What can you invest in with a Roth IRA?

A Roth IRA is funded with after-tax dollars, meaning you pay income taxes upfront. The contributions grow tax-free, and you can withdraw the contributions and investment earnings tax-free when you retire. A Roth IRA offers greater flexibility than a 401(k), and you can invest in a wider pool of investment options than are available to 401(k) participants.

A Roth IRA can invest in almost all financial assets, including stocks, bonds, mutual funds, exchange-traded funds, and real estate. The only financial assets that Roth IRAs cannot invest in include life insurance, cryptocurrency, and collectibles. Typically, a Roth IRA can invest in any financial assets that a traditional IRA can hold. The earnings generated from these investments will grow tax-free, and you won’t pay taxes or penalties on the money if you observe the Roth withdrawal rules.

Investing Your Roth IRA Savings

When you contribute to a Roth IRA, these contributions are placed in various investments to grow and earn income. These investments will grow over the years through compounding, and the retirement savings could grow into thousands of dollars by the time you retire. Generally, a Roth IRA can hold any type of financial asset, from stocks, bonds, REITs, ETFs, etc.

The common types of assets that you can invest in with a Roth IRA include:

Stocks

Stocks give Roth investors part ownership of a company, and they are commonly held investment options in Roth IRA accounts. Historically, stocks have provided higher returns than bonds, and they have the best chance of growing the Roth IRA account balance in the long term. However, stocks can be volatile in the short term, and you should invest in stock as part of a diversified retirement portfolio.

Typically, the best stocks for Roth IRAs include income stocks and growth stocks. Income stocks pay high dividends, and they can provide high earnings in the long run. Growth stocks invest in small-cap and medium-cap companies that stand the best chance of appreciating in value. You won’t owe any taxes on the dividend income or stock appreciation if you observe the Roth IRA withdrawal rules.

Bonds

When you buy bonds, you are essentially lending money to an entity that pays back the principal plus interest. Although bonds offer lower returns than stocks, they offer more predictable returns. The most popular bonds for Roth investors are corporate bonds and high-yield bonds since the interest income will not be taxed if you meet Roth IRA withdrawal requirements.

However, there is no benefit in holding municipal bonds in your Roth IRA. Municipal bonds pay tax-exempt interest, and they provide a lower yield. Hence, there is no tax advantage of holding the municipal bond in a tax-sheltered retirement account like a Roth IRA.

Mutual Funds

Mutual funds comprise stocks and bonds, and they enable investors to achieve a diversified portfolio without researching individual stocks and bonds. Mutual funds are popular among Roth investors due to their low expenses, professional management, and simplicity.

When investing in mutual funds, you should opt for actively managed funds over passively-managed funds that track an index. An actively managed fund is where the manager is actively buying and selling investments in an attempt to beat the market, and earn a profit for investors. Although active mutual funds charge higher fees than passive mutual funds, you can avoid taxes by holding them in the tax-sheltered Roth IRA.

Exchange-traded funds

ETFs can be traded like stocks, and they can be a good alternative to mutual funds if you want to avoid high investment fees. Typically, ETFs are designed to track a specific market index, and they tend to be passively managed. If you are looking to maximize the ETF returns, look for ETFs that invest in high-income or high-growth equities.

Real Estate Investments

You can use a Roth IRA to invest directly in real estate by owning properties, or indirectly by buying securities that own property.

Direct real estate investment

You can own different types of properties like apartments, condos, single-family homes, etc. using your Roth IRA. However, you can only buy properties directly using a self-directed IRA; you will need to open a self-directed IRA account with an IRA custodian who offers these accounts.

You must observe the IRS rules that guide the buying of real estate using an IRA. For example, you cannot claim deductions for mortgage interest or property taxes related to the property, and you (or your family) must not benefit directly from the property.

Indirect Real Estate Investment

You can own real estate indirectly by investing in securities that own real estate through REITs. Most REITs invest in one type of real estate property, but some REITs may own different types of properties. The most common types of real estate that REITs invest in include apartment buildings, office buildings, shopping centers, medical facilities, hotels, and warehouses.

Who Manages a Roth IRA?

The Roth IRA investor is responsible for deciding how to allocate their contributions to various investment options. However, you can only place your contributions in investment options that are provided by your custodian. In this case, the custodian can be a brokerage firm, bank, or mutual fund company.

The custodian holds your retirement assets and ensures that your investments comply with the IRS guidelines. However, the custodian cannot dictate what investments to invest in. You can change the investment allocation at any time, and even change custodians by rolling over your Roth IRA to a new custodian.