A Roth IRA is a good way to grow your money long-term, but the question many people ask as soon as they secure one is what are the best investments for a Roth IRA? The choices are broad and getting broader with financial innovations that it can seem confusing and difficult to choose. When deciding the best investments for a Roth IRA, it is important to consider the tax burden, growth and return on investment in the long-term and short-term.
- Stocks. There are significant advantages to buying stocks for Roth IRA. Stock have a larger return (usually) than bonds and are taxed at a lower rate. The disadvantage of stocks is they tend to have higher risk than bonds and if one is "lucky" on the stock market and earns significant income, that can mean higher taxes. Stocks are good to buy if investment is far away because if you happen to lose the money, you have more time to earn it back.
- Bonds. These investments for your Roth IRA are more conservative than stocks and are less likely to fail, but they are taxed almost double the rate of stocks. However, since the return tends to be lower, that might mean a lower tax burden in the long term. if you're starting a Roth IRA somewhat close to retirement, it is a good idea to have a higher proportion of bonds to stocks.
- Index Funds. These are increasingly popular investment vehicles which allow investors to have exposure to various stocks within a certain category or sector without having to trade actively. Since index funds usually involve fewer transactions, there are lower taxes than with stocks. Index funds are good conservative investments for a Roth IRA, but be careful. Not all index funds are conservative or created equal. Do significant research before buying.
- No Municipal bonds. Do not choose municipal bonds as investments for your Roth IRA. They are way too burdened by taxes and there are few exemptions.
- Diversify. The best strategy is to use a combination of investments for your IRA and to have a diversified portfolio.