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Investing With Your IRA: ETFs vs. Mutual Funds


Investing for retirement requires careful planning and informed decision-making. An individual retirement account (IRA) is a powerful tool for retirement savings, offering tax advantages that can significantly enhance your future financial stability. IRAs allow individuals to direct pre-tax income, up to specific annual limits, toward investments such as individual stocks, bonds and mutual funds, which can grow tax-deferred. Choosing the right investments for your IRA and diversifying this selection can have a notable impact. But you might not be able to choose on your own. If you’re uncertain, a financial advisor can help guide you in building a diversified portfolio for your specific needs.

ETFs vs. Mutual Funds

Exchange-traded funds (ETFs) and mutual funds are two popular investment options for IRA portfolios. Both possess distinct operational nuances and understanding key differences could help you make smart investment choices.

Let’s begin with a term that you should know as an investor: The net asset value (NAV) price represents the value of each share in a mutual fund or an ETF. It’s calculated by dividing the total value of all the securities in the portfolio by the number of the fund’s outstanding shares.

Now, let’s consider three things when adding mutual funds to an IRA:

  • Diversification: Mutual funds pool money from multiple investors to invest in a diversified portfolio of stocks, bonds, or other securities. This diversification can help spread risk and reduce the impact of poor performance in any single investment on your individual retirement account (IRA).
  • Professional management: Mutual funds are managed by professional fund managers who make investment decisions on behalf of investors. This can be beneficial for individuals who may not have the time or expertise to actively manage their investments, providing a hands-off approach to IRA management.
  • Liquidity: Mutual funds typically offer high liquidity, allowing investors to buy or sell shares at the end of each trading day at the net asset value (NAV) price. This liquidity can be advantageous for investors looking to make changes to their IRA holdings without facing significant transaction hurdles.

And, for a comparison, here are three things to keep in mind when adding ETFs to your IRA:

  • Intraday trading: Unlike mutual funds, ETFs trade on an exchange like a stock, allowing investors to buy and sell shares throughout the trading day at market prices. This intraday trading flexibility can be beneficial for those who want to react quickly to market movements or make tactical adjustments to their IRA holdings.
  • Tax efficiency: ETFs are structured in a way that makes them tax-efficient. The “in-kind” creation and redemption process helps minimize capital gains distributions, potentially reducing the tax consequences within your IRA compared to some mutual funds.
  • Transparency: ETFs disclose their holdings on a daily basis, providing transparency into the assets held within the fund. This transparency allows investors to make informed decisions about the composition of their IRA portfolio.

For a more thorough comparison, let’s take a closer look at three additional things:

Loads and commissions: Loads are essentially sales fees charged by mutual funds, which ETFs do not have. They can be front-end (charged when you buy) or back-end (charged when you sell). These fees may impact your returns and should be factored into your investment decision.

Commissions, on the other hand, are fees paid to brokers for executing trades. ETF trades may incur a commission similar to trading a stock, while mutual funds may be sold without a commission. Some brokerages offer commission-free trades on specific ETFs and mutual funds, which can help minimize costs.

Expense ratios. The expense ratio is the annual fee charged by all funds, expressed as a percentage of the fund’s total assets. The expense ratio could significantly affect your investment returns over time. ETFs generally have lower expense ratios than mutual funds, which might translate into substantial savings over the long term. However, this doesn’t mean ETFs are universally a better choice. Individual investor factors may influence this decision.

Risk considerations. Both ETFs and Mutual Funds come with risks, including market risk, sector risk and management risk. So adjusting your portfolio to reflect your risk tolerance will be a key part of your decision.

One option could be to diversify as much as you can. Diversification can insulate investments against market volatility and align with your portfolio with your risk tolerance. Spreading investments across various asset classes is a common strategy to potentially lower the impact of poor performance by any single investment.

Alternatives to Mutual Funds and ETFs

An IRA custodian reviewing the available investing options with a client.

IRAs can hold various types of investments, not just ETFs and mutual funds. Other options like bonds, individual stocks, certificates of deposit (CDs) and real estate investment trusts (REITs) offer different risk and return profiles. Each has unique risks and limitations.

For example, investing in real estate or a CD is generally considered a safe investment. But you might not see the more rapid growth you could potentially get by investing in certain stocks.

Take note: While investors generally have the flexibility to choose investments for an IRA, there can be certain limitations and restrictions. For example, some IRA custodians or trustees may have specific policies or limitations on the types of investments allowed within their IRA accounts. Additionally, the range of investment options available within an IRA can depend on the offerings of the custodian or financial institution holding the account. So some IRAs may have a limited menu of investment choices.

Bottom Line

A financial advisor using data to help a client compare mutual fund and ETF investments for an IRA.

Mutual funds and ETFs have unique characteristics, and the choice between them for an IRA will depend specifically on your investment goals, preferences and the features of each investment vehicle. You should also keep in mind that both assets can vary in fees, performance and strategy. So make sure that you carefully consider the benefits and drawbacks of each before investing.

Tips for Retirement Investing

  • In order to invest for your retirement it’s important to know what your long-term financial goals are. If you’re not sure, a financial advisor can help you make those goals or help you make a retirement plan to get there. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
  • As you’re saving for retirement it could be really helpful to see what your portfolio growth might look like over time. SmartAsset’s free investment calculator can help you estimate how yours might grow.

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