Can I buy ETFs for my Roth IRA?
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 which provide a dynamic portfolio in one fund that seeks 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.
YES…ETFs can be a great asset in a Roth IRA – especially if they offer long-term growth and/or are less tax efficient (such as MLPs or High Yield Bonds) and would be less appropriate for a taxable brokerage account.
In fact, ETFs can be a great way to get exposure to certain types of assets and strategies that you wouldn't be allowed to do directly within a tax-favored retirement account.
Getting access to ETFs in a Roth IRA
Not all financial institutions give you access to ETFs in their Roth IRAs. Banks, for instance, typically limit you to products like certificates of deposit. To buy ETFs, you'll need to open your Roth IRA with a brokerage firm. My firm uses both Charles Schwab and Fidelity and both firms offer NO TRANSACTION COST ETFs (they don’t even charge their typical $4.95 per trade on certain ETFs).
Why ETFs in a Roth IRA can be especially useful
Any investment in a Roth IRA can give you tax-free income, which helps you save on your taxes in retirement. But for investors who want to use complex investing strategies, ETFs are sometimes the only way to get access to them in a Roth IRA.
For instance, selling stocks short in a Roth IRA isn't typically allowed. However, you can buy certain 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, because their share prices go up when the underlying index goes down. However, please be careful using inverse (or leveraged, see below) ETFs if your plan is to hold them for a long time as they tend to not track the inverse (or multiple) of an index over the long run.
Also, Roth IRAs don't allow you to trade on margin, and so you can't use your retirement account to make leveraged trades. You can buy shares of leveraged ETFs that offer a multiple of the daily returns on a particular type of investment, and that will give you many of the same return characteristics that buying a fund on margin would give you.
Using a Roth IRA to invest gives you a number of advantages (and should be considered when comparing your option to a Traditional vs. Roth IRA), the most important of which is that any growth coming either from investment income or from share-price appreciation is free of tax, even when you start taking withdrawals in retirement. By tapping into the profit potential of ETFs, you can make the most of a Roth IRA opportunity, and get started on producing the long-term returns you'll want in order to reach your financial goals.
The above information on ETFs is accurate, though I would add that if you are purchasing index funds, many investors who may not be familiar with trading stocks could benefit from going the old-fashioned route and investing in the mutual fund version of the ETF instead.
ETFs are a tool to consider, and one of their largest benefits is their tax-efficiency, which, is lost in a Roth IRA.
If you’re more of a long-term investor than a trader, don’t worry about missing out if you are reading about the benefits of ETFs. For most, mutual fund investing provides all of the benefits without some of the trading hassles.
Yes you can!
A Roth IRA is a specific account type which is used for retirement savings and investing. You can choose to invest the way you wish, which may include:
- Exchange Traded Funds (ETSs)
- Mutual Funds
- Individual Stocks
- Other traditional investments
The only restrictions that may be imposed are those by the financial institution holding your account. Be aware of potential fees, commissions, expense ratios, and transaction charges attributed to the investments you select and the financial institution holding your account.
Stephen Rischall, CRPC