You can invest in a wide variety of assets in a Roth IRA, including exchange-traded funds (ETFs). When your Roth IRA is held by an online broker or traditional broker-dealer, it can facilitate the purchase of ETFs.

Including ETFs in your Roth IRA can be an inexpensive and effective way of investing in your retirement. The returns you’ll see from adding carefully selected ETFs are magnified by the tax-free growth afforded by a Roth IRA.

Key Takeaways

  • ETFs are among a wide variety of investments you can choose for a Roth IRA.
  • They can help build a diversified retirement portfolio.
  • Typically, ETFs have lower fees than mutual funds, making them a cost-effective investment.
  • ETFs trade on an exchange like stocks, which provides flexibility.
  • Growth and income ETFs can be a good fit to include in a Roth IRA because investment gains and withdrawals are tax-free.

Benefits of ETFs in a Roth IRA

ETFs are a great way to build a solid retirement portfolio because they provide diversification and typically have lower fees than traditional mutual funds. A majority of ETFs are passively managed and track indexes and sectors⁠, which result in lower expense ratios.

Like mutual funds, ETFs offer both broad diversification and access to very specific sectors in the market. For example, there are ETFs that track specific indices such as the S&P 500, technology sector ETFs, and socially responsible ETFs.

Another benefit is that ETFs trade on an exchange like stocks, unlike mutual funds, which can only be purchased at the end of each trading day.

Creating leverage within a Roth IRA can be next to impossible due to investment restraints on retirement accounts. Including a leveraged ETF in your Roth IRA is one way to solve this problem. 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, making them riskier investments.

Leveraged ETFs are best suited for sophisticated investors with a high risk tolerance.

Choosing ETFs for a Roth IRA

ETFs simplify the task of investing. They trade like a stock during market hours and provide investors access to a basket of many stocks in one product. At the same time, choosing the best ETFs for retirement can be challenging because there are so many available.

Consider the tax advantages of Roth IRAs. Contributions are made with after-tax dollars, which means investments grow tax-free and you also don’t pay any tax on withdrawals at retirement. More aggressive and growth-oriented funds are appropriate for a Roth IRA because of the benefits of tax-free growth.

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 tax-free retirement income.

Launched in 1993, the first ETF was the SPDR S&P 500 ETF (SPY). It tracks the S&P 500 Index.

What Are Common Roth IRA Investments?

What Is an Expense Ratio?

An expense ratio is the combination of fees that covers a fund’s annual operating expenses. In general, passively managed funds, such as a majority of ETFs, typically have lower expense ratios than actively managed funds.

How Much Can I Contribute to a Roth IRA?

The Bottom Line

ETFs are among the many types of investments allowed in a Roth IRA. They offer a combination of diversification, low costs, and the flexibility to trade like a stock. In order to include ETFs in a Roth IRA, you’ll need to have an account with a financial institution that offers them.

Advisor Insight

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 benchmarks. 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.

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