Here's What Happens When You Keep Your IRA in Cash

Saving for retirement in an IRA is one of the best things you can do for your future. It's important to have money to fall back on once your career comes to an end. And the higher your IRA balance by the time you retire, the more financial freedom you're apt to have later in life. 

But one thing you don't want to do with your IRA is keep all of your money in cash. If you do, you might end up with a major shortfall on your hands.

The problem with keeping your IRA in cash

If you're going to keep your retirement savings in cash, it makes more sense to do so in an IRA than a regular savings account. That's because you'll get a tax break on your IRA contributions, whereas there's no tax break on money you put into a savings account. 

That said, the issue with keeping your IRA in cash is that you want your money to grow at a fast enough rate to outpace inflation. Inflation is a natural part of the economic cycle that causes the value of money to erode over time. But you want your retirement savings to grow at a faster rate than inflation so you get more buying power when you're older. And leaving your IRA in cash may not allow for that. 

Investing in stocks could make a huge difference

Right now, many high-yield savings accounts are paying around 4%, which is a really high interest rate. Over time, you're more likely to earn about a 3% return.

But even if we want to be optimistic and assume a 4% average annual return on cash, if you fund your IRA with $200 a month over 45 years and keep it in cash, that leaves you with an ending balance of around $290,000. For context, a recent survey by Northwestern Mutual found that workers today think it will take an average of $1.27 million in savings to be able to retire comfortably.

Meanwhile, over the past 50 years, the stock market has delivered an average annual 10% return (before inflation), as measured by the S&P 500's performance. If you were to invest your monthly $200 contributions over 45 years in stocks instead of sticking to cash, you'd end up with a total balance of $1.725 million. That puts you beyond where workers today think you need to be for a comfortable retirement.

Of course, that $1.27 million figure should be taken with a grain of salt. The amount of money you need for a comfortable retirement should hinge on factors like your desired lifestyle and goals. 

But either way, it's pretty clear that keeping your IRA in cash alone is not a great formula for growing long-term wealth. So if you want to retire with a nice sum of money, be willing to invest your retirement savings in stocks. 

There is some risk involved, and there's no getting around that. But remember, the stock market's average annual 10% return over the past 50 years accounts for both good years and bad. Over time, the market has shown that it's likely to reward investors who take a long-term approach to buying and holding stocks. And if you're willing to do the same, there's a good chance you'll be rewarded, too.