5 Best Investments for Your Roth IRA

So you already know that a Roth IRA is the best way to grow tax-free wealth. But here's the thing, just opening a Roth IRA isn't enough. Don't make the mistake of only contributing money to your Roth IRA and thinking that's it, you're invested. Because after you put money into the Roth IRA, you have to then go and buy investment. Otherwise, you're not invested. Think of your Roth IRA as a garden with very fertile soil. Whatever you plant in it is going to grow tax-free. But you do need to plant something, otherwise nothing's going to grow. And not only do you need to plant seeds, you also need to plant the right combination of seeds. Otherwise, you risk doing it all wrong and you're not going to end up with that beautiful, thriving, healthy garden that's going to throw off passive wealth and income for you long after you stop working. So in this video, let's talk about the five best investments for your Roth IRA, starting with an S&P 500 index fund. This is the first seed you should plant in your Roth IRA. Think of this as the strong, sturdy trees in your garden. An S&P 500 index fund represents the top, largest 500 companies in the United States. Think companies like Apple, Microsoft, and Google. What makes this investment so powerful? Consistency and reliability. Over the last century, the S&P 500 has delivered an 8% to 10% average annual return. In other words, 50 years ago, if you'd planted $10,000 into an S&P 500 index fund, that money would be worth close to $2.2 million today. That's why an S&P 500 index fund is one of the backbones of a smart investment portfolio. Something else that's great about an S&P 500 index fund is that they're really, really low cost. Because this fund simply tracks and copies what's in the S&P 500 index, hence the name index fund, the fees for this type of fund are very, very low. We're talking cheaper than 0.1%. That is peanuts. Compare this to a fund that's not an index fund, an actively managed fund, where the stocks are picked by a very smart, active stock picking manager. And these types of funds tend to charge as high as 1% to 2% in fees. Over time, these fees eat into your returns and could cost you over $100,000. That's why you want to stick to low cost index funds whenever possible. And an S&P 500 index fund is a great place to start. Some really popular choices are VOO, which is Vanguard's S&P 500 ETF. The expense ratio is 0.03%. And if you prefer a mutual fund, VFIAX is Vanguard's S&P 500 mutual fund. For more on the difference between mutual funds and ETFs, check out this other video here. Now, once you've invested your money into an S&P 500 index fund and planted these trees in your garden, the trees will grow tall and strong, weathering all the seasons if you just leave it alone and let it do its thing. So we just covered the S&P 500 index fund, which is the 500 largest companies in the US. But what about all the other companies in the United States, the ones that weren't big enough to make it into the S&P 500? For example, we have companies like Shake Shack. We have companies like Bed Bath & Beyond. We have companies like Crocs and Williams-Sonoma. So these are what you call small-cap and mid-cap companies. The S&P 500 is only large-cap companies. Altogether, the large, small, and mid-cap, this makes up what you call the total market index fund. Small companies tend to grow more, and so your returns can be a lot higher than if you only invested in an S&P 500 fund. Over the last 50 years, small-cap stocks returned an average of 11.4%, whereas large-cap stocks returned 10.7%, meaning a $10,000 investment into only large-cap stocks would have grown to $2.2 million, whereas into small-cap stocks would have grown to $3.1 million. Think of the analogy of a baby versus a teenager. A teenager is almost fully grown as an adult, whereas a baby has a long way to go. So small-cap companies are like the babies. The growth is a lot more extreme, whereas large-cap companies, because they've already grown so much, the returns and growth are limited. That being said, you actually want to have both because large-cap companies, although they don't grow as much, they're also more stable. Small-cap companies will really juice up your returns, but you also need some stability, which is why a total market index fund, which includes all the small, mid, and large-cap companies, is actually the most diversified approach. So just like when choosing S&P 500 funds, you want to go for low-cost index funds. We're looking for low-cost total market index funds. A couple of good ones to look into are VTI and VTSAX. Something to note is if you own a total market index fund in your Roth IRA, you do not also need an S&P 500 index fund because that would be redundant. A total market index fund also contains the S&P 500 stocks, so you do not need both. Now, if you want a really comprehensive list of all the best index funds out there, all the funds that we're going to be talking about in this video, then you're going to love my index fund cheat sheet. I've gone and found all the best index funds for you with clickable links and descriptions of everything, and it will make the investing process go so easy for you. The link is below or just use this QR code to download it. All right, so