Best investments for a Roth IRA

Key points

• A Roth IRA is a tax-advantaged retirement account that allows you to invest with after-tax money, and then enjoy tax-free investment growth and withdrawals.
• A Roth IRA is a great option for investors who expect to be in a higher tax bracket during retirement than they are now.
• Some of the best investments for your Roth IRA are mutual funds and ETFs, including stock market funds, dividend funds and more.

Whether you’re a few years from retirement or decades away, it’s important to set aside money to invest for retirement. While many people start investing in their workplace 401(k) plan, another great option is an individual retirement account (IRA).

IRAs have plenty of advantages, including having more control over your investments than a 401(k) or similar plan. You also have the benefit of choosing between a traditional and Roth IRA, each of which offers its own tax advantages.

How does a Roth IRA work?

A Roth IRA is one of the most popular types of retirement accounts available to individuals. Using this type of account, you can enjoy tax-free investment growth and tax-free withdrawals during retirement.

“Roth simply means that you will pay tax now and receive the tax benefit of not paying taxes later,” says Brennen Schlagbaum, a Certified Public Accountant and the founder of Budgetdog, which offers financial courses and advice.

Roth IRAs differ from traditional IRAs and 401(k)s because of the timing of the tax advantage. In a traditional account, you’ll get a tax deduction for your contributions but will pay income taxes on your withdrawals during retirement. With a Roth account, you pay taxes when you contribute.

When you’re deciding whether a Roth IRA is right for you, it primarily comes down to your tax liability today versus your tax liability during retirement.

“A general rule of thumb is to select Roth if you believe you will have higher taxes in the future and select traditional if you think taxes are higher now,” Schlagbaum says.

One way to determine whether a Roth IRA is right for you is based on your current versus future earnings. People early in their careers who expect their income to increase might want to take advantage of the Roth IRA while their income is lower. On the other hand, high-income earners may decide a Roth IRA isn’t right for them since it doesn’t allow them to save on taxes today.

The other thing to consider is whether tax rates overall will increase.

“One unknown variable is that we do not know future tax rates. However, perspective is key,” Schlagbaum says. “We currently have historically low tax rates.”

Best investments for a Roth IRA

When you open a Roth IRA and are ready to start contributing, it’s important to find investments that can help you grow your money for retirement and reach your financial goals.

“There is no such thing as a ‘best investment,’” Schlagbaum says. “Everyone’s situation is vastly different and there will always be a nuanced way of looking at finance. However, one type of investment you cannot go wrong with are index funds and/or ETFs.”

ETFs—short for exchange-traded funds—and index mutual funds have plenty of advantages, including low investment fees and portfolio diversification.

U.S. stock index funds

U.S. stock funds are some of the best investments for a Roth IRA. When you invest in a total stock market index fund, you gain exposure to every part of the market, including large-cap, mid-cap and small-cap stocks.

The benefit of a stock index fund is you have a well-diversified portfolio that’s guaranteed to match the stock market. Because of their passive nature, these funds also tend to have low investment fees.

U.S. bond index funds

U.S. bond funds can help you mitigate your investment risk. While they generally have lower returns than stocks, they also have less volatility, meaning they perform better during an economic downturn.

Unlike stocks, which generate a return through capital appreciation, bonds allow you to earn a fixed income in the form of interest payments. That interest can be reinvested to help your portfolio grow even more.

Global stock index fund

U.S. stocks and bonds make up the majority of most investors’ portfolios. However, you can diversify your portfolio even more by investing in global stock funds. These global funds will include stocks from around the world, allowing you to gain exposure to markets and companies from other countries.

S&P 500 index fund

The S&P 500 is a stock index that includes 500 of the largest companies in the stock market. The S&P 500 is often used as a proxy for the stock market, and investing in an S&P 500 index fund can give your portfolio broad diversification and the ability to benefit from the overall growth of the stock market.

