If there's one thing most people know about retirement savings, it's that Roth IRAs are a solid choice for your money. But if you’re not familiar with investments, understanding potential returns and growth can be a bit confusing.
The secret to maximizing your returns might be simpler than you think. Roth IRA interest rates depend on what you invest in, so it's all about focusing on smart investments and diversifying your portfolio.
In this article, we'll demystify the subject and provide a few tips to make your money grow overtime.
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How much interest does a Roth IRA earn?
Since Roth IRAs aren't investments themselves, they don't earn or pay interest rates directly. Instead, the investments held in the account generate returns over time. So, what is the average rate of return on a Roth IRA?
The stock market has historically provided 10% of average return. But it's possible to earn more (or less), depending on your choices and market fluctuations. “Depending on the investments you choose, the average rate of return on a Roth IRA is between 7% and 10% per annum,” says Bill Ryze, certified Chartered Financial Consultant (ChFC) and board advisor at financial services company Fiona.
It's also possible to earn less if you primarily opt for low-risk investments. That said, it's important to note that all investment returns depend on the stock market, which is always fluctuating and changing with no guarantees of any outcome.
Difference between return and interest rate
Though the terms “return” and “interest rate” are used interchangeably on many occasions, they aren't the same thing.
A return is the gain (or loss) on a given investment over a specific period. “It is expressed as a percentage of the initial investment, and it includes interest, dividends, and capital gains,” Ryze says.
On the flip side, he says, an interest rate is “the percentage earned on an investment—it is typically expressed annually and does not include capital gains or dividends.”
How to invest with a Roth IRA account
With a Roth IRA you can invest in multiple assets, including stocks, bonds, mutual funds, exchange-traded funds (ETFs), certificates of deposits (CDs), and money market funds, Ryze says.
But to start investing in a Roth IRA, you first need to figure out if you're eligible, as there are income and contribution limits to consider.
For 2024, the Roth IRA contribution limit is $7,000 per year, or $8,000 if you're over 50. These limits apply if your income is below $146,000 for single individuals or below $230,000 for married couples filing jointly.
The next step is to open your Roth IRA account. You can use any service you want, from financial planning firms to robo-advisors. Just be aware that your choice of provider will influence the investment options available to you. If you want access to a wide range of investment, a full-service brokerage account might be your best option.
How can I make my Roth IRA grow faster?
There's no formula to magically make the money in your Roth IRA grow faster. Your growth potential is impacted by the market fluctuations and the risk level of the investments you choose. But you can employ some strategies to optimize your returns. Here's what Ryze recommends:
1. Contribute the maximum allowed
Aim to contribute the maximum amount allowed each year (or at the very least, the maximum amount you can possibly afford). Higher contributions generally yield higher returns, especially when combined with other efficient investment strategies.
2. Diversify your investment portfolio
“Diversify your investments by spreading them across different asset classes,” Ryze says. This means you should combine low-risk investments—which have low potential returns and losses, with high-risk investments that have high potential for returns and losses.
Ryze advises playing it safe on one side and taking some risks on the other by investing in growth-oriented assets such as stocks or ETFs, with high growth potential.
3. Reinvest your earnings
Create a habit of reinvesting your earnings, “including dividends and interest, to benefit from compounding,” Ryze says. With compounding, you get returns not only from your original investment, but also from the returns of said investment. That's why leveraging the compounding effect can maximize your earnings.
FAQs
How much will a Roth IRA grow in 20 years?
The growth of your Roth IRA balance is directly impacted by factors like the investments held in the account and your contributions. But it's possible to have an idea of how much your account can grow based on the average return of a Roth IRA.
“For example, if you contribute $6,000 annually and receive an average return of 7%, your account could grow to approximately $255,000 in 20 years,” Ryze says. You can find Roth IRA calculators online that will do the math for you.
Is a Roth IRA better than a 401k?
Not necessarily—it depends on your goals. “A Roth IRA offers tax-free withdrawals without any required minimum distributions (RMDs),” Ryze says. “On the other hand, a 401(k) allows higher contribution limits and may include employer matching. The best option for an individual depends on their specific financial situation and retirement goals.”
Is a CD better than a Roth IRA?
If you're looking for a low-risk investment, a CD might be the better option. “A CD is a low-risk instrument that offers a fixed interest rate and it typically has lower returns,” Ryze says. If you want higher returns and don’t plan to touch that money until retirement, then a Roth IRA could be more interesting. “A Roth IRA provides higher potential returns through various instruments. However, it comes with market risk,” he adds.
To decide, assess if short-term or long-term returns are more important for you. “A CD is a suitable short-term investment because of its low-risk saving potential,” Ryze says. “The Roth IRA is generally preferred for long-term growth.”
How does a Roth IRA grow interest?
A Roth IRA is not an investment by itself, but a means to make investments that may grow your funds. “A Roth IRA grows through the returns generated by the investments within the account,” Ryze says. “The returns include interest, dividends, and capital gains.”
How can I maximize my Roth IRA profit?
Some key strategies to maximize returns include diversifying your portfolio by making low and high-risk investments and reinvesting your returns. You should also aim to contribute the maximum allowed by the IRS every year, which in 2024 is $7,000 for individuals younger than 50 and $8,000 if you're over age 50.