Which investments are best for Roth IRAs?

Which investments are best for Roth IRAs?

So you are in the market for a Roth IRA, that popular, flexible, tax-advantaged vehicle that can be used to save for retirement — smart choice — but here comes the next question: which investments are best for a Roth IRA?

Roth IRA Mutual Fund Options For Investment

There are three basic options for your Roth IRA investments:

  1. Index funds
  2. Exchange traded funds (or ETFs)
  3. Managed mutual funds

It's essential whatever you choose it has as low an expense ratio as possible. Small fees can really add up. The expense ratio is what the fund charges you to run it, reflecting operating expenses such as compliance and other administrative costs. Even the cost of marketing the fund to you is passed down in some way through the expense ratio.

One very popular investment vehicle, The Vanguard Fund, has an average fund expense ratio of 0.18% and many investors see it as a low-cost leader. Regardless of what you choose, make sure you know the fund expense ratio and it's as low as possible, for sure under 1%.

Here's more about each:

Index Funds

A mutual fund that invests in indexes which are compiled and calculated independently, such as the Standard & Poor's 500.

Two main attractions with index funds:

  1. Index funds typically offer the lowest cost to manage your investments. (Since you are not doing it yourself, there's no escaping having to pay someone else. The goal, of course, is to keep that amount as low as possible.)
  2. Index funds generally outperform managed funds. You would think a paid professional who runs a mutual fund would do better than a market average, but history has consistently proven that to be a false expectation.

Related >> How to Start a Roth IRA

By far, the most popular index funds mimic the S&P 500 stock market index. There are other funds which purport to be index funds; however, they don't track an actual index. (Bond funds, for example, are called index funds simply because they offer the low management costs commonly associated with index funds.)

Exchange Traded Funds (ETFs)

One of the benefits of investing for your retirement through a Roth IRA (or a traditional IRA, for that matter) is the fact that you are not restricted solely to mutual funds. Through an IRA, you can invest in individual stocks, which opens the door to ETFs, which are nothing more than mutual funds which trade on a stock exchange just like stocks.

Related >> Considering EFTs

Most ETFs are index funds, but they offer a wider array of specialized investments. For instance, if you want to invest in gold, there are several ETFs which allow you to do that. One such ETF (which uses the GLD symbol) owns the actual gold bars, and they hold more gold than all national governments except the big three.

ETFs offer low costs, but not always quite as low and the index funds referred to above. If cost is an important consideration for you — and it should be take the time to check out all the costs of anything you want to invest in before you take the plunge.

Managed Mutual Funds

Although somewhat maligned recently, managed mutual funds still account for more than 70 percent of all retirement investment funds. There are a few reasons for that:

  1. Convenience. Managed mutual funds are usually the most convenient way to invest as an employee.
  2. Low risk. They are the oldest of the three options listed here, and have proven themselves to be pretty safe in terms of risk.
  3. Variety. They offer by far the widest variety of specialized investment options. For instance, if you don't want any investment dealing with GMO, tobacco, or other issues, you are more likely to find a managed mutual fund to meet your needs than an ETF or index fund.

Related >> A primer on mutual funds

The popularity and wide variety of managed mutual funds come with two penalties, though:

  1. High cost. Of the three options, managed funds usually are by far the most expensive. You may see rates which look low, e.g., 1.5 percent. Remember, though, that your long-term return is unlikely to be more than 7 or 8 percent. That means they will take 20 to 50 percent of your annual growth. That's a steep price for many.
  2. Bewilderment. It is not easy to distinguish between the bewildering arrays of managed mutual funds. They all seem to offer things like value and growth, and you never know which buzzwords are simply marketing gimmicks to get you to pick their fund.

When you consider that index funds and ETFs are generally simpler and cheaper, it's easy to understand why they have grown much more in recent years at the expense of managed funds.

Conclusion

Most people consider the best way to invest through a Roth IRA is by putting your money every month into index funds. They typify the get-rich-slowly ideology. Some of you will want to purchase individual stocks in your Roth IRA. Some will want to purchase real estate or invest in precious metals. If you make educated decisions, these can be excellent moves. However, for most investors, index funds are a smart way to own a piece of the market while mitigating risk.

Part 1: The extraordinary power of compound interest
Part 2: What is a Roth IRA and why should you care?
Part 3: How to open a Roth IRA (and where to do it)
Part 4: Which investments are best for a Roth IRA?
Part 5: Questions and answers about Roth IRAs

Learn More:

Safety – the Main Objective for Retirement Investments

The main objective of any investment for retirement is safety: You don't want to invest in anything risky. You may enjoy investing in things like individual stocks or property, but we all know those can be risky investments. When it comes to your retirement funds, you want to stay away from things with inordinate risk.

