Maxed out your 401(k) match and still have some cash left over to invest with? Before you open a taxable brokerage account, consider checking if you qualify for a Roth IRA. This handy account allows investors to make after-tax contributions in exchange for tax-free future withdrawals.
“A Roth IRA is an account that you can contribute after-tax contributions to, with investment returns, income and dividends growing tax deferred,” says Scott Krase, wealth manager at Connor & Gallagher OneSource. While contributions can be withdrawn any time without penalty, earnings only receive tax-exempt status after age 59 1/2, provided the account has been open for at least five tax years.
“Roth IRAs are an attractive financial savings vehicle because investors can contribute to them regardless of age and take advantage of tax-free income in retirement, with no required minimum distribution, unlike a traditional IRA which requires distributions at age 70 1/2,” says Tiana Patillo, financial advisor manager at Vanguard.
However, there are restrictions on who can access a Roth IRA and how much can be contributed to one. “Modified annual gross income, or MAGI, limits on Roth IRA contributions for the 2023 tax year are $153,000 for single filers and $228,000 for married couples filing jointly,” Krase says. “For 2023, the contribution limit for most investors is $6,500, or $7,500 if you are 50 or older.”
That being said, there are ways to access a Roth IRA even if your income exceeds this threshold. “If your income is too high for a Roth IRA, you could use a ‘backdoor strategy’ by placing your contribution in a traditional IRA, which has no income limits,” Patillo says. “Then, you’d move the money into a Roth IRA using a Roth conversion.”
Roth IRAs are also very flexible in terms of investment options. While 401(k) accounts may have a limited number of fund selections, a Roth IRA can invest in a wide range of assets, from individual stocks, mutual funds and even exchange-traded funds, or ETFs.
“The type of assets held in your Roth IRA should be based on your risk tolerance, time horizon for needing the funds, and your goals for retirement,” Krase says. For a do-it-yourself, or DIY, investor, a portfolio of mutual funds and ETFs can offer greater diversification compared to single stocks, but there are some considerations to keep in mind.
“Generally, investors should allocate funds that are inherently less tax-efficient in a Roth IRA,” says Lauren Wybar, senior wealth advisor at Vanguard. “For example, taxable bonds and real estate investment trusts make regular income payments, and actively managed stock funds are more likely to distribute taxable capital gains. By holding these investments in a Roth IRA, investors can avoid immediate tax burdens.”
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Here’s a look at seven of the best funds to hold in a Roth IRA:
| Fund | Inception Date | Total Annualized Return Since Inception |
| Vanguard Total World Stock Index Fund Admiral Shares (ticker: VTWAX) | 2/7/2019 | 9.1% |
| DFA US Small Cap Value Portfolio I (DFSVX) | 3/2/1993 | 10.8% |
| iShares Core High Dividend ETF (HDV) | 3/29/2011 | 9.8% |
| Schwab U.S. REIT ETF (SCHH) | 1/13/2011 | 6.3% |
| Fidelity Freedom Index 2060 Fund Investor Class (FDKLX) | 8/5/2014 | 7.4% |
| iShares Broad USD Investment Grade Corporate Bond ETF (USIG) | 1/5/2007 | 3.8% |
| Vanguard Balanced Index Fund Admiral Shares (VBIAX) | 11/13/2000 | 6.3% |
Vanguard Total World Stock Index Fund Admiral Shares (VTWAX)
“Roth IRAs are especially beneficial for younger investors because there is greater saving potential due to that tax-free compounding,” Patillo says. For maximum growth potential, a young investor with a long time horizon and high risk tolerance could opt for VTWAX. This passively managed mutual fund is entirely comprised of globally diversified equities by tracking the FTSE Global All Cap Index.
Currently, VTWAX holds over 9,500 stocks split between multiple geographies, with 62% held in North American stocks, 11% in Pacific-region stocks, 17% in European stocks and 10% in emerging-market stocks. This split reflects the current market-cap weighted composition of the world’s investable markets. VTWAX charges a 0.1% expense ratio, or $10 annually for a $10,000 investment, and requires a $3,000 minimum investment.
DFA US Small Cap Value Portfolio I (DFSVX)
“You’ll want to hold assets in a Roth that are expected to outperform your other holdings over the long term,” says Allen Mueller, founder and financial planner at 7 Saturdays Financial. For aggressive investors that believe in the academic body of research behind factor investing, a fund like DFSVX that targets stocks with small market caps and lower valuations can be a potential high-conviction core holding.
