September 14, 2010

You’re interested in opening a Roth IRA, but you’re still learning more about the process. One critical question you must know the answer to is what type of investments to put in your Roth IRA. This is a two-sided question. You need to know:

1. What investments you want to put your money into
2. What investments the company you own your Roth IRA with offers

We’ll start with the first issue.

What Investments Should I Use in My Roth IRA?

It all depends on your financial plans and goals. The most common investments you’ll see are:

• Stock mutual funds - You’ll see index funds and actively managed funds .
• Bond mutual funds - These also come in index and actively managed varieties
• Mixed asset funds - As you might expect, funds that are a mix of stock and bond holdings. You’ll see some actively managed funds in this category, but you’ll also see some real winners that are target retirement funds. These target retirement funds automatically adjust the balance of stock and bond holdings as you get closer to the date listed on the fund.
• Certificates of Deposit - Your conservative CDs are also an option to hold in your Roth IRA .
• Exchange-Traded Fund (ETF) - ETFs are similar to mutual funds in that they usually track an index. They usually cost less on an annual basis. The only catch is they usually carry a charge to buy and sell them on the stock exchange like stocks.
• Individual stocks - Most Roth IRA companies will let you buy individual stocks to augment your portfolio’s performance.
• Real Estate. Investors can also choose to hold real estate investments in their Roth IRA .
• Exotic Investments. Investors who elect to hold a self-directed Roth IRA may decide to invest in exotic investments .

I’m a fan of most of these investment options. I don’t think many people are intelligent enough to pick individual stocks — myself included. For now I’m personally sticking with target retirement funds with a very low annual expenses. Once my portfolio gets to be enormous I may look into finer adjustments with specific index funds.

What Investments Are Available for My Roth IRA?

You can want all of those investments listed above — and some exotic investments — but it doesn’t matter if your Roth IRA holder doesn’t offer those investments. What you’ll see a lot of is the company you’re opening the Roth with will offer a lot of their own investment products. This makes sense — you’ve got an account there. They want to make sure they are the ones benefiting from all the annual expense and transaction fees from your investments. However, this isn’t good for you.

If you open up an account at Bank A and Bank A only offers their own products then you’ll likely end up paying higher fees. If you can only use Bank A products it won’t matter for you that Mutual Fund Company A and B offer similar products for a cheaper price. You’ll be stuck with the higher costs. (And those costs will kill your investment return over time.) So picking the right firm that offers the best products for your financial goals is key. Make sure you identify what investments you want before you select a firm. The firm’s available investments should match up with what you’re targeting.