Best Types of Roth IRA Investments

Roth IRAs are tax-advantaged retirement accounts. If you decide that a Roth IRA is right for your financial goals, and you qualify to open one, it's important to understand which investments are the best so you can maximize your money. You can invest in equities, bonds, cash, commodities, mutual funds, and more in a Roth IRA. So keep reading to learn how to pick the best investments for your Roth IRA.

Roth IRA Advantages

It’s common for people to get confused when they hear the term “Roth IRA,” according to Chloe Elise, CEO and founder of the financial literacy company Deeper Than Money.

“Many think a Roth IRA is the investment itself, when in actuality, the Roth IRA is just the vehicle for saving,” Elise told The Balance in an email. “There are many options for investments you can put inside it.”

First, IRA stands for individual retirement arrangement or account. With a traditional IRA, contributions are made with pre-tax dollars, and you pay income taxes on withdrawals in retirement. With a Roth IRA, however, contributions are made with after-tax dollars and withdrawals are not taxed. So the main benefit of a Roth IRA over a traditional IRA is that returns on investments inside the account grow tax-free.

“It is a great tool, especially for someone who is younger and in a lower tax bracket than they expect to be in retirement,” Elise said. “If someone has the ability to contribute to a Roth IRA, I highly recommend they make the maximum annual contribution.” 

Another benefit: There are no required minimum distributions (RMDs) for Roth IRAs, which means you can continue generating returns on the balance for life and also pass it to your heirs tax-free.

However, keep in mind that only earned income can be contributed to a Roth IRA. Contributions may also be limited based on income and filing status; if your earned income is too high, you can’t contribute to a Roth IRA at all.

Best Investments for a Roth IRA

Roth IRAs can hold just about any type of investment, including equities, bonds, cash, commodities, mutual funds, and more.

“There really is no wrong choice in an objective sense,” said David Frederick, the director of client success and advice at First Bank. “The difficulty comes with missed opportunities."

But using a Roth as just another retirement savings account, as you would a traditional IRA or taxable account, may not be the most strategic move. In general, it makes sense to place the investments you project to have the highest returns in the Roth IRA account, according to Doug Carey, owner and founder of WealthTrace, a financial planning and retirement planning software company.

“This is due to the fact that Roth IRA withdrawals will not be taxed,” Carey told The Balance in an email. 

Some examples of best-suited Roth IRA investments include:

Actively Managed Funds

Actively managed funds (exemplified by many available mutual funds) tend to be more expensive to own than passively managed funds (such as index funds and exchange-traded funds (ETFs). One big reason for the cost gap is that the active fund’s manager needs to make frequent trades to attempt to outperform the market. This can generate taxable short-term capital gains. However, by holding actively managed funds in a Roth, you are protected from having to pay taxes on those gains.

Dividend-Paying Stocks

Some stocks pay shareholders dividends, which are a share of the company’s profits, often distributed at regular intervals. Dividend income is also subject to long-term capital gains taxes; non-qualified dividends are taxed as ordinary income. Again, by holding these types of assets in a Roth IRA, you can avoid having to pay those taxes.

Real Estate

Real estate investments, such as REITS, can be very well-suited for a Roth IRA, Frederick said.

“Depending on its structure, real estate may pay out cash that would be taxed as ordinary income, which is no problem in the Roth.”

He added that real estate may create a concentrated investment position, which should be avoided in a foundational account like a traditional IRA, but fits in well in a supplemental account like a Roth.

High-Growth Stocks

Frederick said that high-growth, speculative investments may have an effective place in the Roth as well. For one, these types of investments can trigger potentially expensive long-term capital gains when sold, which can be avoided by investing in them via a Roth.

And because you aren’t required to take RMDs from a Roth, “you may be able to hold the investments relatively longer in pursuit of a return,” Frederick said.

Crypto

If you’re looking to set aside some of your retirement funds for a newer, highly volatile investment such as crypto (and are comfortable with the risks), a Roth IRA can be one of the best places to do this, for the reasons mentioned. But be aware of the account’s rules about holding alternative investments, as not all providers allow them.

Investments You May Not Want in a Roth IRA

On the other hand, lower-yield investments are not ideal to hold in a Roth IRA. That’s not to say they’re bad investments. Instead, you’d be better off keeping them in a different type of account.

“Because their balances will not grow like equity investments will over time—especially with interest rates still low—the tax benefits of the Roth IRA are diminished,” Carey said. Those types of funds would be better off in a traditional IRA or a taxable account, he added.

Below are a few examples of investments that aren’t ideal for a Roth IRA.

Low-Yield Bonds

Some bonds, such as corporate bonds, have the potential to produce high yields. Most bonds, however, are considered lower-risk investments that provide modest returns. U.S. savings bonds, Treasury Inflation-Protected Security (TIPS) bonds, and other low-yield bonds are a good way to offset the risk of more-volatile stocks and funds in your portfolio, but they may be better-suited for your traditional IRA or taxable account.

Annuities

Annuities are complex investment tools that are best left out of a Roth IRA. These insurance contracts come with their own tax advantages, but those advantages are superseded by the tax rules of the Roth. In addition, if you ever decide to move the money elsewhere, you might have to deal with surrender charges.

Passive Funds

Funds that are passively managed, such as index funds and ETFs, don’t come with as many fees and tax consequences as their actively managed counterparts. So while including them in your Roth IRA portfolio isn’t necessarily a bad idea, you won’t reap the same kind of savings.

Deposit Accounts

One of the main reasons to keep a portion of your money in a savings account, money market account, or even a certificate of deposit (CD) is to maintain some liquidity, especially for emergencies. So holding one of these accounts in a Roth IRA or any other long-term tax-advantaged retirement account is somewhat pointless. Plus, deposit accounts tend to be the lowest-yielding savings options, meaning they don’t really benefit from Roth’s tax benefits.

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