Which is better: an index fund or a Roth IRA?

When I’m out in public I often get this question from fans who recognize me. It usually goes something like this: “So I’ve heard Roth IRAs are good and index funds are good, but which is better?” And my answer to them is always the same: “How dare you speak to me.”‎

But seriously, this question is demonstrating a core misunderstanding of what these things are. Let’s break them down:‎

• A Roth IRA on its own is an empty account. It’s just a bucket that holds stuff. If you put nothing into it, it’s worthless. If you just put cash into it and leave the cash there, it’s just a savings account. The magic happens when you put cash into a Roth IRA and then INVEST IT. You use that cash to buy something that goes up in value! The Roth IRA protects that growth from all future taxes!‎
• An index fund is the thing that goes inside of the Roth IRA! It’s a collection of an entire market of stocks that are purchased conveniently and inexpensively. When you own an index fund it goes up in value over time!‎

So the whole process goes like this: Madison wants to get rich and minimizes taxes. So she completes the following steps:‎

1. She opens a Roth IRA (now she has an empty account)‎
2. She contributes money to that Roth IRA (now she has cash in there doing nothing)‎
3. She uses the cash inside her Roth IRA to buy an index fund (Now she’s on her way to getting rich!)‎

So it doesn’t make sense to ask if one is better than the other. You need both!‎

As always, reminding you to build wealth by following the two PFC rules: 1.) Live below your means and 2.) Invest early and often.‎


p.s. If you don’t count personal finance events, I think I’ve been “recognized” in public exactly once, and that person was too shy to say hi and DM’d me afterwards to tell me. If you see me, please say hi. I promise it will be a bigger thrill for me than for you.‎

via Instagram