Many investors are choosing index funds as part of their Roth IRA investment portfolio. There are several reasons that they make good sense. If you’ve been wondering why index funds are a winning combination in your Roth IRA, this guide will provide some solid answers. Before we look at reasons for why index funds can help you build the best Roth IRA, we provide a brief overview of what exactly index funds are.
What is an Index Fund?
The name gives away the meaning. An index fund is a type of fund tied directly to an index such as the S&P 500, the Dow Jones Industrial Average, or the Russell 300, which are some of the larger and better known indices. Many others exist that cover a smaller segment of the market. The S&P Global 100, the Dow Jones Global Titans 50 and the AMEX Volatility Index are just a few of the hundreds of smaller funds. In each case, the index fund mimics the index and is equivalent to owning a micro-share of each stock in the index. Your return with the index fund will be exactly the same as that of the index.
Why Add Index Funds to a Roth IRA?
There are several advantages to including index funds as you seek to build the best Roth IRA. These include:
1. The stability of the indices, leading to long-term gains, is the primary reason that it makes sense to include index funds in your Roth IRA. Since index funds can’t underperform the market, your gains can be expected to be very good in the long-run. They don’t “beat the street” but they do keep pace with it for the most part, and in some cases may do slightly better or slightly worse than the Dow Jones Industrial Average, for example. We won’t get bogged down in the Efficient Market Hypothesis, but it essentially says that it is very difficult to beat the major indices and to try to do so takes unusual skill. It also presents very high risk, and that is not something most investors want as part of crafting the best Roth IRA possible.
2. The low expense ratios of index funds make them very attractive to savvy investors. They are passively managed funds, so to speak, and their expense range averages between 0.2% to 0.5%. That is quite a bit lower than the 1.25% to 2.5% typical of actively managed funds. In addition, there are no sales charges, or loads, associated with most index funds.
3. Index funds have historically performed better than mutual funds. Over a 30-year period, most index funds will make you more money than most mutual funds. That’s what the record shows in the vast majority of cases.
Conclusion
The best Roth IRA is one that is diversified but also tied directly to proven, long-term climbers like the major index funds. If you want to add strength and stability to your growing Roth IRA portfolio, seriously consider investing in today’s top index funds. With a small amount of research you’ll understand why index funds are a winning combination in your Roth IRA.