Can I Buy ETFs in My IRA?
ETFs have become a popular investment choice for retirement portfolios. Before making their decision, however, investors should understand the operational nuances between ETFs and mutual funds before making any final choices.
ETFs differ from individual stocks in several key ways, including their day-to-day trading ability and wider diversification capabilities.
Taxes
ETFs tend to be more tax-efficient than mutual funds due to being created and redeemed via brokerage accounts, rather than directly with fund companies. This typically reduces recordkeeping costs for brokerage firms, leading to reduced overall expenses for investors. Furthermore, ETFs usually make relatively few transactions (on average less than 10% turnover rate2).2 But gains realized from selling shares for profit trigger taxes upon their sale resulting in tax bills for ETF investors.
ETFs also disclose their holdings regularly, providing transparency into the assets they own and helping IRA owners avoid unintended tax consequences from selling investments they had no intention of selling. ETFs offer another advantage by not carrying front- or back-end loads as charged by mutual funds, which can add up over time; plus being able to trade during the day may provide more frequent trading opportunities and potentially higher returns.
Liquidity
ETFs tend to be more tax-efficient than mutual funds due to their tendency not to distribute capital gains to investors, whereas many mutual funds do and this can cause taxable events in investor portfolios compared with when purchasing ETFs in your IRA.
ETFs are also highly liquid investments, meaning you can buy or sell shares throughout the trading day at market prices without incurring substantial transaction fees. This allows for quick reactions to changes in the market or tactical adjustments of IRA holdings without incurring large transaction fees.
Liquidity should always be your top consideration when looking at ETFs, particularly those tracking complex indexes or using leverage to boost returns (adding derivatives and debt to boost returns). Such strategies often feature wider spreads between bid and ask prices that could make entry and exit trades more complex and slower compared to their non-leveraged counterparts – something particularly true with leveraged ETFs that often exhibit greater volatility than non-leveraged ones.
Fees
ETFs and mutual funds both contain various costs that can reduce returns, but ETFs tend to have lower expenses than mutual funds – making them particularly suitable for investors saving for retirement in tax-advantaged accounts like an IRA.
ETFs come with both explicit costs such as brokerage fees and fund management fees as well as implicit costs such as bid-ask spreads and trading commissions that can have an enormous impact on returns if they’re purchased regularly or infrequently.
Further, some ETFs that employ derivatives and debt may be more volatile than their underlying indexes, which could increase returns when markets rise while amplifying losses when losses occur. It’s crucial that investors carefully consider these risks before choosing ETFs for investment in their IRA.
Distributions
ETFs differ from mutual funds in that their net asset value (NAV) price can fluctuate throughout the day and you can purchase or sell their shares intraday on stock exchanges, providing greater liquidity without incurring transaction fees for switching positions quickly and easily.
ETFs are popularly utilized within IRAs due to their tax efficiency; meaning, they typically make fewer capital gains distributions which may help minimize tax liabilities when withdrawing your money in retirement.
Finally, many ETFs specialize in dividend-paying stocks to provide steady income during retirement. Examples of such ETFs include Schwab U.S. Dividend Equity ETF SCHD which invests in high-yield stocks like Broadcom AVGO and Texas Instruments TXN as well as Fidelity Select Dividend ETF DVV which holds companies like Valero Energy VLO and Exxon Mobil XOM which pay regular dividends.
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