When planning for retirement, where you keep your investments, known as “asset location,” can significantly impact your long-term financial outcomes. This strategy involves placing investments in accounts that best suit their tax treatment to maximize returns.
For example, certain funds, due to characteristics like high income generation, frequent turnover or strong growth potential, are more beneficial when held in accounts with tax advantages. However, even passively managed index funds with low turnover can benefit from this strategy.
Consider the Vanguard 500 Index Fund Admiral Shares (ticker: VFIAX), a low-cost mutual fund that mirrors the performance of the S&P 500. Since its inception on Nov. 13, 2000, up to Dec. 31, 2023, VFIAX has delivered an annualized return of 7.6% with distributions reinvested.
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However, after accounting for taxes on distributions and capital gains from selling shares, the net return to investors would have been reduced to 6.4%. This annual difference of 1.2 percentage points, although seemingly minimal, translates into a substantial reduction in total returns over time due to the power of compounding.
Therefore, by strategically placing assets with high growth potential, high turnover or those generating significant income into a tax-advantaged account like a Roth IRA, investors can significantly enhance their long-term net returns.
As Scott Krase, a wealth manager at Connor & Gallagher OneSource, explains, “A Roth IRA is an account that you can contribute after-tax contributions to, with investment returns, income and dividends growing tax-deferred.”
The benefits of a Roth IRA include tax-free growth on dividends, capital gains and income within the account. Moreover, withdrawals are tax-free and without penalty after the age of 59 1/2, provided the account has been open for at least five years.
Tiana Patillo, a financial advisor manager at Vanguard, further highlights the attractiveness of Roth IRAs, stating, “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.”
To be eligible for Roth IRA contributions in 2024, individuals must meet specific modified adjusted gross income thresholds. This year, single filers earning less than $146,000 and joint filers earning less than $230,000 qualify for the full contribution. The current contribution limit is $7,000, with an additional $1,000 catch-up contribution allowed for those age 50 and older.
Here are seven of the best mutual funds and exchange-traded funds, or ETFs, to hold in a Roth IRA:
| Fund | Expense ratio |
| Vanguard Wellington Fund Investor Shares (VWELX) | 0.25% |
| Vanguard Total World Stock Index Fund Admiral Shares (VTWAX) | 0.10% |
| Avantis All Equity Markets ETF (AVGE) | 0.23% |
| Invesco S&P 500 GARP ETF (SPGP) | 0.34% |
| Invesco S&P 500 Equal Weight ETF (RSP) | 0.20% |
| iShares Morningstar Multi-Asset Income ETF (IYLD) | 0.60% |
| Schwab U.S. REIT ETF (SCHH) | 0.07% |
Vanguard Wellington Fund Investor Shares (VWELX)
“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, or REITs, make regular income payments, and actively managed stock funds are more likely to distribute taxable capital gains.” In a Roth IRA, the tax drag from these assets is eliminated.
Consider VWELX, a long-standing actively managed mutual fund from Vanguard that has been in operation since 1929. This fund allocates two-thirds of its portfolio to blue-chip dividend stocks with quality fundamentals and favorable valuations, and one-third to investment-grade bonds. With a higher 2.4% 30-day SEC yield and greater turnover, it is a perfect candidate for a long-term Roth IRA holding.
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. When it comes to a long-term, buy-and-hold investment, few funds match VTWAX’s level of diversification. This mutual fund tracks over 9,800 stocks from the FTSE Global All Cap Index, covering U.S., developed and emerging markets for a 0.1% expense ratio.
Investors who buy and hold VTWAX are essentially betting on the continued long-term growth of the global stock market, which is much safer than betting on individual sectors or countries. For those looking to sidestep the $3,000 minimum investment requirement, Vanguard also offers VTWAX in ETF form as the Vanguard Total World Stock ETF (VT), with a lower 0.07% expense ratio.
Avantis All Equity Markets ETF (AVGE)
For a shot at potentially outperforming VTWAX, investors can use “smart beta” ETFs, which target factors such as size, value and profitability that produce outperforming stocks. “These companies have a high discount rate embedded in their market price, and a high discount rate generally drives higher expected returns for investors,” says Ted Randall, senior portfolio manager at Avantis Investors.
AVGE mimics the globally diversified composition of VT, but with a tilt toward multiple underlying Avantis ETFs that target U.S., international and emerging small-cap value stocks screened for robust profitability. It charges a 0.23% expense ratio, which is inclusive of all underlying ETF fees. So far, the fund has attracted just over $325 million in assets under management.
Invesco S&P 500 GARP ETF (SPGP)
Investors looking to outperform the S&P 500 can use a factor ETF like SPGP. “SPGP picks the 75 stocks in the S&P 500 that have demonstrated the highest composite of three-year trailing earnings per share and sales per share growth, with the highest earnings-to-price ratio, highest return on equity and lowest debt-to-equity ratio,” says Nick Kalivas, head of factor and core equity ETF strategy at Invesco.
The whole idea of this ETF is to provide investors with exposure to growth stocks, but with a composite value-quality overlay to help put a guardrail on overpaying. “Constituents are weighted by their growth score, so that the stocks with the highest growth rate receive the highest weight in the portfolio,” Kalivas says. SPGP charges a 0.34% expense ratio and pays a 1.4% 30-day SEC yield.
[SEE: 7 Best Growth ETFs to Buy Now]
Invesco S&P 500 Equal Weight ETF (RSP)
S&P 500 investors looking to minimize concentrations in a handful of mega-cap stocks can avoid market-cap-weighted index funds and use an equal-weighted ETF like RSP. However, these funds tend to come with higher turnover owing to the quarterly rebalancing, which can cause greater distributions. Case in point, RSP pays an above-average 1.7% 30-day SEC yield, making it a prime candidate for a Roth IRA.
“RSP also provides investors an entrance into factor-based investing, as the process of equal weighting provides access to the small size factor and the quarterly rebalance provides access to the value factor,” Kalivas says. “Each quarter the fund trims companies that have risen above their equal-weight percentage and adds to stocks that have fallen below their equal-weight percentage.”
iShares Morningstar Multi-Asset Income ETF (IYLD)
“To take advantage of the tax benefits, it is generally better to hold investments in your Roth IRA that would otherwise generate taxable income,” says Jim Penna, senior manager of retirement services at VectorVest Inc. “For example, stocks that pay dividends or generate capital gains, real estate investment trusts, or REITs, known for favorable dividend payouts, and high-yield bond funds fit into this category.”
IYLD is an example of an income fund that would be best held in a Roth IRA. Currently, this fund features allocations to high-yield junk bonds, preferred shares, floating-rate bonds, emerging-market bonds and dividend stocks, and even mortgage REITs. It pays a high 5.9% 30-day SEC yield with monthly distributions and charges a 0.6% expense ratio.
Schwab U.S. REIT ETF (SCHH)
“If you are younger and retirement is still years away, consider allocating a good portion toward ETFs that focus on growth,” Penna says. “Historically, these investments have potential for higher growth over time that you will generally pay no taxes on when held in a Roth IRA.” For a combination of growth and income, investors can buy SCHH, which holds a market-cap-weighted portfolio of U.S. REITs.
“In a Roth IRA, REIT funds are great holdings for taking advantage of the comparatively high tax-free distributions,” says Kaleb Paddock, founder and certified financial planner at Ten Talents Financial Planning. “In addition, you also benefit from price appreciation given the historically strong returns the real estate sector has provided.” SCHH pays a 3.9% 30-day SEC yield and charges a 0.07% expense ratio.
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Update 03/14/24: This story was previously published at an earlier date and has been updated with new information.