we covered the U.S., but did you know that the U.S. stock market is only 60% of the global stock market? So what about the remaining 40%? That's where international stock funds come in. The reason why you want to include international funds in your Roth IRA portfolio is because there are some periods when international stock markets outperform the U.S. Now, granted, in the last decade or so, the U.S. stock market has been by far the outperformer and shining star, but it hasn't always been that way, nor can you expect that to continue in the future. For example, between 2000 to 2009, the U.S. stock market actually drastically underperformed. The S&P 500 returned minus 9.1%, whereas international developed markets went up by 17.7%, and emerging markets, these are companies like Russia, China, and Brazil, sort of the third world countries, these stock markets returned 154% in that period. So even though you definitely want your stable evergreen trees that the U.S. stock market, you want that in your garden, you also want to diversify with other types of trees like these international stock funds. That's because geographic diversification matters. If you only hold U.S. stocks, there will be periods when you actually lose money, whereas investors who diversified with international stocks are actually making money. So the way to include international stocks in your Roth IRA portfolio is to add an international index fund, such as VEA, which is Vanguard's ETF for developed countries outside of the U.S., or VWO, which is Vanguard's index fund for emerging market countries. Or if you want to invest in all international companies, whether it's developed countries and emerging market countries in one convenient fund, you can also look into a fund like VXUS. Once again, grab my index fund cheat sheet because that will break it all down for you. All right, and now for the next piece of your garden, to diversify, we're going to add a few shrubs, some plants, some, what are these? Some bushes, whatever you want to call it, and bonds are a great addition to your portfolio because they are very complementary to stocks. Like if stocks are your peanut butter, then bonds are your jelly, and together they make the most amazing combination. Actually, that's a really dumb analogy. The reason why bonds are so complementary to stocks is because they actually respond completely opposite to the way stocks respond to different economic situations. For example, when the economy is growing a lot, bonds kind of chug along, whereas stocks are doing really well. And then when the economy is not doing well, like in a recession, bonds actually do really well, whereas stocks suffer. Even though they're not that exciting to have, especially when the economy is growing and you wish you'd had most of your money in stocks, when those difficult periods come around, you will be so glad that at least a piece of your portfolio is unbothered and still thriving despite everything else losing money. For example, in the financial crisis, if you had a portfolio of 100% stocks in the worst of the market crash, your portfolio went down by as much as 50%. Whereas if you had a portfolio of 50% stocks and 50% bonds, your portfolio only went down by 25%. That is a lot easier to stomach than a 50% drop. Now, if you're kind of on the young side, if you have say 20 to 30 years until you actually need to retire and live on that money, then a 50% drop is not so much a problem because you can just wait it out for the recovery. But if you're on the older side and you're about to retire in a year to five years, a 50% drop in your portfolio would have taken you much longer than that to recover from and that would have affected your retirement. That's why the older you are, you want to have more in bonds. The reason why bonds are so much more stable than stocks is because bonds are a form of lending money, whereas stocks are a form of ownership. When you own a piece of a company, you get to benefit in all of the upside as well as all of the downside. But if you just lent money to a company, like you invested in a bond, you just get your interest payments and then the return of your principal. And even if the company does really, really well, you just get your interest and your principal. And also if the company does really bad because a bond is a legal obligation, your money is actually quite protected. So if you want to add bonds to your Roth IRA portfolio, a couple of good ones to look into are BND. This is Vanguard's Total Bond Market ETF. You could also look into funds like FUAMX. This is Fidelity's Intermediate Treasury Index Fund. And again, for a breakdown of all these different index funds, as well as many more, don't forget to check out my index funds cheat sheet. And now for the fifth investment to add to your garden, REITs. REITs stand for Real Estate Investment Trusts. And these are basically stocks in very large companies that own a bunch of real estate. What I love about REITs is that they allow you to be a real estate investor without having tens of thousands of dollars or hundreds of thousands of dollars to put in a down payment on a property. Because instead of you buying the property directly, you could also just buy shares in a company that owns a lot of real estate. And