Roth IRAs, a specialized tax-advantaged investment account introduced by the Taxpayer Relief Act of 1997 and named after Sen. William Roth, will celebrate their 28th anniversary in January.
As the new year approaches, eligible individuals can contribute up to $7,000. However, don’t wait for January to start planning; if you haven’t already maximized your contributions for 2024, now is the time to act before the year ends.
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Investments in Roth IRAs grow tax-free, whether that growth comes from capital gains, dividends or interest income. Moreover, if you are at least 59 1/2 years old and your Roth IRA has been open for at least five years, withdrawals are also tax-free, offering substantial benefits in retirement.
“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, a financial advisor manager at Vanguard.
However, Roth IRAs are not available to everyone. Eligibility for making the full contribution is subject to income limits: single filers must have a modified adjusted gross income of less than $146,000, while the limit for married couples filing jointly is $230,000. Individuals age 50 and older are also eligible for an additional $1,000 “catch-up” contribution.
If you’re planning how to invest your Roth IRA contribution, financial experts often recommend an “asset location” strategy. This approach involves placing investments in accounts that optimize tax efficiencies. In a Roth IRA, this typically means focusing on investments that promise high growth or income.
“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.”
Here are seven of the best funds to hold in a Roth IRA, according to experts:
| Fund | Expense Ratio |
| Vanguard Wellington Fund Investor Shares (ticker: VWELX) | 0.26% |
| Vanguard 500 Index Fund Admiral Shares (VFIAX) | 0.04% |
| Fidelity Contrafund (FCNTX) | 0.39% |
| iShares Core U.S. REIT ETF (USRT) | 0.08% |
| Grayscale Bitcoin Mini Trust ETF (BTC) | 0.15% |
| Avantis All Equity Markets Value ETF (AVGV) | 0.26%* |
| Amplify CWP Enhanced Dividend Income ETF (DIVO) | 0.56% |
*AVGV has a 0.02% fee waiver that is currently set to expire at the end of 2024. If the waiver is not renewed the expense ratio will be 0.28% starting in 2025.
Vanguard Wellington Fund Investor Shares (VWELX)
As Wybar noted, actively managed mutual funds expected to make large capital gains distributions due to their high turnover (internal buying and selling of securities) are great candidates for a Roth IRA. In this account, tax drag can be eliminated entirely. A great example is VWELX, a balanced active fund that holds two-thirds of its assets in stocks and one-third in bonds. It’s got a long track record of success, having been founded back in 1929.
The 10-year annualized total return of VWELX sits at 8.3%, which puts it at the top of the pack when it comes to balanced funds. However, after taxes on distributions and sales of shares, Vanguard estimates the 10-year annualized return will be cut down to just 6.3%. Thus, if you own VWELX and want it to compound at full potential, consider prioritizing it for a Roth IRA over a taxable brokerage account.
Vanguard 500 Index Fund Admiral Shares (VFIAX)
“Roth IRAs are especially beneficial for younger investors because there is greater saving potential due to that tax-free compounding,” Patillo says. Even a fairly tax-efficient mutual fund that pays qualified dividends and has no capital gains distributions due to low turnover can benefit from inclusion in a Roth IRA. A great example is VFIAX, which tracks the S&P 500 for a 0.04% expense ratio.
Over the past 10 years, VFIAX has returned an annualized 13% with distributions reinvested. But if you were taxed on said distributions and share sales, Vanguard estimates your return would have been cut down to 11%. It might not seem like much, but a 2% difference in annualized returns over a decade can leave a lot of money on the table. Thus, for maximum growth, VFIAX is best kept inside a Roth IRA.
Fidelity Contrafund (FCNTX)
“If you are younger and retirement is still years away, consider allocating a good portion toward funds that focus on growth,” says Jim Penna, senior manager of retirement services at VectorVest Inc. “Historically, these investments have potential for higher growth over time that you will pay no taxes on when held in a Roth IRA.” One of Fidelity’s most popular growth funds to consider is FCNTX.
Don’t let the “Contrafund” name fool you — FCNTX is actually a large-cap growth fund, and a very effective one at that. Managed by William Danoff since 1990, FCNTX has outperformed the S&P 500 over one-, three-, five- and 10-year periods despite a higher 0.39% expense ratio. However, its 18% turnover leads to fairly large annual capital gains distributions, making it best suited for a Roth IRA.
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iShares Core U.S. REIT ETF (USRT)
“To take advantage of the tax benefits, it is generally better to hold investments in your Roth IRA that would otherwise generate taxable income,” Penna says. “For example, stocks that pay dividends or generate capital gains, REITs — known for favorable dividend payouts — and high-yield bond funds fit into this category.” Remember, the dividends from real estate investment trusts (REITs) are not qualified; they’re taxed as ordinary income.
Consider USRT, which tracks a portfolio of 132 REITs via the FTSE Nareit Equity REITs Index for a 0.08% expense ratio. USRT’s most recent September distribution consisted solely of ordinary income, with no capital gains, qualified dividends or return of capital. Therefore, if you want to keep this ETF’s 2.9% 30-day SEC yield in its entirety, a Roth IRA might be the ideal account to hold it in.
Grayscale Bitcoin Mini Trust ETF (BTC)
“Acting as a tax-free piggy bank, Americans can use Roth IRAs to invest in high-growth assets while maximizing their tax savings in the future,” says Chris Kline, chief operating officer and co-founder of Bitcoin IRA. “It’s one of the reasons Bitcoin — whether via ETFs or direct custody in self-directed IRAs — is becoming a popular choice to diversify within retirement accounts.”
If you can withstand the high volatility, a Bitcoin ETF combined with a Roth IRA could deliver potent tax-free capital gains down the line. For this role, consider BTC, which trades at around $7.80 per share with a 0.15% expense ratio. This spot Bitcoin ETF is actually a spinoff of the older and pricier Grayscale Bitcoin Trust ETF (GBTC), which charges a much higher 1.5% expense ratio.
Avantis All Equity Markets Value ETF (AVGV)
If you want to try to beat the market in a Roth IRA, consider “factor investing” with small-cap value 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. For this role, Avantis Investors offers AVGV, a fund-of-funds.
AVGV currently holds six other ETFs, providing exposure to large-, mid- and small-cap value stocks across U.S., international developed and emerging markets. With AVGV, you get a globally diversified factor-tilted portfolio for a competitive 0.26% expense ratio, which is inclusive of all underlying ETF fees. Avantis Investors handles all the periodic rebalancing on your behalf to keep things hands-off.
Amplify CWP Enhanced Dividend Income ETF (DIVO)
Using your Roth IRA for retirement income, but hesitant to sell shares to fund it? In this case, a covered call ETF like DIVO could be suitable. This ETF combines an actively managed portfolio of 20 to 25 blue-chip dividend growth stocks with an options overlay designed to produce higher-than-average monthly income, at the cost of some capital appreciation. Currently, DIVO pays a 4.9% distribution yield.
“By blending dividend-paying stocks with tactical covered call strategies, DIVO seeks to boost income while managing volatility, making it an attractive option for Roth IRA holders looking to optimize tax-free growth and consistent cash flow,” says Christian Magoon, founder and CEO of Amplify ETFs. This ETF sits at the top of the “Derivative Income” fund peer category at Morningstar with a five-star rating.
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7 Best Funds to Hold in a Roth IRA originally appeared on usnews.com
Update 11/14/24: This story was previously published at an earlier date and has been updated with new information.
