When it comes to saving for retirement or building long-term wealth, the Roth IRA stands as one of the most potent types of investment accounts for U.S. investors. Since its inception in 1998, this account has been a cornerstone in most American retirement plans.
“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.
The account’s “double tax advantage” makes it a compelling option: Contributions are made with after-tax dollars, allowing for tax-free growth and, importantly, tax-free withdrawals in retirement at age 59½. You can cash out your contributions at any time, penalty-free.
“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.
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One often-overlooked aspect of wealth building is the strategic placement of specific types of investment funds across various account types — a concept known as “asset location.”
When you have multiple accounts with different tax implications, such as a tax-deferred 401(k), a health savings account (triple-tax-advantaged for medical expenses) and a taxable account that is subject to capital gains tax, optimizing the type of investments you hold in each can have a substantial impact.
This is because not all funds are created equal, and some can yield significantly higher after-tax returns when housed in a Roth IRA. For example, funds that generate high returns but are also tax-inefficient may be best suited for a Roth IRA, where their growth and withdrawals are tax-free.
On the other hand, conservative or tax-efficient funds might be better placed in a taxable account. Similarly, your 401(k) might be best for funds that offer steady but lower growth, which will eventually be taxed as income upon withdrawal.
In other words, it’s important to consider not just what you invest in, but also where you invest.
That being said, the Roth IRA’s plethora of benefits also come with certain limitations 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.”
Investors who fall into this category still have options when it comes to a Roth IRA. “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.” However, this may result in a taxable event for the year the conversion takes place.
Here are seven of the best mutual funds and exchange-traded funds, or ETFs, to hold in a Roth IRA:
| Fund | Expense ratio |
| Vanguard Total Stock Market ETF (ticker: VTI) | 0.03% |
| Vanguard 500 Index Fund Admiral Shares (VFIAX) | 0.04% |
| Vanguard High-Yield Corporate Fund Investor Shares (VWEHX) | 0.23% |
| Fidelity Freedom Index Income Fund Investor Class (FIKFX) | 0.12% |
| Avantis All Equity Markets Value ETF (AVGV) | 0.26% |
| iShares Core High Dividend ETF (HDV) | 0.08% |
| Schwab U.S. REIT ETF (SCHH) | 0.07% |
Vanguard Total Stock Market ETF (VTI)
“Roth IRAs are especially beneficial for younger investors because there is greater saving potential due to that tax-free compounding,” Patillo says. For younger investors with a high risk tolerance, a total stock market index ETF like VTI could be a great way to put this strategy into play. Historically, this fund has delivered excellent performance, with an annualized 8.1% return since its inception in May 2001.
By tracking the CRSP U.S. Total Market Index, VTI delivers diversified exposure to some 3,800 large-, mid- and small-cap U.S. stocks, weighted by market capitalization. Its portfolio spans all 11 stock market sectors, ensuring that investors have all their bases covered. For a 0.03% expense ratio, investors can confidently track the investable U.S. market.
Vanguard 500 Index Fund Admiral Shares (VFIAX)
Roth IRA investors looking to purchase a broad stock market index may prefer a mutual fund. Unlike ETFs, the price of a mutual fund is determined once per day at market close, with investors buying at that price. For a set-it-and-forget-it investor, this feature can help cut down on transaction costs and time spent compared to buying and selling ETFs, which trade like stocks.
For a long-term growth-oriented mutual fund, Vanguard offers VFIAX with a 0.04% expense ratio. This fund tracks the S&P 500 index, a well-known benchmark of U.S. large-cap stocks. Historically, the S&P 500 has been very hard to beat, with some 93.4% of all U.S. large-cap funds underperforming the index over the past 15 years, according to the latest S&P Indices Versus Active, or SPIVA, report.
Vanguard High-Yield Corporate Fund Investor Shares (VWEHX)
“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 great example is VWEHX, which actively manages a portfolio of high-yield bonds, also known as “junk bonds.” These corporate bonds have a lower credit rating but make up for it with greater yields. Given its high 7.1% 30-day SEC yield, active management and corporate bond holdings, a fund like VWEHX is best held in a Roth IRA to eliminate tax burdens. The fund charges a 0.23% expense ratio.
Fidelity Freedom Index Income Fund Investor Class (FIKFX)
“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,” Connor & Gallagher’s Krase says. For instance, a young investor may prefer a growth-oriented fund that can fluctuate aggressively. On the other hand, an older investor may prioritize low-volatility funds that emphasize capital preservation and income.
For the latter, Fidelity offers FIKFX, which has a retirement income focus. This fund targets a fairly conservative allocation of 11% in U.S. stocks, 8% in international stocks, 43% in U.S. bonds, 5% in international bonds, 3% in long-term Treasurys, 20% in inflation-protected bonds and 10% in short-term cash equivalents. The fund pays monthly dividends and charges a 0.12% expense ratio.
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. One of the easiest ways to achieve this is via factor ETFs, which target specific types of stocks found by research to contribute to long-term outperformance versus the market. Size and value are two well-known factors.
By overweighting stocks with low market capitalizations and stocks that trade at low valuations, investors may be rewarded with market-beating returns over the long run. To put this strategy into play, consider AVGV, which holds five other Avantis ETFs that provide exposure to both large- and small-cap value stocks across U.S. and international markets. The ETF charges a 0.26% expense ratio.
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. “In a taxable account, these funds can incur a significant tax drag on their yield.” This can be less than ideal for investors who want to withdraw the dividends as income or reinvest them.
For a 0.08% expense ratio, HDV offers exposure to a portfolio of 75 high-yielding U.S. stocks such as Exxon Mobil Corp. (XOM), Johnson & Johnson (JNJ) and Coca-Cola Co. (KO). By holding HDV in a Roth IRA, investors can take full advantage of the ETF’s high 4% 30-day SEC yield, whether to reinvest it for long-term compounding or to withdraw it for immediate income.
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 a low-cost pick, consider SCHH, which charges a 0.07% expense ratio.
This ETF provides exposure to the broad U.S. REIT market by tracking the 126 holdings represented in the Dow Jones Equity All REIT Capped Index. However, it does exclude mortgage and hybrid REITs. Notable REITs in SCHH’s top holdings currently include Prologis Inc. (PLD), Equinix Inc. (EQIX) and Public Storage (PSA). The ETF currently pays a 4% 30-day SEC yield.
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Update 09/22/23: This story was previously published at an earlier date and has been updated with new information.
