A Roth IRA held at a brokerage firm is able to facilitate the purchase of exchange-traded funds, or ETFs. Using ETFs within your Roth IRA can be an inexpensive and effective investment for retirement savings. The returns you see from using carefully selected ETFs are magnified by the tax-free growth afforded by the Roth IRA.
ETFs are a great investment choice to build a solid portfolio, because they have lower fees than traditional mutual funds but can offer anything from broad diversification to very specific sectors in the market. For example, there are index ETFs that track a specified index such as the S&P 500, representing the performance of the U.S. stock market. There are also tactical-allocation ETFs managed by professionals that provide a dynamic portfolio in one fund that seek to adjust to ever-changing market conditions. Creating leverage within a Roth IRA can be next to impossible with investment restraints on retirement accounts. Purchasing a leveraged ETF within the Roth IRA, however, solves this problem.
Choosing the best ETFs for retirement can be challenging. ETFs can simplify the task of investing, because they trade like a stock during market hours and provide smaller investors access to a basket of many stocks through one product. When building your portfolio with ETFs in your Roth IRA, you may want to choose more aggressive, growth-oriented funds knowing the earnings are tax-free in the present time and in retirement. If you are nearing retirement or are already retired, you may want to choose ETFs with high income distributions. These could be distributed to you as a retirement income without tax.
Scott Bishop, CPA, PFS, CFP®
STA Wealth Management, LLC, Houston, TX
For investors who want to use complex investing strategies, ETFs are sometimes the only way to access such strategies in a Roth IRA. For instance, selling stocks short in a Roth IRA isn't typically allowed. However, you can buy ETFs that are designed to move in the opposite direction as a stock market index or other benchmark. These inverse (or short) ETFs give you similar returns to short selling.
Also, Roth IRAs don't allow you to trade on margin, so you can't use your retirement account to make leveraged trades. You can, however, buy shares of leveraged ETFs that offer a multiple of the daily returns on a particular type of investment, which will give you many of the same return characteristics that buying a fund on margin would.