What Should You Invest in Your Roth IRA? Dos and Don'ts

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A Roth IRA can hold almost any financial asset, so the practical question is which ones make the best use of its tax treatment. For most savers that means stocks, stock funds, ETFs, bonds and bond funds, target-date funds and REITs. Contributions go in after tax, and qualified withdrawals come out tax-free, which makes the account well suited to assets you expect to grow the most over a long period. Individual stocks are allowed, and you buy and sell them in a Roth brokerage account the same way you would in a taxable one. A Roth IRA cannot hold life insurance or most collectibles, and it cannot be used for borrowing, margin trading or personal-use property.

Why the Roth’s tax treatment shapes what you hold

With a traditional IRA, contributions may be deductible depending on your income and other factors, and withdrawals in retirement are taxed as ordinary income. With a Roth IRA, you get no deduction up front, but qualified withdrawals, including all the growth, are tax-free. A Roth also has no required minimum distributions (RMDs) during the owner’s lifetime. Traditional IRA owners must begin RMDs at age 73, while Roth money can stay invested and pass to heirs.

This tax structure is the reason many investors place their highest expected-growth holdings in a Roth. Every dollar of growth in a Roth can come out tax-free, while growth in a traditional IRA is eventually taxed as income. That is a reason to consider stocks and stock funds for the Roth, not a guarantee they will outperform. Higher expected return comes with higher volatility.

What you can invest in through a standard Roth IRA

The IRS bars only a short list of assets from IRAs. In practice, the menu is set by your custodian. Large brokerages generally offer the products they sell: stocks, bonds, mutual funds and ETFs. Real estate, private companies and precious metals typically require a self-directed IRA (SDIRA) with a specialized custodian.

Common holdings in a standard Roth IRA include:

• Individual stocks: dividend payers for income or growth companies for capital appreciation. Dividends can be reinvested without creating a tax bill.
• Bonds: U.S. Treasuries, municipal and corporate debt. If you want bond exposure without picking individual issues, bond mutual funds and bond ETFs hold many at once.
• Mutual funds: professionally managed pools that offer diversification in a single purchase. Index funds tracking benchmarks such as the S&P 500 are a common core holding.
• Exchange-traded funds (ETFs): baskets of securities that trade like a stock during market hours, often with low expense ratios.
• Target-date funds: a mix of stocks and bonds that shifts toward fixed income as the target retirement year approaches, which handles rebalancing for you.
• Real estate investment trusts (REITs): companies that own, operate or finance income-producing property and pay out dividends. Because REIT dividends are generally taxed as ordinary income in a taxable account, sheltering them is one of the Roth’s clearer advantages.
• Cash equivalents and CDs: some providers offer money market funds or CDs within a Roth. These protect principal but use tax-free growth on the asset least likely to grow.

Do individual stocks make sense in a Roth IRA?

They can, with trade-offs that are sharper inside a Roth than in a taxable account.

What works in their favor. A stock that compounds for decades produces the largest tax-free gain the account can deliver. Frequent buying and selling also creates no capital gains tax, so you can rebalance or take profits without reporting anything for that year.

What works against them. First, losses cannot be deducted. In a taxable account, selling a loser at a loss can offset gains; inside a Roth that loss has no tax value. Second, contribution room is limited each year. If a concentrated position falls by half, you cannot deposit extra money to make up for it beyond the annual limit, so the lost tax-sheltered capacity is gone. Third, a single company can fail outright, while a broad fund spreads that risk across hundreds of holdings.

For these reasons many Roth investors use diversified funds as the core and limit individual stocks to a portion they could afford to see fall sharply. How large that portion should be depends on your timeline, your other accounts and your tolerance for loss, not on a rule.

Example

This is a hypothetical illustration of the mechanics, not a forecast. Assume you put $5,000 into a stock that grows to $20,000 over 25 years, paying no dividends.

• In a Roth IRA: after age 59½ with the five-year rule met, you withdraw the full $20,000 tax-free.
• In a taxable account: the $15,000 gain is taxed when you sell. At an assumed 15% long-term capital gains rate, that is $2,250 in tax, leaving $17,750.
• In a traditional IRA (assuming the $5,000 was deducted): the entire $20,000 withdrawal is taxed as ordinary income at your rate in retirement.