Many major investment companies offer their own version of an S&P 500 mutual fund or ETF. Because they all track the same index, the contents of each fund should be identical. The major difference will be the fees they charge.

Nasdaq-100 index funds

The Nasdaq is the second-largest stock exchange, behind the New York Stock Exchange. The Nasdaq-100 is an index made up of 100 of the largest, most actively-traded companies listed on the Nasdaq. Because the Nasdaq is home to large technology companies, this index fund gives you plenty of exposure to this part of the stock market.

Dividend stock funds

One of the benefits of Roth IRAs and other tax-advantaged investment accounts is your income is tax-free. As a result, it can be beneficial to use this account for income-producing assets that might otherwise increase your tax burden.

One example of an income-producing asset to add to your Roth IRA portfolio is dividend stock funds. These funds specifically invest in dividend stocks, which provide consistent distributions to their shareholders. You can then reinvest these dividends to grow your portfolio even more.

REIT funds

In most cases, you can’t invest directly in real estate using your Roth IRA (that is, unless you have a special type of IRA called a self-directed IRA). However, you can still gain exposure to real estate by investing in REIT funds.

A REIT—short for real estate investment trust—is a company that owns and operates real estate investments. You get many of the benefits of owning real estate without some of the downsides, such as the time commitment required.

Like other stock funds, a REIT fund holds a variety of REITs so you can gain exposure to many different companies with a single investment.

Target-date funds

Target-date funds are some of the most popular investments for retirement accounts, and it’s easy to see why. These mutual funds, also known as lifecycle funds, gradually adjust their asset allocation over time as you near retirement.

The benefit of target-date funds is they can give you a fully diversified portfolio with a single investment. And because the fund is tied to your retirement year and adjusts over time, you don’t have to worry about making changes to your portfolio yourself.

Things to consider

As you chart your Roth IRA investment journey, there are considerations to ensure the path you take leads to your dream retirement destination. We covered some investment options above, but here are other crucial factors that will shape your Roth IRA investment strategy.

Avoid risk where possible

When it comes to your retirement fund, prioritizing stability over speculation is vital. For instance, while cryptocurrencies like bitcoin offer the potential for high returns, their volatility makes them risky for retirement accounts. Instead, focus on tried-and-true investment methods, such as diversified portfolios of stocks or mutual funds, which offer steady, reliable growth over time.

Factor in tax implications

Understanding the tax implications of your investments is key. Some investments, such as municipal bonds, are generally exempt from federal taxes, rendering no additional benefit when housed in a Roth IRA. But investments like REITs, which yield generous dividends that aren’t sheltered from taxes, could greatly benefit from a Roth IRA’s tax-free growth.

Leverage your retirement timeline

Consider your trading activity and investment timeline. In a Roth IRA, active traders won’t need to report capital gains taxes each year, and distributions during retirement are tax-free. Also, the longer your investment horizon, the higher the potential returns, which could help you save on tax dollars when you eventually make withdrawals. Balancing your investment decisions with these considerations can lead to a more secure retirement.

Frequently asked questions (FAQs)

How do you grow money in a Roth IRA?

The best way to grow money in a Roth IRA is by investing in assets that will appreciate over time and those that can generate an income, such as bonds and dividend stocks.

Can you choose your own investments in a Roth IRA?

Yes, you can choose your own investments in a Roth IRA, and most brokerage firms offer a wide variety of investment options. One exception is if you have your Roth IRA through a robo-advisor, in which case the computer algorithm will choose your investments on your behalf.

How old do you have to be to open a Roth IRA?

In most cases, you’ll have to be 18 to open your Roth IRA. However, if you’re under the age of 18, an adult can open a custodial Roth IRA on your behalf, and you’ll get control of it once you reach adulthood.

What is the downside of a Roth IRA?

The biggest downside of a Roth IRA is you can’t deduct your contributions like you can with a traditional IRA or 401(k). As a result, it won’t help you to reduce your tax burden now.