As its name suggests, DFSVX tracks small-cap stocks that are considered undervalued, factors that have empirically been proven to drive historical asset returns. The fund is managed by Dimensional Fund Advisors, a firm with a reputation for successful factor investing. Historically, DFSVX has beaten its benchmark, the Russell 2000 Value Index, over the last 10 years, returning an annualized 8.5% versus 7%. The fund has an average annual total return, which includes dividends, of about 11% since its inception in 1993.
iShares Core High Dividend ETF (HDV)
“High-yield funds that pay out dividends at a higher rate than a vanilla index fund are great candidates for a Roth IRA,” says Kaleb Paddock, founder and certified financial planner at Ten Talents Financial Planning LLC.”In a taxable account, these funds can incur a significant tax drag on their yield.” An example of a high-yield ETF to consider allocating to a Roth IRA is HDV, which pays a 30-day SEC yield of 4.1%.
HDV tracks the Morningstar Dividend Yield Focus Index, which comprises 75 U.S. stocks that not only pay higher dividends than sector peers but have also been screened for financial health. This helps the ETF avoid “yield traps,” which are stocks that pay high dividends but may have poor fundamentals. Like many of iShares’ “core” lineup of ETFs, HDV charges a low 0.08% expense ratio.
[SEE: 7 of the Best High-Dividend ETFs.]
Schwab U.S. REIT ETF (SCHH)
“In a Roth IRA, real estate investment trust, or REIT, funds are great holdings for taking advantage of the comparatively high tax-free distributions,” Paddock says. “In addition, you also benefit from price appreciation given the historically strong returns REIT investing and the real estate sector have provided.” For exposure to a diversified portfolio of U.S. REITs, investors can consider SCHH.
SCHH passively tracks the Dow Jones Equity All REIT Capped Index, which holds a portfolio of around 120 U.S. REITs with mortgage and hybrid REITs excluded. Thanks to its indexing strategy, SCHH manages to keep portfolio turnover low at 5.8%, and the expense ratio minimal at 0.07%. Generally, the higher a fund’s turnover, the higher its fees are likely to be. The ETF currently pays a decently high 30-day SEC yield of 4.1%.
Fidelity Freedom Index 2060 Fund Investor Class (FDKLX)
As noted earlier, opening a Roth IRA can be particularly advantageous for young investors who can benefit from long-term compounding growth in their investments. For those looking to stay completely hands-off and retire around 2060, a great option can be a target-date fund like FDKLX. This fund provides a ready-made portfolio of U.S. and international stocks and bonds which slowly adjusts itself over time.
As time goes on, FDKLX will gradually increase its bond allocation to become more conservative, targeting income and capital preservation. Right now, the fund is around 90% stocks and 10% bonds, which is suitable for younger, risk-tolerant investors looking for growth. FDKLX charges a 0.12% expense ratio and has no minimum initial investment requirement.
iShares Broad USD Investment Grade Corporate Bond ETF (USIG)
The tax efficiency of fixed-income assets can vary greatly depending on the issuer. For instance, U.S.-government-issued Treasury bonds are usually exempt from state taxes, while municipal bonds are generally exempt from both federal and state taxes. The least tax-efficient fixed-income assets tend to be corporate bonds, which are issued by companies and usually pay out higher yields.
Thus, a corporate bond ETF like USIG may be best allocated to a tax-sheltered account like a Roth IRA. In this account, USIG’s higher 30-day SEC yield of 5.4% won’t incur a substantial drag from taxation any longer. However, do note that the higher yield of corporate bond ETFs like USIG comes from their greater degree of credit risk and default compared to Treasury bonds. USIG charges a 0.04% expense ratio.
Vanguard Balanced Index Fund Admiral Shares (VBIAX)
Investors looking to keep their Roth IRA portfolio simple can opt for a balanced fund like VBIAX. This mutual fund follows the classic “60/40” portfolio strategy, which consists of a 60% allocation to U.S. stocks, and a 40% allocation to U.S. bonds. Historically, this strategy has offered a great balance of risk and return, with VBIAX returning an annualized 6.3% since its inception in 2000.
Another benefit of VBIAX is its low 0.07% expense ratio, which is primarily due to the fund’s passive investment strategy. By tracking the CRSP US Total Market Index and Bloomberg U.S. Aggregate Float Adjusted Index, VBIAX is able to keep fees low, which means better long-term expected returns for investors. However, do note that this fund requires a $3,000 minimum initial investment.
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7 Best Funds to Hold in a Roth IRA originally appeared on usnews.com
Update 05/30/23: This story was previously published at an earlier date and has been updated with new information.
