Roth IRA accounts are tax-advantaged retirement accounts. If you’ve decided that a Roth IRA is the best fit for your financial goals and you meet the criteria to open such an account, it’s important to understand which investments are best so you can make the most of your money. You can invest in stocks, bonds, cash, commodities, mutual funds, and more within a Roth IRA account. So keep reading to learn how to choose the best investments for your Roth IRA.
Advantages of a Roth IRA
It’s common for people to feel confused when they hear the term “Roth IRA,” according to Chloe Elise, CEO and founder of the financial education company Deeper Than Money.
“Many people think a Roth IRA is the investment itself, when in reality, a Roth IRA is just a way to save,” Elise told The Balance via email. “There are many options for investments you can put inside it.”
First, IRA stands for individual retirement arrangement. With a traditional IRA, contributions are made with pre-tax money, and you pay income taxes on withdrawals in retirement. With a Roth IRA, contributions are made with after-tax money and withdrawals are tax-free. So, the main benefit of a Roth IRA over a traditional IRA is that the investment earnings inside the account grow without being taxed.
“It’s a great tool, especially for someone who’s younger and in a lower tax bracket than they expect to be in retirement,” Elise said. “If a person has the ability to contribute to a Roth IRA, I highly recommend they make the maximum annual contribution.”
Note: The maximum annual contribution for a Roth IRA is $6,000 for 2022 and $6,500 for 2023. Those over age 50 can contribute an additional $1,000 each year.
Best Investments for a Roth IRA
Roth IRA accounts can hold any type of investment, including stocks, bonds, cash, commodities, mutual funds, and more.
“There is no objectively wrong choice,” according to David Frederick, customer success and advisory manager at First Bank. “The difficulty lies in the missed opportunities.”
However, using a Roth IRA as just another savings account isn’t the most strategic move. Generally, it makes sense to put investments that you expect to yield the highest returns in a Roth IRA, according to Doug Crouse, owner and founder of WealthTrace financial and retirement planning.
“That’s due to the fact that withdrawals from a Roth IRA won’t be taxed,” Crouse said to The Balance via email.
Some examples of suitable investments for a Roth IRA include:
Actively Managed Funds
Actively managed funds (like many of the available mutual funds) tend to be more costly to hold compared to passively managed funds (like index funds and exchange-traded funds). One of the main reasons for this cost difference is that the active fund manager needs to make frequent trades in an attempt to outperform the market. This can generate short-term capital gains that are subject to taxes. However, by holding actively managed funds in a Roth IRA, you are protected from paying taxes on those gains.
Note: Short-term capital gains are profits from selling assets held for less than one year. They are taxed as ordinary income. Long-term capital gains are on assets sold after being held for more than one year and may be taxed at a lower rate.
Stocks
Dividend-Paying Stocks
Some stocks pay dividends to shareholders, which are a percentage of the company’s earnings, and are often distributed regularly. Dividends are also subject to long-term capital gains taxes; non-qualified dividends are taxed as ordinary income. Again, by holding these assets in a Roth IRA account, you can avoid paying those taxes.
Real Estate
Real estate investments, such as Real Estate Investment Trusts (REITs), are considered very suitable for a Roth IRA account, according to Frederick. “Depending on their structure, real estate may pay cash that could be taxable as ordinary income, which is not an issue in a Roth account.” He added that real estate can create a central investment position, which should be avoided in a core account like a traditional IRA, but fits well in an additional account like a Roth IRA.
High-Growth Stocks
Frederick stated that high-growth and speculative investments may also have an effective place in a Roth IRA. For example, these investments can lead to incurring costly long-term capital gains when sold, which can be avoided by investing in them through a Roth IRA.
Cryptocurrencies
If you’re looking to allocate some of your retirement funds to invest in a recent and highly volatile cryptocurrency (and feel comfortable with the associated risks), a Roth IRA could be one of the best places to do it, for the reasons mentioned. However, you need to be aware of the account’s rules regarding holding alternative investments, as not all providers allow this.
Note: Most retirement account management institutions will not allow you to invest in alternative assets like cryptocurrencies, promissory notes, mortgage certificates, or private equity funds. Instead, you will likely need a self-directed retirement account, which allows you to invest in these types of investments.
Investments That May Not Be Suitable for a Roth IRA
On the other hand, low-yield investments are
Source: https://www.thebalancemoney.com/best-types-of-roth-ira-investments-5219820
Leave a Reply