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Powerful Vanguard Mutual Funds for Your Roth IRA

VTI and BND are a good place to start for a Roth IRA

The Vanguard Group Inc., known as Vanguard, is one of the world's largest investment management and advisory services companies. It's primarily a mutual fund and ETF management company with about $8.1 trillion in assets under management (AUM) as of Jan. 31, 2022. Founded in 1975, the company offers a total of 422 funds, 215 of which are available in the U.S. Vanguard is a full-service broker, offering low-cost investing for long-term buy-and-hold investors and retirement savers.

Investors in the U.S. have access to several tax-advantaged saving plans, including 401(k)s, individual retirement accounts (IRAs), and Roth IRAs. The main difference between a Roth IRA and a traditional IRA is that the former is funded with after-tax dollars. That means that contributions to Roth IRAs are not tax-deductible, as they are with traditional IRAs. But unlike a traditional IRA where withdrawn funds are taxed, a Roth IRA allows investors to withdraw funds tax-free. Fund numbers are as of the second quarter (Q2) of 2022, unless stated otherwise.

Key Takeaways

  • Vanguard was founded in 1975 and has about 215 funds available in the U.S., as well as $8 trillion in AUM.
  • When making a retirement account, a broad stock fund and broad bond fund provide a good foundation, either as the entire basis for investing or to build upon with more complex investments.
  • Roth IRAs allow you to avoid paying taxes on investment returns by investing after-tax income.
  • These include bond funds and REIT funds.
  • VTI and BND can serve as good starting points when looking for Roth IRA investments from Vanguard.

Best Types of Funds for a Roth IRA

A Roth IRA is a type of qualified retirement account that is funded with after-tax dollars and then is allowed to grow income tax-exempt. This is opposed to a Traditional IRA (or 401(k) plan) that uses pre-tax dollars and so provides a tax deduction in a given contribution year. Traditional IRAs then grow tax-deferred, where income tax must be paid on contributions and gains at the time of withdrawal in the future.

Because a Roth IRA does not have this deferred tax liability, it is best to use this type of account to benefit from the tax exemption. That means identifying high-yield investments that pay a high and steady stream of income in the form of interest, dividends, or other distributions. Bonds pay regular interest, and so these are one obvious candidate for a Roth. Others include real estate investment funds, or REITs, which must pay out at least 90% of their operating income as dividends. Preferred shares, too, pay relatively high and regular dividends. These are the types of assets that would benefit most from the Roth as a tax shelter.

Note, however, that a Roth IRA has an annual contribution limit ($6,000 in 2021 and 2022) and also has income limitations.  In 2022, you will not be able to make full Roth IRA contributions if your adjusted gross income (MAGI) is above $129,000 as a single filer and cannot make any contributions at all if you earn $144,000 or more. For married couples filing together, the limits are $204,000 and $214,000, respectively.

Strategically placing high-yielding retirement assets in a Roth account and other assets that may pay low or no income in a traditional account is known as asset location, and it's a key way to minimize your tax exposure come retirement.

Vanguard Total Stock Market ETF (VTI)

  • Expense ratio: 0.03% (as of Q2 2022)
  • Assets under management: $282.9 billion
  • 12-Month Trailing (TTM) yield: 1.33%
  • 1-year trailing total return: 11.58%
  • Inception date: May 24, 2001

The Vanguard Total Stock Market ETF aims to track the performance of the CRSP US Total Market Index. As an exchange-traded fund (ETF), VTI offers investors access to a broad portfolio of equities, and shares of VTI can be traded throughout the day like a stock. VTI is passively managed, utilizing an index-sampling strategy that keeps investor expenses low.

VTI's portfolio consists of 4,070 stocks, with the top 10 accounting for just under a quarter of total invested assets. The fund's holdings include large-cap, mid-cap, and small-cap equities across growth and value styles. While Vanguard does not provide an exact breakdown of the percentage of the portfolio divided across these market capitalization categories, the fund tends toward large-cap stocks. The median market cap of a VTI holding is $129.6 billion. Virtually all of the holdings are U.S.-based companies; only 0.1% are foreign.

Investors who want to create wealth through price appreciation should consider a broad-based equities fund such as VTI. Although equities have higher volatility than bonds, they have a track record of returning more over a long period of time. If investors have a low-risk tolerance or are nearing retirement, they might consider a more income-oriented portfolio.

VTI is the ETF equivalent of The Vanguard Total Stock Market Index Fund (VTSAX).

Vanguard Total Bond Market ETF (BND)

  • Expense ratio: 0.04% (as of Q2 2022)
  • Assets under management: $81.5 billion
  • 12-Month Trailing (TTM) yield: 2.02%
  • 1-year trailing total return: -4.11%
  • Inception date: April 3, 2007

The Vanguard Total Bond Market ETF tracks the Bloomberg U.S. Aggregate Float Adjusted Index, a broad, market-weighted index. Provides gives investors broad exposure to the taxable investment-grade U.S. dollar-denominated bond market. The fund excludes inflation-protected and tax-exempt bonds.

