An index fund is a type of mutual fund or exchange-traded fund that aims to track the performance of a specific stock index. A Roth IRA is a type of tax-advantaged investment account. Index funds are one type of investment you could hold inside a retirement plan like a Roth IRA.
Here’s a closer look at investing in index funds through a Roth IRA.
Key Points
• A Roth IRA is a tax-advantaged retirement account, while index funds are investments that can be held within such accounts.
• Investing in index funds within a Roth IRA allows for tax-free growth and withdrawals.
• Index funds provide diversification and offer the potential for long-term growth, which could make them an efficient choice for retirement savings.
• When selecting an index fund, consider factors like risk tolerance, investment goals, expense ratios, and historical performance.
• It’s important to regularly review your Roth IRA and the investments in it and make any necessary adjustments to meet your financial objectives and comply with contribution limits.
Understanding Your Investing Options in a Roth IRAs
A Roth IRA is an individual retirement account that allows you to set aside after-tax dollars for retirement. Because you’ve already paid taxes on the money you contribute to the Roth IRA, you can withdraw it tax-free in retirement, which is an attractive feature to some investors.
Roth IRAs can offer a number of different investment options, including:
• Exchange-traded funds (ETFs)
• Real estate investment trust (REIT) funds
• Bonds
Index funds, target-date funds, and REITs can feature a mix of different investments. So, you might invest in a target-date fund that has a 70% allocation to stocks, and a 30% allocation to bonds, for instance. When comparing different funds it’s important to consider the expense ratio you might pay to own it and its past performance.
Some brokerage companies that offer IRAs may also offer other investments, such as individual stocks, commodities, or even cryptocurrency. Evaluating your personal risk tolerance, investment timeline, and goals can help you decide how to invest your money if you’re opening a retirement account online like a Roth IRA.
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What Are Index Funds?
An index fund is a type of mutual fund or ETF that aims to track the performance of a specific stock index. A stock index measures a specific segment of the market. For example, the S&P 500 index tracks the 500 largest companies listed on public stock exchanges in the U.S.
Index funds typically work by investing in the same securities that are included in the index they’re trying to match. So, for example, if an index fund is using the S&P 500 as its benchmark, then its holdings would reflect the companies that are included in that index.
Index funds are a type of passively managed fund, since assets turn over less frequently. In terms of performance, index funds are not necessarily designed to beat the market but they can be more cost-friendly for investors as they often have lower expense ratios.
Long-term Benefits
Index funds offer the opportunity for long-term appreciation. Because they track the stock market, which historically has an annual return of about 7% (as measured by the S&P and adjusted for inflation), index funds may be able to get a similar rate of return over time, minus any fund fees.
Why Invest in Index Funds Through a Roth IRA?
As noted above, you can hold a range of investments in a Roth IRA, including index funds. Investing in index funds may help diversify your portfolio. Here are some of the other possible factors to consider.
Tax-free Growth and Withdrawals
Because you’ve already paid taxes on the money you contribute to a Roth IRA, you can withdraw it tax-free in retirement, as long as you are age 59 ½ and meet the five-year rule, which dictates that your account has to be open for at least five years before you start withdrawing funds. Tax free withdrawals in retirement might appeal to you if you expect to be in a higher tax bracket at that time.
Any earnings you have from index funds or other investments grow tax-free in a Roth IRA and they can be withdrawn tax-free in retirement.
Supporting Retirement Goals
Because they offer the potential for long-term growth, index funds can be part of a retirement savings strategy. An investor can choose the funds that best fit their risk tolerance and investment goals. The fees are also lower for index funds than some other types of investments, which means you can keep more of your earnings over the long term.
How to Invest in Index Funds in a Roth IRA
If you’ve decided to invest in index funds through your Roth IRA, the process for getting started is relatively simple:
1. Decide which index fund or funds you’d like to invest in (see more on that below).
2. Log into your Roth IRA account.
3. Find the fund you’d like to purchase and select “Buy.” You may be able to specify a specific dollar amount you want to spend or choose the number of shares you want to buy.
4. Review your order to make sure it is correct, then finalize it.
Tips on Choosing the Right Index Funds
While index funds operate with a similar goal of matching the performance of an underlying benchmark like the S&P 500, they don’t all work the same. There can be significant differences when it comes to things like the expense ratio, the fund’s underlying assets, its risk profile, and its overall performance.
When choosing an index fund to invest in, consider the following factors:
• Risk tolerance. How much risk are you willing to take with your investments? Knowing if you’re a conservative, moderate, or aggressive investor is important to choosing index funds that make the most sense for you. Our risk tolerance quiz can help you figure out which category you fall into.
• Your goals. What specifically, are you hoping to get out of your investment? Are you saving for the long term and aiming for it to grow over time? Are you putting away money for retirement? Determining exactly what you want to do with your investment will help you decide what type of index funds to invest in.
• Broad vs. specialized fund. Broad funds attempt to mimic the performance of a stock market as a whole, while a specialized fund like a small cap index fund, for example, targets companies with a smaller market capitalization. A specialized fund can be riskier because you’re invested in one type of asset, while a broad fund can provide some diversification, although like any investment, there are still risks involved.