Flexibility is a Good Thing (Unless It's a Bad Thing)

The fact that you can use a Roth IRA to hold a variety of investments is good news – it offers flexibility. What's good about it is that you can invest in pretty much any type of investment through your Roth IRA – stocks, bonds, exchange-traded funds (ETFs), mutual funds (including index funds), and even real estate.

The bad news is that you can invest in pretty much anything – including things which might not work for you. For instance, if you thought Twitter was going to be a good stock to invest in, you would be banging your head against a wall right now.

Consider This When Selecting an Investment

With a clear understanding of the purpose of an IRA – a tax-advantaged vehicle designed to help you save for retirement – we can begin to answer the question about which investments are best for a Roth IRA. Here's what to consider:

Funding

By far, the majority of the population earns their living from a job, which typically gives them two paychecks every month. The Roth IRA is perfect for that since you can easily put away a certain amount every month, a little bit at a time. But investing in rental property is quite a bit more difficult (effectively precluding that type of investment for many) because it requires a big chunk of money at a time.

Automation

If you're like most people, setting time aside to make investment decisions is a challenge because your life is a daily whirl of activity. The tactic most successful people use is automation: They have a set amount deducted from every paycheck which is then automatically deposited into their Roth IRA account. For automation to work, you want to pick an investment which lends itself to a set amount invested every two weeks or so.

Basic Investing Concepts

It's a mistake to jump into investing and make your decisions blindly. Before you begin any investment program, it's important to have an understanding of basic concepts. Here are a few posts on some important topics:

You may also want to Google articles on risk tolerance and asset allocation. To learn more about investing, head to your library and borrow one of the following books:

The Bogleheads' Guide to Investing
A Random Walk Down Wall Street – by Burton Malkiel
The Only Investment Guide You'll Ever Need – by Andrew Tobias
Saving and Investing – by Michael Fischer

These books will help you become acquainted with concepts like asset allocation, diversification, risk tolerance, stock valuation, and more. The better educated you become, the better investment decisions you will make.

More about...Investing, Retirement

Become A Money Boss And Join 15,000 Others

Subscribe to the GRS Insider (FREE) and we’ll give you a copy of the Money Boss Manifesto (also FREE)

Yes! Sign up and get your free gift
Become A Money Boss And Join 15,000 Others
guest
32 Comments
Oldest
Newest Most Voted
Inline Feedbacks
View all comments
adam
adam
13 years ago

What do you think of the Vanguard index I’m thinking of investing in
https://flagship.vanguard.com/VGApp/hnw/funds/snapshot?FundId=0056&FundIntExt=INT
Its got a low expense, and a low minuim

J.D.
J.D.
13 years ago

I’ve had a couple of people contact me saying that they had hoped I would provide more specific recommendations. They want more info regarding asset allocation, too. I wrestled over how much to include about asset allocation. But it’s a very personal subject, and discussing it would have totally changed the article. However, it’s very clear that there’s great demand for an article on this subject. I’m never going to be able to provide specific investment advice — it’s just not possible, and I’m not qualified — but I can write another article in the near future about asset allocation… Read more »

Troy Hoshor
Troy Hoshor
13 years ago

My big confusion regarding IRA investments are A) minimum investments B) fees other than expense ratios. I use Fidelity, for example, and that Fidelity index fund you pointed out has a minimum investment of $10,000. So this means I need to spend 2.5 years into another fund while I accumulate the minimums needed to put money into an index fund. This is something I don’t see mentioned when many people chant “Index funds, Index funds!” Right now I’m in one of the lifecycle funds. Also, expense ratios are supposed to be key, but what I’ve seen (being a Fidelity customer)… Read more »

Jack
Jack
13 years ago

I highly recommend the books JD mentioned in this post. Great post!

Debbie
Debbie
13 years ago

Troy, a lot of those minimums disappear when you have money sent over monthly with some kind of automated investment plan. One thing about Roth IRAs is that there will be no more taxes. Therefore one philosophy is to keep those items which are taxed at the highest rates in your Roth IRA. For example, bond income is taxed at regular earnings rates; stock gains are taxed less, at capital gains rates; and I think the taxes on dividends are lower still. Funds with a higher turnover have higher taxes (at least while you’re growing it–I assume the taxes are… Read more »

debtkid
debtkid
13 years ago

Ahhh….PALM. Sounds like most of my trades…downhill, and fast! Good thing I stopped trading…maybe someday I’ll have money to “invest” and not “trade”.

