Investing isn’t just about choosing investments—it’s also about choosing the right accounts to hold them. That’s because different investments are taxed in different ways, and different accounts have different tax rules. Some investments generate taxable income every year, while others are taxed only when they’re sold. A tax-efficient strategy pays attention to both sides, matching investments with accounts that make sense for their tax characteristics.
Roth IRAs are one type of tax‑advantaged retirement account with distinct features. Because of their potential for tax-free growth and withdrawals, the types of investments you hold inside them can have an outsized impact on long‑term after‑tax results.
What is a Roth IRA?
A Roth IRA is a type of retirement account that’s funded with after-tax dollars. Unlike accounts that offer a potential tax deduction up front, such as traditional IRAs, Roth IRAs don’t provide a deduction for contributions. Instead, qualified distributions of earnings can be tax- and penalty-free.1
Because eligibility rules and annual contribution limits apply, Roth IRA contributions can be valuable. That’s why thinking carefully about which investments to place in a Roth—and which to hold elsewhere—may make a meaningful difference over time.
Asset location strategy for Roth accounts
Where you hold an investment can affect how much of any return you ultimately keep after taxes. Paying taxes on investment income year after year—such as interest, short-term gains, or nonqualified dividends—can reduce how much your investments compound over time.
Once you’ve set an overall asset allocation based on your goals, risk tolerance, and time horizon, asset location becomes the next step: deciding which accounts should hold which parts of your allocation. Read Fidelity Viewpoints: Asset allocation: What it is and how to develop one.
Here’s a quick overview of how different account types are taxed:
- Taxable accounts, such as brokerage accounts, generally require you to pay taxes on interest, dividends, and realized capital gains in the year they occur.
- Tax-deferred accounts, including traditional 401(k)s, traditional IRAs, and annuities, allow taxes to be postponed until money is withdrawn—at which point distributions are typically taxed as ordinary income.
- Tax-free withdrawals may be allowed from Roth IRAs and Roth 401(k)s, which are funded with after-tax dollars but allow for tax-free growth potential and tax-free qualified withdrawals.
Roth IRA investments to consider
When deciding what to hold in a Roth IRA, it can help to focus on the types of investments that may benefit most from tax-free growth potential.
1) Taxable bonds
Interest from taxable bonds (for example, corporates, high-yield, or agency debt) is taxed as ordinary income each year in a taxable account. In a Roth IRA, that interest can accumulate without annual taxes, and qualified withdrawals are tax-free1—reducing ongoing tax drag.
Trade-off: Dedicating too much Roth space to lower-return assets can underuse the account’s long-term growth potential.
2) Actively managed equity funds with higher turnover
These types of funds may produce relatively higher distributions than funds with low turnover. Holding them in a Roth IRA can help avoid those year-to-year tax bills.
Trade-off: Consider overall diversification and fund costs alongside the tax benefits.
3) Cash equivalents (CDs, money market funds)
Useful inside a Roth for their tax treatment, which is similar to bonds, since interest would be taxable in a brokerage account.
4) Selected higher-growth potential investments
If you’re confident in certain long‑term growth investments, putting them in a Roth may help you keep more of the gains. Most broad index funds are already tax‑efficient in taxable accounts, but some higher‑growth investments may still make sense to place in a Roth.
Lower priority for Roth
- Municipal bonds and muni funds: Their interest is already federally tax-advantaged.
- Broad market index funds, ETFs, and tax-managed equity funds: Typically designed to keep annual taxes low.
- Individual stocks in some cases: If you tend to realize mostly long-term gains, taxable accounts can be effective.
Read Fidelity Viewpoints: Investing ideas for your IRA
A quick tax comparison
- Taxable account: Interest, nonqualified dividends, and realized capital gains can eat into returns every year, reducing compounding.
- Roth IRA: Earnings can potentially compound without annual taxation, and qualified withdrawals are potentially tax-free, removing that drag over time.
This is why pairing tax-inefficient income or high turnover strategies with tax-advantaged accounts—and reserving taxable accounts for tax-efficient holdings—can help improve after-tax outcomes over the long run.
Read Fidelity Viewpoints: Investing beyond your 401(k)
Putting it all together
If you think of your portfolio as a garden, asset allocation is choosing what to plant—how much stock, bond, and cash exposure makes sense for your goals and time horizon. Asset location is choosing where each plant goes so it can thrive.
Consider using your Roth IRA for the investments that benefit most from its tax-free environment: taxable bond income, strategies that generate higher annual distributions, and a measured slice of long-term growth potential. Highly tax-efficient index funds and municipal bonds may make the most sense in taxable accounts where their natural tax advantages already help reduce drag. And when rebalancing, try to make changes inside tax-advantaged accounts first to help avoid triggering capital gains.