:max_bytes(150000):strip_icc()/the_3_best_vanguard_mutual_funds_for_your_roth_ira-5bfc3571c9e77c005181a040.jpg "Powerful mutual funds from Vanguard for your Roth IRA")
The Vanguard Group Inc., known as Vanguard, is one of the world’s largest investment management and advisory services companies. It is primarily an ETF and mutual fund management company with around $8.1 trillion in assets under management (AUM) as of January 31, 2022. Founded in 1975, the company offers a total of 422 funds, 215 of which are available in the US. Vanguard is a full-service broker, offering low-cost investments for long-term buy-and-hold investors and savers for The retirement.
Investors in the US have access to several tax-advantaged savings plans, including 401(k), individual retirement accounts (IRAs), and Roth IRAs. The main difference between a Roth IRA and a traditional IRA is that the former is funded with after-tax dollars. That means contributions to Roth IRAs are not tax deductible, as they are with traditional IRAs. But unlike a traditional IRA where withdrawn funds are taxed, a Roth IRA allows investors to withdraw funds tax-free. Fund numbers are for the second quarter (Q2) of 2022, unless otherwise noted.
key takeaways
- Vanguard was founded in 1975 and has around 215 funds available in the US, as well as $8 trillion in AUM.
- When creating a retirement account, a broad stock fund and a broad bond fund provide a good foundation, either as the complete foundation for investing or for developing more complex investments.
- Roth IRAs allow you to avoid paying taxes on investment returns by investing your after-tax income.
- These include bond funds and REIT funds.
- VTI and BND can serve as good starting points when looking for investments in Vanguard Roth IRAs.
The Best Types of Funds for a Roth IRA
A Roth IRA is a type of qualified retirement account that is funded with after-tax dollars and then allowed to grow without income taxes. This is as opposed to a traditional IRA (or 401(k) plan) that uses pre-tax dollars and therefore provides a tax deduction in a given contribution year. Traditional IRAs then grow tax-deferred, where income tax must be paid on future contributions and earnings at withdrawal.
Because a Roth IRA does not have this tax-deferred obligation, it is better to use this type of account to benefit from the tax exemption. That means identifying high-yield investments that pay a high and steady stream of income in the form of interest, dividends, or other distributions. Bonds pay regular interest, so these are an obvious candidate for a Roth. Others include real estate investment trusts, or REITs, which must pay out at least 90% of their operating income as dividends. Preferred stocks also pay relatively high and regular dividends. These are the types of assets that would benefit the most from the Roth as a tax haven.
Keep in mind, however, that a Roth IRA has an annual contribution limit ($6,000 in 2022 and $6,500 in 2023) and also has income limitations. You will not be able to make full contributions to the Roth IRA if your adjusted gross income (MAGI) in 2022 is more than $129,000 as a single taxpayer (adjusted to $132,000 for 2023) and you cannot make any contributions if you earn $144,000 or more (adjusted to $153,000 for 2023). For married couples filing jointly, the limits for 2022 are $204,000 and $214,000, respectively ($218,000 and $228,000 for 2023).
Strategically placing high-yield retirement assets in a Roth account and other assets that can pay little or no income in a traditional account is known as asset allocation, and is a key way to minimize your tax exposure in retirement.
Vanguard Total Stock Market ETF (VTI)
- Expense index: 0.03% (as of the first quarter of 2023)
- assets under management: 1.2 trillion dollars
- 12-month performance with follow-up (TTM): 4.40%
- 1-year follow-up total return: -8.23%
- Start date: May 24, 2001
The Vanguard Total Stock Market ETF is intended to track the performance of the CRSP US Total Market Index. As an exchange-traded fund (ETF), VTI offers investors access to a broad portfolio of stocks, and VTI shares can be traded around the clock like a stock.VTI is passively managed, using an index sampling strategy that keeps investor expenses low.
VTI’s portfolio consists of 3,969 stocks, with the top 10 accounting for just under a quarter of total invested assets. The fund’s holdings include large-cap, mid-cap and small-cap stocks across growth and value styles. The median market capitalization of VTI’s holdings is $117.7 billion. Virtually all of the holdings are US-based companies; only 0.2% are foreigners.
Investors who want to build wealth through price appreciation should consider a broad-based stock fund like VTI. Although stocks have higher volatility than bonds, they have a track record of outperforming over a long period of time. If investors have a low risk tolerance or are nearing retirement, they might consider a more income-oriented portfolio.
VTI is the ETF equivalent to the Vanguard Total Stock Market Index Fund (VTSAX).
