When you open an investment account like a traditional or Roth IRA, there’s a common mistake a lot of people make that could cost them thousands of dollars in the long run.
In this article, we’ll explain that investment mistake and what you can do to avoid it.
Avoid this mistake with your traditional or Roth IRA
Many people are making a simple error when they fund a brokerage account: They’re leaving their funds in a temporary settlement account without actually taking the additional step of investing the money.
When you open an account, it should follow a predictable pattern: You open the account, you fund the account and then you choose your investments.
It’s that last step on the right in this graphic from Fidelity Investments that people are forgetting!
Understanding the problem
When you open a brokerage account, the money you transfer to the account “lives” in a settlement fund until you choose to put it into this investment or that.
But what if you never select any investment?
The answer is that your money continues sitting there, earning paltry interest in a settlement fund, while it could instead be earning bigger bucks in the stock market.
That’s the very mistake too many people are making. They’re transferring money to their newly opened brokerage account and thinking they’ve done everything they need to do.
In reality, that settlement account where your money lives at the brokerage is only intended to be a pit stop.
You’ve got to choose a final destination for your money — and money expert Clark Howard has a place where he likes for you to start.
“Even if it’s not your thing, I like for you to put the money in a target date retirement fund closest in year to when you want to retire. That way your money is invested from the get-go. If you later want to do something more exotic with how your money is invested, then you can do it.”
Editor’s note: For a complete understanding of how target date retirement funds work, see this article.
But if you fail to make a selection, it’s a “you snooze, you lose” kind of situation. Your money just sits there and doesn’t really work for you.
How bad of a problem is this really?
Here’s an example: Let’s say that you contributed $10,000 to a brokerage account 10 years ago.
Now let’s say the money went into your settlement fund and sat there, never being invested. Over a period of 10 years, that money would only earn a little more than $300. That’s next to nothing!
Now consider the alternative: You took that same hypothetical $10,000, sent it to your brokerage and actually picked an investment like an S&P 500 index for the money.
According to research by Charles Schwab, that money would be worth somewhere between $16,000 and $30,000 today.
So, don’t make the rookie mistake of funding a traditional or Roth IRA or any other investment account but then not selecting a specific investment for the money to flow into.
How can you tell if you’re making this simple mistake?
Now that you know what the #1 mistake people make when opening an investment account is, it’s time to double-check that you’re not making it.
To do that, just log in to your brokerage account online and check the dashboard for something that looks like this…
This particular example is from a Vanguard brokerage account. As you can see, there’s about $20 in a settlement fund earning next to nothing that could be invested.
OK, so $20 may not be a huge deal. But for you it could be a problem of thousands of dollars sitting there!
If you’re not comfortable checking your account online, you could always call up your brokerage house and ask them if you have any money hanging out in a settlement fund.
Here’s some contact information to get you started:
Opening an investment account but not actually picking any investments is a big danger for first-time investors. But you can avoid this common pitfall by taking a moment to check that your money is not sitting in a settlement fund.
If you need help picking low-cost investments for your money in a settlement fund, check out our recommendations here.