Should Part of a Large IRA Be Invested More Aggressively?

A common rule of thumb is that your investments should become more conservative as you get closer to retirement.

That makes sense for many people. But what if you are 65, have a large IRA, substantial assets elsewhere, and don't expect to need most of the IRA to fund your lifestyle anytime soon?

Should your age alone determine how that IRA is invested?

I don't think it should. The more important question is what the money needs to accomplish.

Someone who depends on an IRA to pay monthly living expenses is in a very different position from someone whose retirement expenses are already well covered by other investments, Social Security, a pension or other income. The first investor may have relatively little room for a significant decline. The second may have considerably more capacity to take investment risk.

This goes back to the idea that different parts of your money can have different jobs.

For some investors, that could mean keeping much of an IRA conventionally invested while allowing a smaller portion to pursue higher growth. For someone with substantial assets elsewhere, a larger portion might reasonably have a longer time horizon and a more aggressive investment objective.

There is another reason an IRA can be particularly interesting for active investment strategies: taxes.

Some active strategies trade frequently and may realize a large number of short-term gains. In a regular taxable account, those gains can create current tax liabilities. That can mean periodically taking money out of the portfolio to pay taxes rather than leaving all of it invested.

Inside an IRA, investment gains generally aren't taxed as they occur. With a traditional IRA, taxes are generally deferred until money is withdrawn. With a Roth IRA, qualified withdrawals can be tax-free.

That can be particularly useful for an active strategy because more of the capital can remain invested and continue compounding rather than being reduced by current taxes. It doesn't make the underlying investment strategy less risky or guarantee higher returns. It simply removes one potential source of tax drag while the money remains inside the account.

But tax advantages alone aren't a reason to make an IRA aggressive.

Before taking substantially more risk, I would ask a few basic questions. How soon will you need this money? How much of your retirement wealth is represented by this IRA? Would a large decline affect your lifestyle or retirement plans? And perhaps most importantly, could you actually tolerate watching the account fall significantly without abandoning the strategy?

Required distributions and inherited IRA rules can also affect the time horizon. Traditional IRA owners generally must begin required minimum distributions at the applicable age, while inherited IRAs can have their own distribution requirements.

So I don't think the answer to “How aggressively should my IRA be invested?” can come simply from your age.

For someone who will soon depend heavily on the IRA, preserving capital and managing volatility may be especially important. But for someone with a large IRA, a long time horizon, substantial resources elsewhere and the ability to tolerate significant volatility, part of the account may reasonably have a different objective.

The better question isn't simply, “How old am I?”

It is, “When will I need this money, and what do I want it to accomplish?”