Pros and Cons of Trading in Retirement Accounts

September 7, 2023 Advanced
Trading in a retirement account has potential advantages and disadvantages for traders to consider as they assess if trading in a retirement account is part of their strategy.

Each trader has their set of unique reasons for investing. Some invest for long-term goals, while others are more focused on income. Some investors are willing to take on riskier assets for potentially higher gains, while others tread with caution.

With this in mind, traders can view their retirement account from their own lens as they make decisions about a trading strategy. Actively trading in a retirement account like an individual retirement account (IRA) comes with a different set of criteria than trading in a general account. That's why it's important for traders to aim to ensure the moves they make today don't risk putting their retirement income in jeopardy.

If a trader decides they want to trade stocks within their retirement account, there are a number of potential advantages and disadvantages to consider. Primarily, trades within accounts like IRAs or 401(k)s may benefit from tax advantages, and this strategy can be useful when rebalancing. However, traders should be aware that seemingly routine trades also have the potential to hamper portfolio performance and can be a riskier strategy.

Does risk tolerance decline with age?

Determining an appropriate risk tolerance level is a key part of figuring out whether or how a trader should be trading in their retirement account. Generally, risk tolerance is connected to a trader's investing horizon and tends to decline as they age. Some younger traders who have decades to allow their portfolios to weather market ups and downs might prefer more risk to try to pursue more return.

In contrast, traders approaching retirement who want their retirement accounts to provide income might gravitate toward a less risky portfolio to manage their funds with a more conservative approach. Traders must consider their own situation to determine their unique risk tolerance level when trading in a retirement account.

How to choose portfolio allocation

Once a trader has determined their risk level, they'll have a better sense of how much they might want to allocate to active trading in their retirement account and how much they should keep invested for the long term. In any circumstance, it's important for traders to re-evaluate their situation regularly.

More active trading may lead to more uncertainty in a portfolio, so traders who are comfortable taking on more risk might allocate a greater percentage of their portfolio to active trading than those who are more risk averse.

As with any portfolio, professional financial advisors often recommend having a healthy amount of diversification. Lumping everything into one investment is rarely a good idea. No matter how much a trader chooses to allocate to active trading, they should consider having ample emergency funds so they can attempt to avoid tapping into their retirement security funds early to meet unexpected expenses. But remember: Asset allocation and diversification don't eliminate the risk of experiencing investment losses.

Potential investment goals for trading in retirement accounts

Retirement accounts can offer tax advantages, which have the potential to bring savings advantages to investors making profitable trades. However, trading in a retirement account is not necessarily ideal for all investment goals.

Considering trading in your retirement account?

Before a trader begins trading in their retirement account, they should make sure they understand the rules of the road. There are many different types of IRAs, each with different benefits and requirements, depending on their personal situation and financial goals.

Retirement accounts are generally not ideal for short-term goals like buying a car or saving for college expenses, because depending on the type of account, there are different rules for withdrawals, penalties, and distributions. With few exceptions, early withdrawals carry a penalty, which is why traders and investors need to understand the fine print before opening an account.

How do investment strategies change over time?

Trading in a retirement account does allow traders to respond to market conditions. However, it's also risky because buying and selling quickly could also lock in losses if emotions are a driving force.

As a trader's investment goals, time horizon, and risk tolerance levels change throughout life, they can reshape a trader's investment strategies, including how they approach trading in their retirement account.

Professional advisors recommend developing a plan for trading in a retirement account and a strategy for what to do during downturns. And, of course, traders should avoid making decisions based on emotional reactions to short-term market movements.

The information provided here is for general informational purposes only and is not intended to be a substitute for specific individualized tax, legal or investment planning advice. Where specific advice is necessary or appropriate, consult with a qualified tax advisor, CPA, financial planner, or investment manager.

Investing involves risk, including loss of principal.

Diversification strategies do not ensure a profit and do not protect against losses in declining markets.

The information here should not be considered an individualized recommendation or personalized investment advice. The type of securities and investment strategies mentioned may not be suitable for everyone. Each investor needs to review a security transaction for his or her own particular situation.

All expressions of opinion are subject to change without notice in reaction to shifting market conditions.