When constructing a portfolio for your Roth IRA—a type of tax-advantaged individual retirement account—you have a variety of investment options to choose from.
Just like traditional IRAs, Roth IRAs can grow tax-free. However, unlike traditional IRAs, contributions to Roth IRAs are not tax-deductible. Still, you can withdraw contributions tax- and penalty-free from a Roth IRA at any time. You can withdraw earnings without paying taxes or penalties as long as you abide by the Roth IRA withdrawal rules: you must have been contributing to that–or some other–Roth IRA for more than five years. And you must have reached at least age 59 ½ or qualified for an exemption, such as an IRS-recognized disability.
If you're building a Roth IRA to save for retirement, you'll want to design a portfolio using a long-term, buy-and-hold approach. A strong portfolio will be diversified across different asset classes, such as stocks and bonds, and across market sectors. Further diversification can be obtained by investing in assets from different geographic regions. You should also focus on minimizing costs, such as fees, because they are a major factor in determining returns over the long term.
A few core index funds, including exchange-traded funds (ETFs) and conventional mutual funds, should be enough to meet most investors’ diversification needs at a minimal cost. On the surface, the tax efficiency of ETFs may appear to make them a favored fund option since they don’t regularly distribute capital gains.3 But capital gains are not taxed in a Roth IRA4. Nor are they taxed inside any tax-sheltered account like an IRA or 401(k), whether it is a traditional or Roth type of account. That negates what would otherwise be a potential advantage of ETFs over mutual funds when they are held in taxable brokerage accounts. As a result, investors should consider both ETFs and mutual funds when considering investments for their Roth IRA.
Key Takeaways
- Roth IRAs are a type of tax-advantaged individual retirement account that should be invested in with a long-term perspective in mind.
- Roth IRA investors who want to dampen volatility over time should aim for a portfolio that combines a broad-based U.S. stock index fund with a broad-based U.S. bond index fun.
- Investors willing to tolerate more volatility in pursuit of greater total returns over extended periods can throttle back their diversification, aiming for a Roth IRA portfolio with little if any allocation to bonds.
- In contrast, investors looking to increase their diversification might consider adding a global or international stock index fund or even an emerging markets fund for those with a greater appetite for risk.
- Investors are likely to want to shift into less risky assets as they approach retirement.
U.S. Stock Index Funds
One of the central building blocks of a long-term retirement portfolio is a broad-based, passively-managed (and thus low-cost) U.S. stock index fund, which will serve as the main driver of growth for most investors.
You can choose either . U.S. total market funds attempt to replicate the performance of the entire U.S. equity market, including small-cap and mid-cap stocks, whereas an S&P 500 index fund is focused entirely on large caps. Small- and mid-caps may exhibit higher volatility but producehigher returns.
There's strong evidence that index funds, which attempt to mimic the performance of an index by passively investing in the securities included in the index, generally outperform actively-managed funds over the long term. One reason for that outperformance is differences in costs, such as management fees.
A passively-managed U.S. stock index fund, when held for the long term, has the potential to benefit from the growth of the U.S. equity market over time. Such a strategy may avoid the significant trading costs of actively-managed funds whose managers try to time the short-term ups and downs of the market.
A broad-based U.S. stock index fund carries a certain degree of risk but provides you with fairly strong growth opportunities. It's foundational for a long-term retirement account. However, those with a very low risk tolerance or who are approaching or entering retirement may want to trim their risk of volatility by boosting their portfolio’s allocation to income-oriented assets such as bonds.
U.S. Bond Index Funds
Adding a U.S. bond index fund to your investment portfolio will help reduce your portfolio’s overall risk over time. Bonds and other debt securities typically offer investors more stable and secure sources of income compared to stocks, but they tend to generate lower returns. A low-cost bond fund that tracks a U.S. aggregate bond index can provide investors with broad exposure to this less risky asset class most of the time. An aggregate bond index typically provides exposure to Treasurys, corporate bonds, and other types of debt securities.
For a long-term retirement portfolio, most investors want exposure to stocks and bonds, which they can achieve through a single stock index fund plus a single bond index fund or through a so-called balanced fund, which holds both stocks and bonds.
Mixing and matching stock funds with bond funds, or by your choice of one balanced fund rather than another, you can achieve any specific ratio you like of stocks to bonds. The exact proportion of stocks to bonds that you seek will depend on five primary factors: how close you are to retirement age, how long you expect to live, how risk-averse you are, your financial goals, and how much you prioritize growth through stocks versus income from bonds.
