Many investors consider the 401(k) and health savings account, or HSA, as the twin pillars of retirement planning. Yet, nestled right alongside these options is the often underestimated Roth IRA — an invaluable asset for those who qualify.
Named after Sen. William Roth of Delaware, the Roth IRA was introduced in 1997 as part of the Taxpayer Relief Act. Senator Roth championed this initiative with the primary purpose of giving Americans a more flexible, tax-advantaged way of saving for retirement.
“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.
[Sign up for stock news with our Invested newsletter.]
The tax advantages don’t just extend to investment returns, though. After age 59 ½, if a Roth IRA has been open for five years, investors can withdraw earnings tax-free. This is in addition to contributions, which can already be cashed out anytime without penalty.
Providing not just tax advantages but a flexibility that’s hard to beat, the Roth IRA can therefore serve as a cornerstone in a savvy investor’s overall financial plan.
“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 73,” says Tiana Patillo, financial advisor manager at Vanguard.
Despite these perks, investing in a Roth IRA is not without constraints. Chief among these are income qualification levels and annual contribution limits investors need to be aware of.
“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.”
Still, there are strategies investors can use to legally circumvent some of these limitations. “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.”
Here’s a look at seven of the best mutual funds and ETFs to buy and hold in a Roth IRA:
| Fund | Expense ratio | Year-to-date return as of Aug. 14 |
| Vanguard S&P 500 ETF (ticker: VOO) | 0.03% | 18.1% |
| Fidelity Total Market Index Fund (FSKAX) | 0.015% | 17.5% |
| Vanguard Total Corporate Bond ETF (VTC) | 0.04% | 1.9% |
| Vanguard Target Retirement 2070 Fund (VSVNX) | 0.08% | 12.8% |
| Avantis All Equity Markets Value ETF (AVGV) | 0.26% | 3.9%* |
| Schwab U.S. Dividend Equity ETF (SCHD) | 0.06% | 0.3% |
| Fidelity Real Estate Index Fund (FSRNX) | 0.07% | 2.1% |
*AVGV began trading on June 29, 2023.
Vanguard S&P 500 ETF (VOO)
“Roth IRAs are especially beneficial for younger investors because there is greater saving potential due to that tax-free compounding,” Patillo says. When it comes to long-term compounding potential, few investments are capable of beating a low-cost S&P 500 index ETF like VOO, which charges a low 0.03% expense ratio, or around $3 annually for a $10,000 investment.
Consider the latest results of the S&P Indices Versus Active, or SPIVA, scorecard, which showed that as of Dec. 31, 2022, 93.4% of all U.S. large-cap funds failed to outperform the S&P 500 index over the trailing 15 years. For investors who can handle the volatility of an all-equity holding like VOO, the long-term returns have historically been difficult to outperform.
Fidelity Total Market Index Fund (FSKAX)
Investors looking for maximum simplicity can consider a mutual fund like FSKAX in lieu of an exchange-traded fund, or ETF, like VOO. Compared to ETFs, mutual funds do not require an investor to buy and sell shares throughout the trading day, which can minimize transaction costs from bid-ask spreads and brokerage commissions. Setting up automated investments with a mutual fund can also be simpler.
A total stock market index fund like FSKAX makes for an ideal long-term buy-and-hold in a Roth IRA thanks to its high level of diversification and low costs. By tracking the Dow Jones U.S. Total Stock Market Index, FSKAX not only holds all the stocks in the S&P 500, but also thousands of other mid- and small-cap stocks. All this comes at an ultra-low 0.015% expense ratio with no minimum required investment.
Vanguard Total Corporate Bond ETF (VTC)
“Generally, investors should allocate funds that are 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.”
A good example is VTC, which holds investment-grade corporate bonds that are less tax-efficient compared to Treasury and municipal bonds. By holding VTC in a Roth IRA, investors can avoid incurring a tax drag on the ETF’s high yield-to-maturity of 5.5%, which can significantly improve long-term net investment returns. The ETF also charges a low 0.04% expense ratio.
Vanguard Target Retirement 2070 Fund (VSVNX)
“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. These considerations are not static. As investors age, earn more and accrue more assets, their goals may shift from growth to capital preservation and income as retirement nears. To account for this, consider a target-date fund.
A great example is VSVNX, which holds a diversified portfolio of U.S. and international stocks and bonds. Currently, VSVNX holds a 90% stock and 10% bond allocation, suitable for young investors looking to retire around 2070. Over time, VSVNX will incrementally increase its bond allocation, becoming more conservative as the target retirement date nears. The fund charges a 0.08% expense ratio.
[How to Save and Invest for a Long Retirement]
Avantis All Equity Markets Value ETF (AVGV)
“You’ll want to hold assets in a Roth that are expected to outperform your other holdings over the long term,” says Allen Mueller, director of financial planning at 7 Saturdays Financial. To achieve this, investors can employ a factor-investing approach that targets stocks with particular characteristics identified by research to contribute to outperformance. These include size, value, investment and profitability.
AVGV provides factor investors with an all-in-one, globally diversified option via an “ETF of ETFs” approach. The ETF allocates to five other Avantis ETFs that have both large-cap value and small-cap value objectives, thus providing exposure to both the value and size factor across U.S., international-developed and emerging markets. AVGV charges a 0.26% expense ratio.
Schwab U.S. Dividend Equity ETF (SCHD)
“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. “In a taxable account, these funds can incur a significant tax drag on their yield.” By holding these assets in a Roth IRA, investors can compound reinvested dividends more efficiently.
A dividend ETF to consider is SCHD, which currently pays an above-average 30-day SEC yield of 3.6%. This ETF tracks the Dow Jones U.S. Dividend 100 Index, which implements strict screeners for 10 consecutive years of dividend payments, sufficient free cash flow, good return on equity and an above-average five-year dividend growth rate. SCHD charges a 0.06% expense ratio.
Fidelity Real Estate Index Fund (FSRNX)
“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 a low-cost REIT fund, consider FSRNX, which charges a 0.07% expense ratio.
This passively managed fund tracks the MSCI US IMI Real Estate 25/25 Index, which provides exposure to a diversified portfolio of U.S.-listed real estate sector and REIT stocks. The fund also employs securities lending to generate additional income for investors. Like most Fidelity funds, FSRNX does not charge a transaction fee on Fidelity’s platform and requires no minimum investment.
More from U.S. News
Vanguard vs. Fidelity: Which Is Better for You?
ETF vs Mutual Fund: How to Choose for Your Investing Strategy
7 Best Funds to Hold in a Roth IRA originally appeared on usnews.com
Update 08/15/23: This story was previously published at an earlier date and has been updated with new information.
