Put simply, Roth IRAs don’t pay an interest rate.
That’s not to say you won’t earn a return on the money you put into a Roth IRA — you will, especially over the long term — but that return isn’t determined by the Roth IRA itself. It’s determined by the investments you select within that Roth IRA.
An investment account, not an investment
A Roth IRA is akin to a shopping cart — it’s basically an empty basket until you fill it. But with a Roth, you’re filling that basket with investments, not Cheerios.
Unlike a savings account, which comes with its own interest rate that adjusts periodically, investing in a Roth IRA is a two-step process: You first fund the account, and then you choose the investments that will power your yield.
To access a broad array of investments, you usually need to open your IRA at an online broker or brokerage firm. While banks offer IRA accounts, the investment options within bank IRAs are typically limited to savings accounts or certificates of deposit, which have returned historically low yields for nearly a decade now.
» Eager to open an account? Read our step-by-step guide to opening a Roth IRA.
How you earn money in a Roth IRA
The money you earn through a Roth IRA is 100% dependent on the investments you choose in the account.
If you open a Roth IRA and fund it with the current maximum annual contribution — $5,500 for those under age 50 — each year for 10 years, but fail to invest that money, you’ll end up with $55,000. That’s simply each year’s contribution multiplied by 10, with no investment return. In fact, the purchasing power of that balance will likely be dimmed by inflation.
Building a diversified investment portfolio within your Roth IRA is what causes the magic to happen: In those investments, your money starts working for you in the background, growing and compounding while you go about your daily life. And the longer you leave that money invested, the more it will grow.
To calculate how your own Roth IRA contributions might grow over time, use our Roth IRA calculator.
In addition to the growth differential shown in the chart above — note the Roth IRA invested in a diversified portfolio laps the uninvested cash over four times — you’ll make the most of the Roth IRA’s tax advantages when you choose to invest. Because you’ve already paid taxes on your contributions to the account, all of that growth can be pulled out as a qualified distribution in retirement, completely tax free.
» Not familiar with the benefits of a Roth IRA? Check out our complete guide.
So what is the best Roth IRA?
The idea that a Roth IRA is just a vessel for your investments doesn’t mean that all Roth IRAs are created equal. As noted above, where you open your Roth IRA has a big impact on the investments you’re able to access. In addition, the fees you pay for maintaining the account and purchasing those investments may vary widely.
If you want access to the widest range of investments, you’ll want to open your IRA at a broker. There, you can manage your account yourself, picking and choosing investments based on your goals and risk tolerance. Most brokers will offer access to individual stocks, bonds — some of which do pay a fixed interest rate — and mutual funds, including index funds and exchange-traded funds.
If you’d rather be hands-off and don’t mind a more limited investment selection, you can open a Roth IRA at a robo-advisor. These computer-aided investment services will manage your account for you, building a portfolio that aligns with your goals and adjusting it as needed. Most robo-advisors use index funds or ETFs.
» View NerdWallet’s picks: The best Roth IRA accounts
Watch out for fees
No matter where you open your Roth IRA, you’ll want to pay attention to costs. At a broker, you might pay transaction fees to buy and sell investments, and there are annual fees — called expense ratios — for the mutual funds you choose. For robo-advisor management, you’ll generally pay an annual fee of around 0.25% to 0.50%, plus the cost of the expense ratios of the funds the advisor chooses for your portfolio.
All of these costs can reduce your overall investment return, because every dollar you pay to fees is a dollar that doesn’t go into your investment.
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