that would basically be the same thing as owning the real estate directly. REITs are specifically required to not only invest in huge portfolios of real estate, but they're also required to pay out 90% of the rental income to you as the investor in the form of dividends. So REITs are actually a great form of passive income, and you can essentially receive rental income without all the headache and the capital. The thing to watch out for with REITs, however, is to diversify in different sectors. REITs often focus on specific sectors of real estate, such as residential real estate, commercial real estate, medical real estate, even industrial real estate, storage, and so much more. So for example, if there's a huge decline in retail in-person shopping, then REITs that own a lot of shopping malls, they would really suffer. So to get around this, you can actually invest in REITs that invest in a variety of different sectors of real estate. One example of a REIT fund like this This is Vanguard's REIT Index Fund, which covers commercial, industrial, and residential properties. When you're looking for REITs, another thing to look at is the dividend yield. Dividend yield is how much in dividends you're getting per year divided by the stock price. And the idea behind dividend yield is if it's a really high dividend yield, you're getting more bang for your buck because for a cheaper stock price, you're going to get more dividends. High dividend yields are good, low dividend yields are bad. There is one catch though, because sometimes there is such a thing as too good to be true. When the dividend yield looks a little too high, then that's something to look into further. For example, in a time when most REITs are paying anywhere from 3-6% in dividend yield, NYMT is paying double digits, 13%. Now this sounds great, but it's actually a warning sign because it means the stock price is a little too low, they're paying way too high dividends, which means your principal actually could be at risk. NYMT is an example of a REIT that might look good if you only look at its dividend yield, but if you look at its history, you'll see that it never really recovered from the 2008 financial crisis and the stock has just been on the decline. So don't be misled by high dividend yields when picking out your REITs. Also, FYI, all the investments we're talking about in this video, they all pay dividends. It's just that REITs tend to pay a little bit higher because by law, they are required to pay out 90% of their income as dividends. So those are the five elements of a Roth IRA garden or a really well diversified investment portfolio. All that being said, if you don't want to go through the trouble of picking out all these investments, I have one sixth bonus option for you, which is to buy a target date fund. Buying a target date fund is kind of like buying a ready-made garden. It already comes with all of these things in the right proportions. All you have to do is pick the fund that is right for your retirement age. For example, if you're 30 years old today, you would pick a 2055 target date retirement fund, meaning this fund includes the right mix of stocks and bonds that's appropriate for someone of your age, for someone who's planning to retire in the year 2055. Target date funds, earlier on, they invest heavily in stocks and then as you approach retirement age, as it gets closer to the year 2055, the fund will automatically start shifting some of your money into bonds to create more stability and get you ready for a stable retirement. Target date funds are really the ultimate set it and forget it investment. So if you're kind of lazy, but you still want to do something with your Roth IRA and make sure that money grows, they're a really good option to look into. Personally, I don't prefer target date funds because they're not customizable. For example, if you wanted to take more risk and have more in bonds than is appropriate for someone your age, then you won't be able to do that with target date funds. They also tend not to include REITs. So if you like real estate, then with a target date fund, you're not going to get as much exposure. That being said, if you want to learn more about target date funds, then check out this video on my channel here. Now you can see how investing your Roth IRA is like planting a garden. And the key is you want it to be diversified. You want it to have a lot of different varieties. You want to have your strong, stable trees. You want to have your shrubs and your flowers. And then the key is you also want to leave it alone. You want to water it. You want to check up on it, but you don't want to take things out, sell things off and just meddle with it too much. Because in 10, 20 years, you'll be amazed at how much it grows. Future you is going to thank you, especially because you're going to be able to pull all this money out tax free. Now, don't forget you have until April 15th of every year to contribute for the previous tax year. As of now, you can put up to $7,000 a year. So once you get that money in, make sure you plant your seeds because future you is going to thank you. If you liked this video and want to learn more, make sure to check out some of my other investing videos right here and I'll see you in the next one. Bye.