• Performance history. A fund’s performance history can help you see how the fund has handled different market conditions. Look to see how it has consistently performed relative to the benchmark it tracks. You can also compare its performance to other index funds in the same category.
• Expense ratios. These ratios represent the annual cost of managing an index fund. They’re expressed as a percentage of your total investment. Keep in mind that a small difference in expense ratios can add up over time. With a smaller expense ratio, less of your investment goes to management costs.
Managing Your Index Funds
Even though index funds are passively managed, it’s a good idea to review them from time to time.
First, check their performance to see if they are mirroring the index they follow, minus the expense ratio. If their performance is not keeping up, you may want to consider another fund.
Also, keep an eye on fees. If you see that the fees for your index funds are growing over time, you may want to change your investment.
Managing Your Roth IRA
Similarly, with a Roth IRA, it’s wise to review your account and the investments inside it at least once a year. Monitor how well your assets are performing and see if they are on track to help you reach your goals.
You may find that you need to do some portfolio rebalancing. Based on how your assets have performed, you might have a different asset allocation than you originally started out with, as some things may have performed better than others. For instance, maybe stocks outperformed bonds. Review your asset allocation carefully and make any adjustments needed to help stay true to your risk tolerance and investment goals.
Finally, contribute to your Roth IRA each year if you can, but be sure not to over-contribute. The IRS sets the maximum limit for annual Roth IRA contributions. For 2024, the maximum limit is $7,000, or $8,000 if you’re age 50 or older. You have until the tax filing deadline to make contributions for that tax year. For 2025, the maximum limits are the same: $7,000 or $8,000 if you’re 50 or older.
It’s important to note that the limits are cumulative. If you have more than one Roth IRA, or a Roth IRA and a traditional IRA, your total contributions to all accounts cannot be greater than the limit allowed by the IRS. Unlike traditional IRA contributions, Roth IRA contributions are not tax-deductible.
Also, be aware that you’ll need to have earned income for the year to contribute to a Roth IRA, but there are limits. The IRS sets a cap on who can make a full contribution, based on their filing status and modified adjusted gross income (MAGI).
Here are the income thresholds for the 2024 and 2025 tax years:
| Filing Status | You Can Make a Full Contribution for 2024 If Your MAGI is… | You Can Make a Full Contribution for 2025 If Your MAGI is… |
|---|---|---|
| Single or Head of Household | Less than $146,000 | Less than $150,000 |
| Married Filing Jointly | Less than $230,000 | Less than $236,000 |
| Married Filing Separately and Did Not Live With Your Spouse During the Year | Less than $146,000 | Less than $150,000 |
| Qualifying Widow(er) | Less than $230,000 | Less than $236,000 |
Contribution amounts are reduced as your income increases, eventually phasing out completely. The 2024 phaseout limits are $146,000 for single filers, heads of households, and qualifying widows or widowers. The limit for couples is $230,000.
If you’re married and file separate returns but lived with your spouse during the year, you’d only be able to make a reduced contribution for 2024 if your MAGI is less than $10,000.
The 2025 phaseout limits are $150,000 for single filers, heads of households, and qualifying widows or widowers. The limit for couples is $236,000. And if you’re married and filed separate returns and lived with your spouse during the year, you can make a reduced contribution only if your MAGI is less than $10,000.
Recommended: Roth IRA Calculator
The Takeaway
A Roth IRA is a tax-advantaged account that can help you save for retirement. There are a number of different investment options to choose from when you have a Roth IRA, including target-date funds and index funds.
If you decide to invest in index funds, research different funds to find the best ones for you, and be sure to look at their performance and expense ratio, among other factors. Also, consider your risk tolerance and goals when choosing index funds to make sure that they are aligned to help you reach your financial goals.
Ready to invest for your retirement? It’s easy to get started when you open a traditional or Roth IRA with SoFi. SoFi doesn’t charge commissions, but other fees apply (full fee disclosure here).
FAQ
Can I lose money investing in index funds?
It is possible to lose money investing in index funds. All investments involve risk and can lose money. However, broad index funds, such as those that use the S&P 500 as a benchmark, are diversified and hold many different types of stocks. Even if some of those stocks lose value, they may not all lose value at the same time.
Is it better to invest in index funds or individual stocks for a Roth IRA?
Which investment is best depends on an investor’s financial situation, goals, and risk tolerance. There is no one-size-fits-all answer. But in general, individual stocks can be more volatile with more potential for risk (they may also have more potential for higher returns). Broad index funds that provide significant diversification may help minimize risk and maximize returns over the long term.
Rebecca Lake
Rebecca Lake has been a finance writer for nearly a decade, specializing in personal finance, investing, and small business. She is a contributor at Forbes Advisor, SmartAsset, Investopedia, The Balance, MyBankTracker, MoneyRates and CreditCards.com. Read full bio.
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Investment Risk: Diversification can help reduce some investment risk. It cannot guarantee profit, or fully protect in a down market.
S&P 500 IndexThe S&P 500 Index is a market-capitalization-weighted index of 500 leading publicly traded companies in the U.S. It is not an investment product, but a measure of U.S. equity performance. Historical performance of the S&P 500 Index does not guarantee similar results in the future. The historical return of the S&P 500 Index shown does not include the reinvestment of dividends or account for investment fees, expenses, or taxes, which would reduce actual returns.
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