara Lee has largely languished in obscurity, Coach has seen more than 20-fold returns since the spinoff.
Not every spinoff gives you gains like that. But a study from Lehman Brothers shows that the vast majority of spinoffs outperform the markets in their first two years as independent companies. That's a potential profit maker you won't want to miss, and with a Roth IRA, you don't have to worry about taking profits as soon as they're big enough to satisfy you.
Do it now
If you haven't set up an IRA yet, there's no time like the present. You have plenty of time before this year's April 18 deadline, but if you get started now, you'll have two extra months for your money to generate tax-free gains.
Have IRA questions? Leave a comment below. And be sure to tune in every Monday and Wednesday for Dan's columns on retirement, investing, and personal finance.