Your IRA offers you tax deferred compounding from the moment you make your contribution until the moment you pull out your money in retirement. Depending on the type of IRA and a handful of other factors, it may also offer you tax benefits either when you contribute to the account or when you withdraw from it in retirement.

Those tax benefits make an IRA a great place to invest for your long-term future, but not every potential investment belongs in your IRA. Some investments make more sense in a taxable brokerage account, while others can fit perfectly well within the confines of a retirement account.

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What should you keep out of your IRA?

Some investments simply don't work as well in an IRA. Direct real estate investments, for instance, while technically legal to hold in an IRA, can cause all sorts of headaches. You lose out on the tax deductibility of depreciation and property taxes, you can't put your own labor into the property, and all expenses must be paid out of the IRA's funds. In addition, financing real estate in an IRA is especially challenging and can expose the IRA to taxes due to something known as "unrelated business taxable income." 

Similarly, partnership-style investments can also generate unrelated business taxable income, exposing your otherwise tax-deferred IRA to taxes. Likewise, companies headquartered in many foreign countries have taxes withheld on dividends, including on investments held in IRAs. While partnerships and foreign companies can be held in IRAs, the potential loss of the tax benefits makes it worthwhile to seriously consider keeping those investments in regular brokerage accounts.

Additionally, precious metals can be challenging and expensive to hold in an IRA. You can't physically have possession of them, for instance. They need to be in the possession of a custodian, and that means custodian fees.There's also a limited set of precious metals allowed to be held in an IRA, which adds risk to you if you're not in compliance with the rules.

Otherwise tax-advantaged investments like in-state tax-exempt municipal bonds can be held in an IRA, but since they're already tax advantaged, they don't really benefit from being there.

IRAs are also prohibited from most margin-related trading activities and actions like short-selling. That limits options strategies and makes it challenging to bet against an investment using money in your IRA, but for most investors, that's not a primary focus.

What should you buy in your IRA?

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Despite those limitations, the tax advantages your IRA offers make it a great place to own more typical investments. Stocks, bonds, and real estate-focused companies known as real estate investment trusts (REITs) all can find a comfortable home in your IRA, as can exchange-traded funds (ETFs) or mutual funds based on those investments. Because there are typically penalties for taking your money out of your IRA before age 59 1/2, IRAs are best suited for money you won't need to touch until you're that age or older.

If you invest both inside your IRA and in an ordinary brokerage account, it may make sense to put the investments with high current income or high trading turnover inside your IRA. That way, you'll be most likely to benefit from the IRA's tax deferred nature. If your primary strategy is buy-and-hold investing in stock index funds, the benefit of that tax-deferred compounding is lessened, as you won't have as many potentially taxable transactions along the way.

IRA-appropriate investments for stocks, bonds, and REITs include:

  • For stock-related holdings, consider an ETF like Vanguard Total Stock Market (NYSEMKT:VTI), which attempts to track an index that encompasses nearly all U.S.-based stocks. With an expense ratio of only 0.05%, it's a low-cost way to get access to stock-like potential returns without the hassle and risks associated with investing in individual companies.
  • For bond-related holdings,¬†consider an ETF like Vanguard Total Bond (NASDAQ:BND), which attempts to track a broad range of government and investment-grade corporate bonds. With an expense ratio of only 0.06%, it lets you keep the vast majority of the interest payments those bonds generate.
  • For REIT holdings, consider an ETF like Schwab US REIT (NYSEMKT:SCHH), which attempts to track the Dow Jones U.S. Select REIT index, it does so with a low 0.07% expense ratio, which keeps more of your money working for you.

The best part of investing in an IRA

No matter what you buy in your IRA, the best part of investing in it is watching your money compound over the decades between when you start and when you retire. Find investments that make sense to hold in your IRA and that match well with your time frame until you need to take out the cash and invest regularly throughout your career. After a career's worth of regular investments and compounding, you might very well be amazed with what you end up with.