Can You Invest in ETFs in an IRA?
ETFs offer wide diversification at lower costs than mutual funds and may leverage assets such as debt or derivatives to boost returns or magnify losses.
ETFs often have lower minimum investment requirements than some mutual funds and usually don’t charge front-end and back-end sales charges (known as loads) that increase your cost of investing.
Tax-Efficient
Investors frequently hold multiple investment accounts, including IRAs, 401(k)s and individual brokerage accounts. Each of these accounts comes with its own tax treatment and should be allocated according to each investor’s goals and risk tolerance. ETFs make excellent choices for IRAs due to their diversification benefits, low costs and ability to trade like stocks.
ETFs tend to be more cost-efficient than mutual funds because they track indexes more closely and require less management – this may translate to greater long-term returns in your retirement savings account.
ETFs are designed to minimize capital gains distributions and may reduce your tax liability when withdrawing funds in retirement. Meanwhile, many mutual funds generate capital gains that they distribute out as dividends, creating potentially taxable events (though this should not be an issue with IRAs). Furthermore, ETFs can be traded throughout the trading day while many mutual funds only offer buy/sell opportunities at their NAV at the end of trading day.
Diversified
ETFs offer greater diversification than mutual funds, with some holding hundreds or even thousands of stocks. Furthermore, ETFs often come with lower fees.
An ETF’s expense ratio measures the fees it charges and, the lower it is, the better for investors as more money goes toward fees which could sap returns over time.
Beyond fees, it’s also crucial to find an ETF that best reflects your risk tolerance and financial objectives. For instance, if your desired investing goal involves emerging markets then an ETF that tracks them would likely be the right option.
If you want to generate income during retirement, an exchange-traded fund (ETF) that invests in dividend-paying stocks could be the perfect solution. These ETFs often distribute dividends as cash payments while others also allow dividend-reinvestment plans (DRIP). Besides considering an ETF’s dividend payout and trading volume when considering purchases and sales of its shares, trading volumes also provide ease of trading and ownership transfers between investors.
Easier to Trade
Although your IRA or Roth IRA allows for individual stocks and bonds, many investors choose ETFs or mutual funds to build their portfolios. ETFs are baskets of securities designed to trade intraday like stocks on an exchange, typically tracking an index.
ETFs offer greater transparency as their holdings are disclosed on a regular basis, and typically do not incur front-end or back-end loads (sales fees that could affect your initial investment), unlike many mutual funds.
ETF investments within an IRA are an ideal way to diversify your portfolio with lower trading costs, making a noticeable impactful statement about your long-term investing goals and retirement.
Note, however, that your IRA cannot trade options or naked calls or borrow cash for hedging strategies like long index put vertical5. Once approved by an administrator, however, limited margin may be used to trade certain spread strategies.
Leveraged
ETFs that utilize leverage and shorting strategies can expose investors to significant risks, with leveraged ETFs in particular being particularly dangerous. Unfortunately, since IRAs do not permit leveraged trades with these products. When considering leveraged ETFs it is wise to consult a financial professional first in order to make sure the fund fits your investment objectives and risk threshold as well as explain any techniques being employed by this ETF to reach its return goals.
Leveraged ETFs amplify market movements, creating dramatic swings between gains and losses in short time frames. If held over longer timeframes – particularly economic downturns – their returns can quickly diminish, leading to reduced returns overall. At TD Ameritrade we offer several non-leveraged funds which offer similar return potential as their leveraged counterparts but without additional risks.
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