Trading futures in an individual retirement account (IRA) comes with benefits as well as risks and limitations. Here’s what you need to know.
Diversification can be a good thing, especially in a retirement portfolio. Most investors use basic investment products to invest in an individual retirement account (IRA) with stocks, bonds, mutual funds, and exchange-traded funds making up a large percentage of their holdings. But what if the different asset classes in your retirement portfolio move up and down pretty closely? An experienced trader or investor might consider adding futures to their IRA.
Adding futures to an IRA account can give investors access (provided they qualify) to markets and asset classes not traditionally traded. For example, futures can give you exposure to the energy markets (crude oil), interest rates (bonds), metals (gold and silver), agriculture (soybeans and corn), equities (E-mini S&P 500), and foreign currency (euro, yen, etc.).
Trading these products via futures contracts can help diversify a portfolio, provide a hedge against inflation, and give investors a few other advantages. For example, futures contracts trade almost 24 hours per day, six days per week, and some of the most active futures contracts can provide deep liquidity. And there may be some tax advantages when trading futures via an IRA, but keep in mind those tax benefits may only apply to profits. Losses can’t be written off in an IRA. So, it’s a good idea to consult with a tax advisor before making the decision to trade futures in a retirement account.
As with anything investment related, trading futures in an IRA comes with risks and limitations.
The potential benefits of trading futures in an IRA might be clear. However, it’s important to understand the differences and intricacies of the futures markets versus more traditional securities. The biggest difference between stocks and futures is the finite life of a futures contract. A stock can be purchased, placed in an account, and held for the long term. In contrast, a futures contract requires more attention; at some point, the futures contract will expire and cease to exist. The futures contract can be closed or rolled to the next expiration cycle using a spread strategy to extend duration, which is a common practice among futures traders.
The next difference is the tick value. A tick represents the minimum price movement of a futures contract. Again, futures are a more attentive trade. Futures contracts have different tick values and tick sizes. It’s important to know the contract specs of what you’re planning to trade. For example, a one-tick move in crude oil futures may be worth $10, whereas for corn futures it could be $12.50. It may seem confusing at first glance, so start with the contracts you’re interested in knowing more about. As you expand your futures trading knowledge and experience, the values will become second nature.
Finally, futures contract symbols are formatted differently than other symbols. The forward slash (/) identifies the product as a futures contract. For example, /CL represents crude oil futures. If you forget that forward slash, you’ll get CL (Colgate-Palmolive) instead of crude oil, so it’s important to remember your slashes. The two letters after the forward slash identify the futures product; the third value identifies its expiration month; and the numbers represent the expiration year. So, for example, /ESM21 stands for the E-mini S&P 500 Index futures contract that expires in June 2021 (see figure 1).
Allocating a small percentage of your retirement portfolio to futures could be helpful at times. Say there’s talk of a commodity boom starting. If investors want to get a piece of that action, adding futures to a retirement portfolio by might be one way to do it.
TD Ameritrade offers a broad array of futures trading tools and resources. Access more than 70 futures products virtually 24 hours a day, six days a week.
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