Exchange-traded funds have taken the investing world by storm, and ETFs now hold more than $3 trillion in assets. Some investors are uncertain, however, whether they're allowed to hold ETFs in a Roth IRA. The answer is yes, and in fact, ETFs can be a great way to get exposure to certain types of assets and strategies that you wouldn't be allowed to do directly within a tax-favored retirement account.
Getting access to ETFs in a Roth IRA
Not all financial institutions give you access to ETFs in their Roth IRAs. Banks, for instance, typically limit you to products like certificates of deposit. To buy ETFs, you'll need to open your Roth IRA with a brokerage firm.
In some cases, if a mutual fund company also has proprietary ETFs, you can get access to them in a Roth IRA. Typically, though, fund companies that offer this option will have you technically open a brokerage account to hold the ETF shares.
Why ETFs in a Roth IRA can be especially useful
Any investment in a Roth IRA can give you tax-free income, which helps you save on your taxes in retirement. But for investors who want to use complex investing strategies, ETFs are sometimes the only way to get access to them in a Roth IRA.
For instance, selling stocks short in a Roth IRA isn't typically allowed. However, you can buy certain ETFs that are designed to move in the opposite direction as a stock market index or other benchmark. These inverse ETFs give you similar returns to short-selling, because their share prices go up when the underlying index goes down.
Also, Roth IRAs don't allow you to trade on margin, and so you can't use your retirement account to make leveraged trades. You can buy shares of leveraged ETFs that offer a multiple of the daily returns on a particular type of investment, and that will give you many of the same return characteristics that buying a fund on margin would give you.
Using a Roth IRA to invest gives you a number of advantages, the most important of which is that any growth coming either from investment income or from share-price appreciation is free of tax, even when you start taking withdrawals in retirement. By tapping into the profit potential of ETFs, you can make the most of a Roth IRA opportunity, and get started on producing the long-term returns you'll want in order to reach your financial goals.
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