Best Investments for Your Roth IRA (2024)

There are a variety of investment options from which investors can choose in constructing a portfolio for their Roth IRA, a type of tax-advantaged individual retirement account. Compared to traditional IRAs, a key feature ofRoth IRAs is that they are allowed to grow tax free, although fund contributions are not tax-deductible.

Upon retirement, investors can make fund withdrawals without paying taxes or penalties as long as they abide by theRoth IRA withdrawal rules. Investors who have reached at least age 59½ and have been contributing to their Roth IRA for more than five years will qualify for tax- and penalty-free withdrawals.

Investors building a Roth IRA to save for retirement will want to design a portfolio using a long-term, buy-and-hold approach. A strong portfolio will be diversified across different asset classes, such as stocks and bonds, and across market sectors. Further diversification can be obtained by investing in assets from different geographic regions. Investors also should focus on minimizing costs, because costs are a major factor in determining returns over the long term.

A few core index funds, including exchange traded funds (ETFs) and conventional mutual funds, may be enough to meet most investors’ diversification needs at a minimal cost. On the surface, the tax efficiency of ETFs may appear to make them a favored fund option since they don’t regularly distribute capital gains. But capital gains are not taxed in a Roth IRA; thus, ETFs lose one of their primary advantages over mutual funds. As a result, investors should consider both ETFs and mutual funds when considering investments for their Roth IRA.

Key Takeaways

  • Roth IRAs are a type of tax-advantaged individual retirement account that should be invested in with a long-term perspective in mind.
  • A good foundation for a Roth IRA portfolio is a combination of a broad-based U.S. stock index fund and a broad-based U.S. bond index fund.
  • Investors looking to increase their diversification might consider adding a global foreign stock index fund or even an emerging market fund for those with a greater appetite for risk.
  • Investors are likely to want to shift into less risky assets as they approach retirement.

U.S. Stock Index Funds

One of the central building blocks of a long-term retirement portfolio is a broad-based U.S. stock index fund, which will serve as the main driver of growth for most investors. Investors can choose either . U.S. total market funds attempt to replicate the performance of the entire U.S. equity market, including small-cap and midcap stocks, whereas an S&P 500 index fund is focused entirely on large caps. The former type of fund is likely to exhibit slightly higher volatility and produce slightly higher returns, but the difference will be fairly minimal over the long term. That’s because even total market funds are generally heavily weighted toward large caps.

Investors also may benefit from the low costs associated with the passive management characteristic of index funds. There is strong evidence that index funds, which attempt to mimic the performance of an index by passively investing in the securities included in the index, generally outperform actively managed funds over the long term. The main reason for that outperformance is differences in costs.

However, there are some investment categories where low-cost active funds tend to outperform passive funds. A passively managed U.S. stock index fund, when held for the long term, has the potential to benefit from the growth of the U.S. equity market over time. Such a strategy may avoid the significant trading costs of actively managed funds whose managers often try to time the short-term ups and downs of the market.

A broad-based U.S. stock index fund carries a certain degree of risk but also provides investors with fairly strong growth opportunities. It is one of the foundations of a long-term retirement account. However, for those with a very lowrisk toleranceor who are approaching the age of retirement, a more income-oriented portfolio may be a better option.

U.S. Bond Index Funds

Adding a U.S. bond index fund to an investment portfolio helps to reduce the portfolio’s overall risk. Bonds and other debt securities offer investors more stable and secure sources of income compared to stocks, but they tend to generate lower returns. An inexpensive bond fund that tracks a U.S. aggregate bond index is ideal for providing investors with broad exposure to this less risky asset class. An aggregate bond index typically provides exposure to Treasurys, corporate bonds, and other types of debt securities.

Investors seeking to construct a long-term retirement portfolio will want to have exposure to both stocks and bonds, which they can achieve through a single stock index fund and a single bond index fund. The exact proportion of stocks to bonds will depend on two primary factors: how close the investor is to the age of retirement and how risk-averse they are.

The traditional investing approach has been that a 60/40 portfolio—60% stocks and 40% bonds—will satisfy the needs of most investors, and that the proportion of stocks relative to bonds should shrink as the investor ages. Another traditional yardstick has been “100 minus your age.” This means that a 30-year-old should hold 70% stocks and 30% bonds, and by age 40, they should have a 60/40 portfolio.

However, that approach has changed for many financial advisors and prominent investors,including Warren Buffett. Many financial experts today recommend holding a higher percentage of stocks, especially as people are living longer and thus are more likely to outlive their retirement savings. Investors should always consider their own financial situation and risk appetite before making any investment decision.

A broad-based U.S. bond or fixed-income fund is generally less risky than an equity fund. However, bond funds don’t provide the same growth potential, which means generally lower returns. They can be useful tools both for risk-averse investors and as part of a portfolio diversification strategy.

Global Stock Index Funds

Investors can diversify their portfolios further by adding a global stock index fund that holds a broad selection of non-U.S. stocks. A long-term portfolio that includes a global stock index fund provides exposure to the broader world economy and lessens exposure to the U.S. economy in particular. Inexpensive funds that track an index like the MSCI ACWI (Morgan Stanley Capital International All Country World Index) Ex-U.S. or the EAFE (Europe, Australasia, Far East) Index provide broad geographical diversification at a relatively low cost.

