A Roth is a type of Individual Retirement Account (IRA) that allows for the tax-free growth and distribution of contributions and earnings. As taxes are never paid on investments within the Roth, the logical conclusion is that investments with the highest tax consequences should be considered for investment within a Roth. However, investments in any account should be analyzed as to how they fit into an overall investment portfolio.
High Interest Investments
Investments that pay high rates of interest, such as high-yield bonds or preferred stocks, can be good Roth investments because the interest they generate is taxable in a regular account, but tax-free in a Roth. However, securities that pay a high yield are generally higher in risk as well, so consider the overall risk of your portfolio before putting a high-yield security in your Roth just to earn the interest. For example, if the rest of your account is invested U.S. Government Bonds, which are considered among the safest available investments, the high-yield bonds in your Roth might prove to be a good diversification move. However, if your Roth is your only account, you may wish to diversify your account a bit more. One way to help lessen your risk is to purchase a mutual fund, which spreads out your investment over hundreds or thousands of securities, rather than just a few.
Frequently Traded Investments
While the capital gains tax rate for 2010 is just 15 percent, if you hold your securities for one year or less, you must pay the less favorable ordinary income tax rate on your stock investments. If you are a frequent stock trader, your tax burden will be lessened by trading the stocks in your Roth as opposed to your taxable investment account.
Long-Term Investments
A Roth IRA is intended to be a long-term retirement savings account, as evidenced by the 10 percent penalty levied by the IRS if you take a distribution before age 59 1/2. As Roth distributions are ultimately tax-free, one Roth investment strategy is to try to achieve the highest account value by the time you reach retirement age, rather than worrying about the year-to-year tax benefits. Under this strategy, it doesn't matter if you put high-yielding securities in your Roth or trade frequently. By purchasing the best long-term investments you can find, you stand the greatest chance of achieving a high account value when you withdraw the funds. The higher the account value, the greater the overall tax benefit.
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