Based on performance data that in some cases goes back to 1820, the traditional view has been that a 60/40 portfolio—60% stocks (mainly U.S. large caps) and 40% bonds (basically 10-year U.S. Treasury notes)—will satisfy the needs of most investors.
Many investors use the 60/40 strategy as a starting point for retirees. They boost the proportion of bonds to stocks as they advance into retirement.
Another popular yardstick is “100 minus your age,” applied throughout life. This means that a 30-year-old should hold 70% stocks and 30% bonds, and by age 40, they should have a 60/40 portfolio.
However, many financial experts, including Warren Buffett, recommend sticking with a higher percentage of stocks, as people are living longer and thus are more likely to outlive retirement savings whose stock weighting is not high enough to keeping them growing well into retirement. Investors should always consider their own financial situation and risk appetite before making any investment decision.
A broad-based U.S. bond or fixed-income fund is generally less susceptible to loss of value in the long run than an equity fund. However, bond funds don’t provide the same growth potential, which means generally lower returns. They can be useful tools both for risk-averse investors and as part of a portfolio diversification strategy.
Global Stock Index Funds
You can diversify your portfolios further by adding a global stock index fund that holds a broad selection of non-U.S. stocks. A long-term portfolio that includes a global stock index fund provides exposure to the broader world economy and lessens exposure to the U.S. economy in particular. Inexpensive funds that track an index like the MSCI ACWI (Morgan Stanley Capital International All Country World Index) Ex-U.S. or the EAFE (Europe, Australasia, Far East) Index provide broad geographical diversification at a relatively low cost.
Investors with a greater degree of risk tolerance may choose to invest in an index fund with a particular focus on emerging market economies. Emerging market countries, such as China, Mexico, and Brazil, can exhibit higher but more volatile economic growth than other countries, such as France or Germany. Though they’re riskier, portfolios with greater exposure to emerging markets have typically yielded higher returns than portfolios focused on non-emerging markets.
Consistent with modern portfolio theory, risk-averse investors will find that investing in a broad-based U.S. stock index fund and a broad-based U.S. bond index fund provides a significant degree of diversification. Adding a global stock index fund to the mix provides a greater degree of diversification, and it has the potential to maximize returns over the long term while minimizing risks.
What Is Best to Invest in for a Roth Individual Retirement Account (Roth IRA)?
Some of the best investments for a long-term retirement account like a Roth IRA are a few inexpensive core index funds. A single low-cost U.S. stock index fund and a single low-cost U.S. bond index fund provide enough diversification to maximize returns and minimize risk over the long term for most investors. Adding a low-cost global index fund will provide added diversification.
Can You Choose Your Own Investments in a Roth IRA?
Yes, you can choose your own investments in a Roth IRA. You can open a Roth IRA using an online broker. When you're ready to buy investments to hold in the account, you will have many options to choose from.
Can You Have Two Roth IRAs?
Yes, you can have two Roth IRAs — or more. There is no limit to the number of Roth IRAs that you can have. However, increasing the number of Roth IRAs does not increase the total amount that can be contributed each year. Whether you have one IRA or multiple IRAs, the total contribution limit across all IRAs is the same. For 2024, that limit is $7,000 for people under age 50, and $8,000 for people age 50 and older, thanks to a rule that permits $1,000 in catch-up contributions.
Retirement Security Rule: What It Is and What It Means for Investors
The purpose of the Retirement Security Rule, also known as the fiduciary rule, is to protect investors from conflicts of interest when receiving investment advice that the investor uses for retirement savings.
The rule was issued by the U.S. Department of Labor (DOL) on April 23, 2024. It takes effect on September 23, 2024 However, a one-year transition period will delay the effective date of certain conditions to 2025.
If an advisor is acting as a fiduciary under the Employee Retirement Income Security Act (ERISA), they are subject to the higher standard–the fiduciary best-advice standard rather than the lower, merely suitable advice standard. Their designation can limit products and services they are allowed to sell to clients who are saving for retirement.
The Bottom Line
If you're looking to save for retirement with a Roth IRA, you'll want to focus on the long term and choose investments that are inexpensive and provide significant diversification. One of the simplest ways to do this is to invest in a few core index funds. Ideally, a strong portfolio will contain a single U.S. stock index fund, which provides broad exposure to U.S. economic growth, and a single U.S. bond index fund, which provides exposure to relatively safer income-generating assets. For added diversification, consider adding a global stock index fund, which provides exposure to a broad range of international, including emerging, markets.