Vanguard Total Bond Market ETF (BND)
- myExpense Ratio: 0.03% (as of the first quarter of 2023)
- Assets under management: $289.3 billion
- 12-month performance with follow-up (TTM): 0.56%
- 1-Year Follow-up Total Return: -9.73%
- Start date: April 3, 2007
The Vanguard Total Bond Market ETF tracks the Bloomberg Aggregate Float-Adjusted Index for the US, a broad market-weighted index. This ETF offers investors broad exposure to the US dollar-denominated investment grade taxable bond market. The fund excludes tax-exempt and inflation-protected bonds.
BND owns 10,164 bonds. The average duration of a BND bond is 6.8 years and the average effective maturity was 8.9 years. Just over two thirds of the bonds are US government bonds. While the remaining third is investment grade debt, about 14.10% of the total are BBB bonds, which are among the highest rated. low on the investment grade scale.
BND is intended to serve as a central bond holding for investors. Bonds generally have low volatility and provide a steady supply of interest payments to the investor. Interest payments are tax-deferred in a Roth IRA, making it an ideal place to keep these types of investments. A broad-based bond fund is typically a lower-return, lower-risk investment vehicle than a stock fund. As a result, bonds can be useful for both risk-averse investors and portfolio diversification.
BND is the ETF equivalent to the Vanguard Total Bond Market Index Fund (VBTLX).
The Vanguard Index REIT ETF (VNQ)
- Expense index: 0.12% (as of the first quarter of 2023)
- Assets under management: $69.7 billion
- 12-month follow-up performance (TMT): 3.95%
- 1-Year Follow-up Total Return: -13.25%
- Start date: September 23, 2004
The Vanguard REIT Index ETF invests in shares issued by real estate investment trusts (REITs), companies that buy and manage office buildings, hotels and other real estate, and tracks the MSCI US Investable Market Real Estate 25/50 Index. This index is primarily a stock REIT index, and VNQ owns REIT shares in 167 different companies.
Because REITs must pay out 90% or more of their operating income as dividends to shareholders, REIT funds tend to have relatively high returns. These can result in a number of taxable events that are deferred in a Traditional IRA but are exempt in a Roth. As a result, a Roth IRA is a good place to have a REIT. Keep in mind, however, that REIT funds are quite sensitive to interest rates, and stock prices can drop sharply as rates rise. This is because the cost of financing property (eg, mortgages) also increases as interest rates rise.
VNQ is the ETF equivalent of The Vanguard REIT Index Fund (VGSLX).
What is the cost of opening a Vanguard Roth IRA account?
In some cases, the minimum investment required to open a Vanguard Roth IRA can be as low as $1,000. For most Vanguard funds, the minimum investment required is $3,000, and that minimum is higher for some funds. There is no fee to open the account.
Does Vanguard offer traditional and Roth IRAs?
Yes. Vanguard offers both Roth and Traditional IRAs.
How much does it cost to open a Vanguard Roth IRA account?
Vanguard charges annual account service fees of $20 per Roth IRA if the total Vanguard mutual funds and ETF assets in the account are at least $1 million. However, this fee can be waived by signing up for the company’s electronic delivery service or by maintaining at least $1 million in qualifying assets. Investors should not overlook that they also pay through expense ratios in individual funds.
Can you make daily transactions in a Roth IRA account?
Like other retirement accounts, a Roth IRA does not allow margin, which can limit day-to-day business activities, including short sales. However, you can still actively trade in your Roth IRA. Because a Roth is tax-exempt, any short-term capital gains made would also be exempt, which is a bonus. However, you may accrue transaction fees.
What index fund should I invest in my Roth IRA?
Many experts advise using buy-and-hold index funds to invest in retirement accounts. Since a Roth IRA is tax-exempt, the best type of index fund would be one that pays a lot of dividends or other distributions. Index funds to look for, therefore, would focus on those that pay a high yield, such as bond funds (especially high-yield bonds), real estate funds (especially REITs), and preferred stock indices. You should put low-yielding index funds into a tax-deferred account, such as a traditional IRA or 401(k).
The bottom line
Roth IRAS can be an effective tool for saving for retirement, and the broad stock and bond funds provide diverse and affordable foundations. Investors may want to go further depending on how much time, energy and risk tolerance they have to invest. For many time-pressed investors, it’s a practical decision to pick a few large and diverse stock and bond funds and continue to invest in them. Some investors will choose another path, opting to aggregate investments in individual companies, including riskier small-cap stocks, and through investing in specific sectors and stock research.