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Finding the Best IRA Investments

Identifying the best IRA investments is less a matter of asset performance and more a matter of asset type and tax considerations. It’s important to not only hold the best-performing investments but to hold them in the right places too.

Investors searching for the best IRA investments will typically approach those investments in the same way that they’d approach investments in their taxable brokerage accounts. This is a good idea from a risk tolerance point of view but can be a poor idea from a financial management and tax consequence point of view.

Now, there is something to be said for being more conservative when investing in a traditional or Roth IRA: Annual contribution caps simply make it harder to replace money should any investments decline in value. But other than that, the level of risk that you’re willing to take in an IRA should generally be consistent with your overall risk profile. An investor who would be considered aggressive may want to skew IRAs to a more moderate or moderately aggressive level of risk.


The factors that determine your risk profile (like willingness to see higher fluctuations in exchange for higher potential returns, time to retirement, etc.) aren’t particularly correlated with factors like the tax-advantaged status of your account. That being said, there are a few tax consequences that should be considered when looking for the best IRA investments.

Tax Considerations of the Best IRA Investments

Actively managed mutual funds – One of the benefits of holding actively managed mutual funds in a tax-advantaged account is sheltering short-term capital gains distributions from immediate tax liability. If you’ve identified an actively managed fund with a strong track record and good management but find that the trading frequency within the fund creates a lot of short-term capital gains, holding that fund in your IRA will effectively tax those gains at your future (presumably lower) income rate rather than your current income tax rate.

Passively managed mutual funds and ETFs – On the flip side of that calculation, passively managed funds aren’t necessarily the best IRA investments as they’re more likely to distribute long-term capital gains and dividends. Long-term capital gains and qualified dividends are already subject to lower tax rates which means there’s less tax benefit to holding those funds in a tax-free Roth or a tax-deferred traditional IRA. That doesn’t make them an inappropriate investment for IRAs, they just don’t benefit quite as much.

Bonds and bond funds – Even in today’s low-yield environment, bonds and bond funds can play an important role when diversifying a portfolio. These investments offer stability and the potential for regular income in retirement. However, if you are investing in either individual municipal bonds or bond funds that derive a high percentage of their income from municipal bonds, holding those funds in an IRA allocates capital to investments that may already be tax-free. In general, you’re best off not holding tax-free munis in a tax-advantaged account. However, there is a scenario in which a municipal bond would be one of the best IRA investments: If it’s a taxable municipal bond. Taxable municipal bonds typically offer comparable credit quality to tax-free munis but offer higher yields because the taxable interest makes them less desirable. Sheltering those bonds in a tax-advantaged account is one way you can take advantage of that higher interest rate.

REITs and MLPs – These investments are both pass-through entities that do not pay taxes at the corporate level. Instead, the tax liability falls on the unitholder (investor) and can create confusing scenarios and even tax liability in your tax-advantaged account. In some cases (such as holding an REIT in a Roth IRA) there’s not really a disadvantage as something like a return of capital (reduces cost basis but is not a taxable distribution) is ultimately a tax-free transaction (although that same return of capital in a traditional IRA would ultimately result in you paying ordinary income tax rates on the money when you withdrew it). And while REITs in Roth IRAs may sound like one of the best IRA investments, holding Master Limited Partnerships (MLPs) in those tax-advantaged accounts may require that your broker pay taxes out of your IRA in the event of high Unrelated Business Taxable Income for the MLP.

Due to the complexity of partnership distributions, many, if not most, MLP investors work closely with their financial advisors and tax professionals when investing in that type of asset, and if you’re uncertain about whether your investments are misaligned with your accounts, we recommend doing the same. There is no single rule for identifying the best IRA investments, but ideally you should invest in assets that are consistent with your risk profile while also maximizing the tax-advantaged nature of your account.

What do you consider to be the best IRA investments?


Brad Simmerman is the Editor of Cabot Wealth Daily, the award-winning free daily advisory.