Now assume the same stock fell to $2,000 instead. In the Roth, the $3,000 loss provides no deduction, while in a taxable account it could offset other gains. The tax-free benefit is largest when the investment grows, which is the logic behind putting growth assets in the Roth, and the gap widens the longer the money compounds.

Trading inside a Roth: what is and isn’t tax-free

Buying and selling stocks in a Roth IRA does not trigger tax, whether you hold for a day or a decade. Dividends and interest are not taxed when paid. Tax comes into play only when money leaves the account, and only if a withdrawal of earnings is not qualified.

Two points catch traders. One is the wash-sale rule: if you sell a stock at a loss in a taxable account and buy the same stock in your IRA within 30 days, the IRS disallows the loss, and because it cannot be added to the IRA’s cost basis, it is lost permanently. The other is that brokerage trading restrictions still apply. Without margin, you generally trade only with settled cash, which can delay a new purchase after a sale.

What a Roth IRA cannot hold

The IRS excludes two categories:

• Life insurance
• Collectibles: art, rugs, antiques, metals, gems, stamps, most coins, alcoholic beverages and other tangible personal property

If IRA money is used to buy a collectible, the amount is treated as distributed in the year of purchase. You may owe income tax on the earnings portion, plus a 10% early withdrawal penalty if you are under 59½.

There is a carve-out for certain precious metals. An IRA may hold one-, half-, quarter- or one-tenth-ounce U.S. gold coins, one-ounce silver coins minted by the U.S. Treasury, certain platinum coins, and certain gold, silver, palladium and platinum bullion. These are usually reached through a self-directed IRA.

A self-directed IRA opens access to real estate, private placements and other alternatives. It also brings more complexity, valuation questions and fraud risk, and the custodian does not vet the investments for you. SDIRAs suit investors who already understand these assets and their tax treatment.

Transactions to avoid

A prohibited transaction is any improper use of the IRA by the owner, a beneficiary or a disqualified person, which includes the owner’s fiduciary and family members. The IRS prohibits:

• Borrowing money from the IRA
• Selling property to the IRA
• Using the IRA as security for a loan
• Buying property for personal use with IRA funds

These rules matter most in self-directed accounts. Buying a rental house through your Roth and letting a relative live in it, or staying in it yourself, falls under these prohibitions.

Margin and limited margin in a Roth IRA

Regular margin means borrowing from your broker with your holdings as collateral, which magnifies gains and losses. It is generally not available in a Roth, because an IRA cannot be pledged as security for a loan. If it were used, the IRS could treat the amount as a distribution, with income tax on the earnings and a possible 10% penalty under 59½.

Some brokers offer limited margin for IRAs, including Roth, traditional, SEP and SIMPLE accounts. It does not lend you money to buy extra securities. It only lets you use sale proceeds before the trade settles, so you can sell one stock and buy another right away. It does not permit short selling or naked options positions, and brokers set their own eligibility requirements, such as a minimum balance, and must approve the account first.

Withdrawal rules that affect your investment choices

Roth withdrawals follow an ordering principle: contributions come out first, then earnings.

• Contributions can be withdrawn at any time, for any reason, without tax or penalty, since you already paid tax on that money.
• Earnings are tax- and penalty-free only if you are at least 59½ and the five-year rule is met. Otherwise, income tax and a 10% penalty may apply unless an exception covers you.

The five-year clock starts on January 1 of the tax year for which you made your first contribution to any Roth IRA. A contribution made in April 2023 for tax year 2022 starts the clock on January 1, 2022, so from January 1, 2027, assuming you are 59½ or older, earnings from any Roth IRA you own come out tax-free. Roth conversions carry their own separate five-year periods for penalty purposes. The details are in Roth IRA withdrawal rules and the five-year rule.

This affects what you hold. Money you may need within a few years is better suited to stable assets, because a forced sale of stocks after a decline locks in the loss. Money with a long horizon can carry more market risk.

FAQs

The Bottom Line

Savers with a long time horizon gain the most from a Roth IRA, because qualified withdrawals, including all growth, come out tax-free and there are no RMDs during the owner's lifetime. Diversified stock funds and ETFs make a sensible core, with individual stocks limited to a portion you could afford to lose, since Roth losses cannot be deducted. Money you may need within a few years belongs in more stable assets.