The short answer is yes. When your Roth IRA is held by a brokerage, the firm can facilitate the purchase of exchange-traded funds (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 provide diversification and access to specialized markets for your retirement savings.
- Typically, ETFs have lower fees than mutual funds, making them a cost effective investment.
- Because investment gains and withdrawals are tax free, growth and income ETFs are a good fit for a Roth IRA.
Benefits of ETFs in a Roth IRA
ETFs are a great investment choice to build a solid portfolio because they have lower fees than traditional mutual funds and can offer anything from broad diversification to very specific sectors in the market.
There are, for example, 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, seeking to adjust to ever-changing market conditions.
A leveraged ETF uses derivatives and debt to boost the returns of the underlying index it tracks. Keep in mind that while returns can be boosted on the upside, leveraged ETFs can also amplify losses, which makes them riskier. Leveraged ETFs are often best left to sophisticated investors with a high risk tolerance.
Choosing ETFs for a Roth IRA
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. At the same time, choosing the best ETFs for retirement can be challenging due to the wide variety available.
ETFs trade on an exchange like stocks, unlike mutual funds, which can only be purchased at the end of each trading day.
Contributions to Roth IRAs are made with after-tax dollars, which means investments grow tax free and you also don’t pay any tax on withdrawals at retirement. Because of these tax advantages, you should consider more aggressive and growth-oriented funds for a Roth IRA.
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.