Building an investment portfolio involves many options. One effective method is using ETFs – exchange-traded funds – which track indexes or sectors. ETFs provide diversification while typically carrying lower fees than mutual funds.
But are they suitable for an IRA? That depends on an investor’s tax situation and investment goals.
Costs
ETFs offer lower costs than mutual funds and individual stocks, and may even be tax-efficient options – making them suitable investments for retirement accounts. But it is essential to understand how expense ratios affect returns.
Most ETFs charge an expense ratio fee, which is expressed as an annual percentage of your investment portfolio. A higher expense ratio decreases your return.
ETFs can be an excellent addition to your IRA portfolio as they typically provide broad diversification and access to different sectors of the market. ETFs typically follow specific indexes while others employ more complex investing strategies; some track particular sectors while others have socially responsible features; some produce dividends while others use leverage (using debt and derivatives) in order to increase returns; however, leveraged ETFs often magnify losses as well as gains, making them more risky than non-leveraged ETFs.
Taxes
ETFs are generally passively managed investments that track an index or industry; however, some are run by managers who attempt to beat the market through active management – these actively managed funds typically incur higher fees than passively managed ETFs.
As a general rule, gains from selling ETFs are subject to ordinary income tax rates both federally and state-level unless held within a tax-deferred account such as an IRA. You may be eligible to buy bonds or bond funds within your IRA account as well, though keep in mind that non-investment-grade (junk) bonds could incur an NII tax.
ETFs offer you the potential to engage in more complex investing strategies, as they allow for complex strategies. For instance, leveraged ETFs use debt and derivatives to increase returns on a particular index or benchmark; however, these ETFs tend to be more volatile than their non-leveraged counterparts and may amplify losses as well as gains.
Liquidity
Liquidity refers to how quickly an investment can be converted to cash, making it an integral component of investing and an indicator of how easily you can access your savings. Investments with higher liquidity tend to be more desirable due to reduced fees when selling. There are two techniques used for measuring liquidity – market and accounting liquidity.
An Individual Retirement Account, or IRA, offers many advantages to investors, including holding ETFs. Many online investment platforms and retirement account providers provide commission-free trading on ETFs; thus making them an appealing option for IRAs.
ETFs differ from mutual funds in that they’re passively managed, offering growth potential while mitigating risk with fixed-income investments such as bonds. You’ll find ETFs at most brokerages or through robo-advisors.
Transparency
An Individual Retirement Account (IRA) can hold virtually any form of investment, from stocks and bonds to mutual funds, annuities, unit investment trusts (UITs) and exchange-traded funds (ETFs). Many investors utilize ETFs as the mainstay of their IRA portfolio due to their lower fees.
ETFs typically track an index and are therefore passively managed, meaning their fees tend to be significantly lower than active mutual fund management fees.
ETFs trade like stocks on an exchange throughout the day and experience price changes. Their holdings are disclosed daily to provide investors with greater transparency into what they own; unlike mutual funds, ETFs do not charge front- or back-end loads – fees charged by brokers when buying or selling ETFs.
Schwab U.S. Dividend Equity ETF SCHD provides investors with exposure to dividend-paying companies such as Broadcom AVGO and Texas Instruments TXN that offer attractive yields, giving investors tax breaks as the income is deferred or protected from taxes.
