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A Roth IRA is considered by many financial experts to be the best retirement plan out there. Workers can invest money on an after-tax basis and then withdraw their funds in retirement (after age 59 1/2) tax-free. They can enjoy decades of compounding growth and never owe the taxman a cent as long as they follow the plan’s rules. No wonder it’s the experts’ favorite plan!

Because the Roth IRA eliminates one of the major costs of trading – taxes – some investors may think they can actively trade their way into even greater gains. They might consider day trading with a top broker or even trading every few months after a stock’s big price swing rather than focus on buy-and-hold investing, which is a time-tested strategy.

But should you actively trade in a Roth IRA? These are the key things to consider first.

Actively trading in a Roth IRA: 5 things to know

1. You can trade actively in a Roth IRA

Some investors may be concerned that they can’t actively trade in a Roth IRA. But there’s no rule from the IRS that says you can’t do so. So you won’t get in legal trouble if you do.

But there may be some extra fees if you trade certain kinds of investments. For example, while brokers won’t charge you if you trade in and out of stocks and most ETFs on a short-term basis, many mutual fund companies will charge you an early redemption fee if you sell the fund. This fee is usually assessed only if you’ve owned the fund for fewer than 30 days.

2. Any gains are tax-free – forever

The ability to avoid taxes on your investments is an incredible benefit. You’ll be able to escape – perfectly legally – taxes on dividends and capital gains. Not surprisingly, this superpower makes the Roth IRA very popular, but to enjoy its benefits, you must abide by a few rules.

The Roth IRA limits you to a $7,000 maximum annual contribution for 2024 ($8,000 if age 50 or older), and you won’t be able to withdraw earnings from the account until retirement age (59 1/2) or later and after owning the account for at least five years. However, you can withdraw your contributions to the account without being taxed at any time, but you won’t be able to replace those contributions later.

The Roth IRA offers a number of other benefits and retirement savers should look into it.

3. You can’t use margin in an IRA

Many traders use margin in their accounts. With a margin loan, the broker extends you capital to invest beyond what you actually own. It’s a useful tool, especially if you’re trading frequently. Unfortunately, margin loans are not available in IRA accounts.

For frequent traders the ability to trade on margin is not just about magnifying your returns. It’s also about having the ability to sell a position and immediately buy another. In a cash account (like a Roth IRA), you have to wait for a transaction to settle, and that takes a couple days. In the meantime, you may be unable to trade with that money even though it’s credited to your account.

A margin account allows you to buy and then trade immediately, as long as you have enough equity in the account. And that can be an advantage in fast-moving markets.

4. Passive investing beats active trading

So you can trade actively in a Roth IRA, but should you? Research consistently shows that passive investing beats active investing, whether you’re an individual investor or a professional.

For example, a 2023 study from S&P Dow Jones Indices shows that about sixty percent of fund managers investing in large companies underperformed their benchmark in the previous year. This deficit increased over time, and in a 20-year period, 95 percent of pros failed to beat their benchmark on a risk-adjusted basis. These are pros with analysts and high-powered tools trained to beat the market.

Instead, you can beat most pros by sticking to a passive approach and you’ll earn the market’s returns. One approach is to buy a fund based on the S&P 500 Index, a collection of hundreds of the largest publicly traded companies. The index has returned about 10 percent annually over long periods, but you’ll need to hold the fund over time to enjoy its returns.

5. You don’t get to deduct losses

If you’re trading in a taxable brokerage account, you’ll get a tax write-off if you make a losing investment. Some investors even make sure they’re getting the largest write-off they can using a process called tax-loss harvesting. They scoop up that benefit and then even repurchase the stock or fund later (after 30 days) if they think it’s poised to rise in the future.

But if you’re trading in a Roth IRA, you won’t get the ability to write off losses. Changes to the tax code in 2017 eliminated the ability to claim any benefit from losses in an IRA account.

Best Roth IRA investing strategy for most investors

An IRA is meant to fund your retirement, not to speculate on investments. You need that money to be there later and you can’t afford to lose it. So the best IRA strategy for most investors is to use a traditional investing strategy – long-term buy-and-hold investing with low-cost index funds.

Index funds invest passively, meaning they track a target index, such as the S&P 500, the Russell 2000, the Dow Jones Industrial Average, the Nasdaq Composite or some other. These funds don’t make active trading decisions and simply hold whatever the index holds.

This strategy means the funds don’t cost a lot to manage, and they end up passing the cost savings on to investors in the form of lower expense ratios, the annual cost to own the fund. The best ETFs will cost you just a few dollars per year for every $10,000 you have invested.

One investment strategy could be to buy three index funds – one based on the largest companies, one on the medium-sized firms and one for the smallest companies. Then add to your investments regularly each year – perhaps through the process of dollar-cost averaging.

But the key part of this strategy is to continue to hold over time, to let your investments keep compounding. You also won’t need to spend a lot of time following the market, as an active investor likely would – and most importantly, you’re more likely to end up with better results.

Bottom line

Those who are thinking about actively trading in their Roth IRA (or traditional IRA, for that matter) should carefully consider the costs and potential benefits. It’s tough to beat the market and you must spend huge amounts of time to do so, when you’re more likely to outperform most investors with a few basic index funds and a simple buy-and-hold strategy.

Editorial Disclaimer: All investors are advised to conduct their own independent research into investment strategies before making an investment decision. In addition, investors are advised that past investment product performance is no guarantee of future price appreciation.