Jacob
Jacob
13 years ago

I specifically like Vanguard’s ETFs. They have an incredibly low expense ratio (I own VTI which has been doing really well over the past year. VTI has an expense ratio of just 0.07%. Thats just 7 cents for every $100. I am willing to pay that.) Besides a low expense ratio, I get some control in what sectors I would like to invest in. So I basically I am getting generally what a managed index fund gives without the extra price or the high minimum. For a college student, being able to invest in increments smaller than $2000 is helpful.… Read more »

Bill
Bill
13 years ago

Great blog!! Great article. Thanks for all the information. I will definitely be guiding others here.

I’ll jump in on the asset allocation for 2007:

Large Growth – 40% (1-2 funds)
Large Value – 20% (1 fund)
Small Growth and Value – 25% (2 funds)
International – 15% (1 fund)

Like J.D. says it’s personal and there are many individual aspects to take into account.

Adam
Adam
13 years ago

As a financial advisor, here’s my two cents…If you’re considering mutual funds for your Roth…make sure you look at what type of shares you’re buying (A,B,or C). They are all designed for different time horizons, and the sales charge (also referred to as the load) is handled differently as well. Also read your prospectus or check with your broker to see about “breakpoints”-discounts on the usual sales load for investing above a certain dollar amount.

Mark
Mark
13 years ago

Let me make a modest point. The Roth IRA has been regarded by some as the greatest tax shelter ever invented. Money put into a Roth is never taxed: not when you make a trade with capital gains, not when you take a qualified distribution in retirement (even if you withdraw $1,000,000!). So it would seem to me that if you had a 401(k) already, with conservative investments in Vanguard mutuals, you should already be “getting rich slowly” for retirement, and you could be a bit more aggressive in the Roth. In fact a lot more–you could day trade, if… Read more »

Curtis Timberlake
Curtis Timberlake
13 years ago

I want to begin an IRA account with $1000 initially. I plan to add more as the year goes by. What mutual fund and where do you all recommend that i put my money in?

Bill
Bill
13 years ago

If you’re talking about a Roth IRA (check the rules), browse over to http://www.schwab.com (my recommendation) and open a Roth IRA with a minimum $1,000.00.

Buy Excelsior Value and Restructuring Fund, symbol UMBIX (Large Company Value Fund). Put all $1,000.00 on that fund. This fund has beaten the market by returning approx. 14% steadily for the past 10 years.

That’s what I’d do. 🙂

Curtis Timberlake
Curtis Timberlake
13 years ago

Thanks Bill. I’ll definitely look into that one. : )

SEAN
SEAN
12 years ago

HELLO EVERYONE: I FOUND THIS WEBSITE http://WWW.IRAAA.ORG AND THOUGHT I WOULD PASS IT ON…LET ME KNOW YOUR THOUGHTS….THANK YOU

KVB
KVB
12 years ago

So, can you clear this up for me? If I have individual stocks in my roth ira, am I taxed or not taxed on capital gains? I thought the answer would be no, based on the fact that earnings are tax free with Roth.

Victoria
Victoria
12 years ago

What online service company do you use for your Roth IRA?

Diane
Diane
12 years ago

I recently opened a Roth IRA with Fidelity. I didn’t have to have a minimum because I am doing an auto deposit each month. This is my very first IRA and I have no experience with this sort of thing. Fidelity is investing the money in Fidelity Cash Reserves I believe it is called. Very little growth so far. Can I pick my own fund or should I just let them pick it for me.

Justin
Justin
12 years ago

Diane,
In Fidelity accounts, Fidelity Cash Reserves is not really a mutual fund. It’s a “holding spot” for cash until you buy into a mutual fund. Call them and get an advisor on the phone- they can lead you through the process of using the money in the Cash Reserves to actually buy shares of a fund. Tjhey also answer questions you might have about some of the funds, diversification, etc.

Al
Al
12 years ago

I am starting my self-employment career and have a SEP-IRA and a Roth IRA. Since Roth IRA is completely tax free and a SEP-IRA is taxed at ordinary income when I withdraw the money, what investments should I place in each?