Investors with a greater degree of risk tolerance may choose to invest in an international index fund with a particular focus on emerging market economies. Emerging market countries, such as China, Mexico, and Brazil, may exhibit higher but more volatile economic growth than the economies of developed countries, such as France or Germany. Though it’s also riskier, a portfolio with greater exposure to emerging markets has traditionally yielded higher returns than a portfolio that’s more focused on developed markets. However, emerging markets have been facing especially heightened risks amid the ongoing COVID-19 pandemic.

Consistent withmodern portfolio theory, risk-averse investors will find that investing in a broad-based U.S. stock index fund and a broad-based U.S. bond index fund provides a significant degree of diversification. Furthermore, the combination of a U.S. stock index fund, a U.S. bond index fund, and a global stock index fund provides an even greater degree of diversification. Such an approach has the potential to maximize returns over the long term while minimizing risks.

What is best to invest in for a Roth individual retirement account (Roth IRA)?

Some of the best investments for a long-term retirement account like a Roth individual retirement account (Roth IRA) are a few inexpensive core index funds. A single low-cost U.S. stock index fund and a single low-cost U.S. bond index fund provide enough diversification to maximize returns and minimize risk over the long term. For added diversification, investors might also include a low-cost global index fund.

Can you choose your own investments in a Roth IRA?

Yes. Investors can open a Roth IRA using an online broker. When they are ready to buy investments to hold in the account, they have many choices and categories to choose from.

Can you have two Roth IRAs?

Yes. There is no limit to the number of Roth IRAs that you can have. However, increasing the number of Roth IRAs does not increase the total amount that can be contributed each year. Whether you have one IRA or multiple IRAs, the total contribution limit across an investor’s IRAs is the same.

The Bottom Line

Investors looking to save for retirement with a Roth IRA will want to focus on the long term and choose investments that are inexpensive and provide significant diversification. One of the simplest ways is by investing in a few core index funds. Ideally, a strong portfolio will contain a single U.S. stock index fund, which provides broad exposure to U.S. economic growth, and a single U.S. bond index fund, which provides exposure to relatively safer income-generating assets. For added diversification, investors should consider a global stock index fund, which provides exposure to a broad range of developed and emerging markets.

Introduction

As an expert in retirement planning and investment strategies, I can provide you with valuable insights on the topic of investing in a Roth IRA. I have extensive knowledge and experience in this area, which I will demonstrate by discussing the concepts mentioned in the article you provided.

Roth IRA Overview

A Roth IRA is a type of tax-advantaged individual retirement account that offers unique benefits compared to traditional IRAs. One key feature of a Roth IRA is that it allows for tax-free growth, meaning that any investment gains within the account are not subject to taxes. However, contributions to a Roth IRA are not tax-deductible.

Upon retirement, investors can make withdrawals from their Roth IRA without paying taxes or penalties, as long as they adhere to the Roth IRA withdrawal rules. To qualify for tax- and penalty-free withdrawals, investors must have reached the age of 59½ and have been contributing to their Roth IRA for at least five years.

Designing a Roth IRA Portfolio

When building a Roth IRA portfolio for retirement savings, it is important to adopt a long-term, buy-and-hold approach. A well-designed portfolio should be diversified across different asset classes, such as stocks and bonds, as well as across various market sectors. Geographic diversification can also be achieved by investing in assets from different regions.

Minimizing costs is crucial when constructing a Roth IRA portfolio, as expenses can significantly impact long-term returns. One cost-effective strategy is to invest in a few core index funds, including exchange-traded funds (ETFs) and conventional mutual funds. These funds provide broad exposure to the market at a minimal cost.

While ETFs may appear tax-efficient due to their avoidance of regular capital gains distributions, this advantage is not applicable within a Roth IRA, as capital gains are not taxed. Therefore, investors should consider both ETFs and mutual funds when selecting investments for their Roth IRA.

Key Concepts from the Article

  1. Roth IRA Withdrawal Rules: Investors can make tax- and penalty-free withdrawals from their Roth IRA if they have reached the age of 59½ and have been contributing to the account for at least five years.
  2. Long-Term, Buy-and-Hold Approach: A successful Roth IRA portfolio should be designed with a focus on long-term investing and avoiding frequent trading.
  3. Diversification: A strong portfolio should be diversified across different asset classes, market sectors, and geographic regions to reduce risk.
  4. Minimizing Costs: Costs play a significant role in determining long-term returns, so investors should focus on minimizing expenses when selecting investments.
  5. Core Index Funds: Investing in a few low-cost core index funds, such as U.S. stock index funds and U.S. bond index funds, can provide sufficient diversification for a Roth IRA portfolio.
  6. Global Stock Index Funds: Adding a global stock index fund to the portfolio can further diversify investments and provide exposure to non-U.S. stocks.
  7. Risk and Return: Investors should consider their risk tolerance and time horizon when determining the proportion of stocks and bonds in their portfolio.
  8. Emerging Market Funds: Investors with a higher risk tolerance may choose to include emerging market funds for potential higher returns, although these investments come with increased volatility.
  9. Modern Portfolio Theory: Combining U.S. stock index funds, U.S. bond index funds, and global stock index funds can provide a well-diversified portfolio that maximizes returns while minimizing risks.

Conclusion

Investing in a Roth IRA requires careful consideration and a long-term perspective. By following a diversified approach, minimizing costs, and selecting core index funds, investors can build a strong portfolio that maximizes returns and minimizes risk. It is important to consider individual risk tolerance, time horizon, and financial goals when designing a Roth IRA portfolio.

Best Investments for Your Roth IRA (2024)
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