BND holds 10,127 bonds. The average duration of a BND bond is 6.8 years, and the average effective maturity was 8.9 years. Just over two-thirds of bonds are U.S. government bonds. While the remaining third is investment-grade debt, about 15.2% of the total is BBB bonds, which are among the lowest-rated on the investment-grade ladder.

BND is intended to serve as a core bond holding for investors. Bonds generally have low volatility and provide a steady supply of interest payments to the investor. Taxes on the interest payments are deferred in a Roth IRA account, making it an ideal place to hold these kinds of investments. A broad-based bond fund is typically a lower-return, lower-risk investment vehicle than a stock fund. As a result, bonds can be useful both for risk-averse investors and for portfolio diversification.

BND is the ETF equivalent of The Vanguard Total Bond Market Index Fund (VBTLX).


The Vanguard REIT Index ETF (VNQ)

  • Expense ratio: 0.12% (as of Q2 2022)
  • Assets under management: $86.3 billion
  • 12-month trailing (TTM) yield: 2.90%
  • 1-year trailing total return: 7.78%
  • Inception date: Sep. 23, 2004

The Vanguard REIT Index fund ETF invests in stocks issued by real estate investment trusts (REITs), companies that purchase and manage office buildings, hotels, and other real property, and it tracks the MSCI US Investable Market Real Estate 25/50 Index. This index is primarily an equity REIT index, and the VNQ holds REIT shares in 164 different companies.

Because REITs must pay out 90% or more of their operating income as dividends to shareholders, REIT funds tend to have relatively high yields. These can cause a series of taxable events that are deferred in a Traditional IRA, but which are exempt in a Roth. As a result, a Roth IRA is a good place to hold REITs. Note, however, that REIT funds are quite sensitive to interest rates, and share prices can fall sharply as rates increase. This is because the cost of financing properties (e.g., mortgages) also increases as interest rates rise.

VNQ is the ETF equivalent of The Vanguard REIT Index Fund (VGSLX).

What Is the Cost to Open a Vanguard Roth IRA?

In a few cases, the minimum investment needed to open a Vanguard Roth IRA may be as low as $1,000. For most Vanguard funds, the minimum investment necessary is $3,000, and that minimum is higher at some funds. There is no fee to actually open the account.

Does Vanguard Offer Roth and Traditional IRAs?

Yes. Vanguard offers both Roth and traditional IRAs.

How Much Does It Cost to Open a Vanguard Roth IRA?

Vanguard charges annual account service fees of $20 per Roth IRA account if the total Vanguard mutual funds and ETFs assets in the account are less than $10,000. However, this fee can be waived by signing up for the company's e-delivery service or by maintaining at least $50,000 in qualifying assets. Investors should not overlook that they also pay through expense ratios at individual funds.

Can You Day Trade in a Roth IRA?

Like other retirement accounts, a Roth IRA does not allow for margin, which can limit day trading activities including selling short. You can, however, still actively trade in your Roth IRA. Because a Roth is tax-exempt, any short-term capital gains earned would also be exempt, which is an advantage. However, you may rack up transaction fees.

What Index Fund Should I Invest in my Roth IRA?

Many experts advise using buy-and-hold index funds for retirement account investing. Since a Roth IRA is tax-exempt, the best type of index fund would be one that pays out a lot of dividends or other distributions. Index funds to look for, therefore, would be focused on those that pay a high yield, such as bond funds (especially high-yield bonds), real estate funds (especially REITs), and preferred stock indexes. You should put low-yielding index funds in a tax-deferred account such as Traditional IRA or 401(k).

The Bottom Line

Roth IRAS can be an effective tool for retirement saving, and broad bond and stock funds provide diverse, inexpensive foundations. Investors may wish to go further depending upon how much time, energy, and risk tolerance they have for investing. For many investors who are short on time, it's a practical decision to pick a few large, diverse bond and stock funds and continue to invest in those. Some investors will choose another course, by opting to add investments in individual companies, including riskier small-cap stocks, and through targeted sector investing and stock analysis.

Article Sources

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  1. Vanguard. "Facts and Figures."

  2. Internal Revenue Service. "Traditional and Roth IRAs."

  3. Internal Revenue Service. “Amount of Roth IRA Contributions That You Can Make for 2022.”

  4. Vanguard. "Vanguard Total Stock Market ETF - VTI."

  5. Morningstar. "Vanguard Total Stock Market ETF VTI - Performance," Select "Trailing Returns: Month-End."

  6. Vanguard. "Vanguard Total Bond Market ETF - BND."

  7. Morningstar. "Vanguard Total Bond Market ETF BND - Performance," Select "Trailing Returns: Month-End."

  8. Vanguard. "Vanguard Real Estate Index Fund."

  9. Vanguard. "VNQ - Performance."

  10. Vanguard. "Roth vs. Traditional IRAs: A Comparison."

  11. Vanguard. "Annual Account Service Fees."

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