Dave
Dave
12 years ago

I recently opened an account at Zecco.com and have been thoroughly impressed. If you have at least $2,500 of cash/stocks/equity in your account, trades are absolutely free! The interface is really easy to use and the Zecco Community offers an easy-to-use way to communicate with other Zecco users. Check it out at: http://friends.zecco.com/r/fe5dbbde7400102b8555

Skye
Skye
12 years ago

I have decided to start investing the max every year now into an IRA. I have done some research, so I know I want a Roth IRA, plus I know I want to use an online-brokerage firm. I won’t be trading a whole lot so that does not matter to me. This money will be purely for retirement and I will not touch it until then. I am currently 38. I will be investing the entire $5,000 to start. What I cannot seem to find, is what to pick to invest in with the stock market doing so poorly right… Read more »

Eric B
Eric B
11 years ago

I know you posted this well over a year ago, but just wanted to mention that my first investment was PALM as well. I bought the morning of its IPO and sold shortly thereafter. Lost a couple hundred as well. Great learning experience.

Nikki
Nikki
10 years ago

I’ve been reading several different websites and posts concerning Roth IRAs – this is one of the best! I’m military (5-10 yrs to retirement), married, kids, plan to start second career around 40-45 years of age, about $200/month to contribute, not too savvy on stocks/bonds/mutual funds/etc. Here is my question…is there such a thing as just a cash Roth IRA? Like simply depositing money into a savings account and letting it collect interest (but you don’t touch it until you’re 59.5 years old or later). Do you HAVE to pick stocks, bonds, ETFs, market funds, etc? What kind of interest… Read more »

Lu
Lu
10 years ago

In reply to Nikki’s question re cash Roth IRA, please be aware that you can open any IRA account (Roth or traditional) at a bank. It can be invested in certificate of deposits, just like your regular accounts. Of course, you would be lucky if you can find anything at 3%.

Tim
Tim
7 years ago

IRA’s are really taking a new life lately. Gold and precious metals are becoming attractive investments for rollover accounts and are really popular options for people looking for a new manager of abandoned accounts after leaving an employer. If I can be of any help offering a guest post on this topic, I’m more than happy to be of service.

arthur holloway
arthur holloway
7 years ago

wouldn’t it be great to have a tax holiday
for IRA toO ROTH IRA account with only 10% tax

As Social Security amount payments are limited
I think this would make standard of living better in later years.

The safest way to invest in a roth IRA
The safest way to invest in a roth IRA
6 years ago

The most underrated aspect of picking funds is to make sure you pick a fund with an expense ratio as low as possible. This will pay off big in the long run.

I also like to dollar cost average my investments to make them as safe as possible. Go to notdebatable.com for a good article explaining the approach I use.

Karthigan Srinivasan @ StretchADime
Karthigan Srinivasan @ StretchADime
4 years ago

I would recommend putting money on a monthly basis into one of the S&P 500 index tracking ETFs like SPY, IVV, or VOO. All of these have very low expense ratios – below 10 basis points. I have written a blog post called Managing 401k Investments that highlights how passively managed market index tracking funds have beaten actively managed funds – http://www.stretchadime.com/managing-401k-investments.

Sanjeev
Sanjeev
4 years ago

Good Article ! I always Max out my Roth IRA in first 3 months of every year. I have been doing that for some time. I have chosen Target Date Retirement fund from Vanguard. It has worked out well for me. I like target date funds because they take care of asset allocation as I grow older. They call it “Gliding Path”. I can only invest $5500. I strongly suggest people to take advantage of ROTH IRA (if qualified) and max out it. The money is tax free when it is taken out. I also suggest to NOT take out… Read more »

jestjack
jestjack
4 years ago

Thank you for this timely article….Perhaps a follow up article about “bewilderment”….Recently I was looking for mutual funds to invest in on line offered by my broker of over 30 years, Charles Schwab. Instead of a straight forward breakdown of companies that are held within a fund, I have a breakdown of funds held in the fund and these particular funds may have other funds within them…Seems to be like a “house of cards” or like “peeling an onion”….Am I missing something?

Kristi @ Femme Frugality
Kristi @ Femme Frugality
4 years ago

Thanks for sharing these tips on investing. I’m not nearly as experienced with investing as most of the other commenters. Breaking into the world of investments feels terrifying. Right now I’m just trying to focus on maxing out my Roth IRA.

Katherine
Katherine
4 years ago

Roth IRA’s are a great investment option. It can be hard to find an investment mix though! My advice is to develop a relationship with a financial planner and assess with him or her all the options. I ended up changing my investment strategy in 2009 – a risky move that my financial planner encouraged me to do, and I am happy to say that it has paid off.

shares