ETFs make excellent additions to IRAs because they provide diversification, low costs and tax efficiency – three categories critical for long-term retirement success including U.S. stocks, bonds and global investing.
Before selecting ETFs for your Roth IRA, carefully consider your goals, risk tolerance and time horizon. Select funds which align with these objectives.
Stocks
Roth IRAs provide tax-efficient investing because the investment gains accrue tax-free as long as money remains in the account. While you can use individual stocks, many investors prefer mutual funds or exchange-traded funds (ETFs).
ETFs (exchange-traded funds) are baskets of investments traded during market hours on an exchange. ETFs offer diversification with low expenses. Some ETFs track broad market indexes while others may target specific sectors.
Value stock funds look for companies whose shares are undervalued, leading to lower volatility and greater long-term returns. Furthermore, dividends from such funds provide extra income during retirement.
Growth stock funds invest in companies with fast-growing stocks. While more risky than value stock funds, they may produce superior long-term returns. Unfortunately, growth stocks tend to offer less in dividend payments than value stocks; for an effective portfolio balancing strategy consider adding both an ETF with fast growth potential and one with value stocks into your Roth IRA portfolio.
Bonds
Roth IRAs provide an efficient means of diversifying a portfolio. After-tax returns from investments may often exceed pre-tax ones; this can make an especially notable impactful difference when dealing with funds like Vanguard Wellesley Income Fund Investor Shares (ticker: VWINX), with quarterly distributions typically adding up to over 5% total return over long periods. Housing these funds within a Roth can maximize their full potential while keeping after-tax returns as low as possible.
Core bond funds focused on investment-grade debt can offer steady income while spreading risk across your portfolio. Many investors also use an account like this one to hold Treasury Inflation-Protected Securities, or TIPS, which protect principal from inflation while yielding tax-free returns when held in an IRA account. But be wary of high-yield bond funds which come with greater risks but may not make you as much money as lower risk, higher-rated ones.
Small-Caps
Roth IRAs provide investors with an effective way to save for retirement with tax-free withdrawals after age 59 1/2, but to maximize its potential investors should select low-cost funds with strong diversification capabilities.
ETFs offer plenty of investment opportunities, but you should select ones that complement your strategy and goals. Ally Trader makes this easier by providing an award-winning Self-Directed Trading account without minimum deposits or commission fees on stocks, ETFs and mutual funds.
Vanguard Dividend Growth ETF (VDIGX) funds focus on companies with a history of increasing dividend payouts, which can be reinvested into more shares over time and expand your returns without incurring taxes. Another good choice is iShares Russell 2000 Value Index Fund (AVUV), which screens small cap stocks based on price-to-book and profitability-to-book ratios and has outshone its benchmark in recent years.
Global Investing
Roth IRAs’ primary goal is to build wealth for retirement, and one method is by selecting ETFs with diverse portfolios that provide significant diversification across asset classes such as U.S. stock index funds, bond index funds and global investing funds. Core index funds tend to be relatively inexpensive while providing significant diversification. These may include US stock index funds, bond index funds and global investing index funds as examples of core index funds that may offer broad coverage across asset classes.
Roth IRA investments should provide an optimal blend of growth potential and steady returns. Technology stocks can generate substantial long-term gains by focusing on growth while reinvesting dividends; however, for greater diversification you should use core bond funds rather than high yield bond funds that carry an increased risk that they won’t meet their interest payment obligations.
Many online brokerages provide low-cost Roth IRA investments. You may also open your IRA at your bank or through a robo-advisor (which charges an annual management fee to manage an ETF portfolio based on age, risk tolerance and other criteria), though an online broker offers more investment choices and lower fees.
