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When people are saving for retirement, many debate whether to open a Roth IRA vs. traditional IRA. Whether there is a bull or bear market, investors can decide which method will help them rebalance their portfolios. This TradingSim article will assist investors who want to decide which method is best for them.

What is the difference between a Roth IRA vs. traditional IRA?

In the comparison between a Roth IRA vs. a traditional IRA, there are many differences.

A traditional IRA has these key characteristics :

Traditional IRA’s are offered by employers to workers.
An account holder can put away a significant part of their pre-tax earnings.
With a traditional IRA, taxes are delayed until funds are withdrawn.
Funds can’t be withdrawn penalty-free until the account holder is 59 1/2.
If an account holder makes large contributions to the IRA, it can lower their taxable income.
Compound interest can help account holders build more wealth in retirement.
Traditional IRA’s don’t have income limits.
Account holders can’t make contributions after they turn 70 1/2.
When account holders turn 70 1/2, they take required minimum distributions.

On the other hand, a Roth IRA has these characteristics:

Roth IRA’s are purchased by an individual.
In 2020, the maximum contribution limit is $6,000.
There is no age limit to Roth IRA contributions.
In contrast to traditional IRAs, Roth IRAs don’t have required minimum distributions.
When a person makes a withdrawal at any time, there are no penalties.

What are the advantages of a traditional IRA?

Steve Frazier is president of financial firm Frazier Investment Management. He says that people that earn too much for a Roth IRA could benefit more from a traditional IRA.

“It’s possible (to be) disqualified from the Roth in the first place,” said Frazier.

David Johnson is a financial adviser at Modern Horizons Wealth Advisors. He said the pretax contributions to traditional IRA’s can help people save money.

“Pretax contributions are one of the few tax reduction strategies many workers have available. Especially now, since fewer are able to itemize because of the increased standard deduction,” said Johnson.

What are the downsides to a traditional IRA?

Some financial experts like Ed Slott says account holders that have a traditional IRA can be affected by increased tax rates.

“With a traditional IRA, you’re at the mercy or uncertainty of what future higher tax rates might do to your retirement savings. With a Roth IRA, you don’t have to worry about future rates, because your tax rate in retirement will be zero,” said Slott.

Young people may also balk at traditional IRAs if they want to make withdrawals before the assigned age of 59 1/2. Slott noted that Millennial account holders may see that requirement as a downside to a traditional IRA.

“That’s a big deal for lots of younger people who are worried, ‘What if I need to get to my money?’” said Slott.

Chris Chen is a financial adviser at Insight Financial Strategists. He said that going from a traditional IRA to a Roth IRA can cause tax liabilities.

“Going from a traditional to Roth is giving up a lot of assets and income. The name of the game is not to pay no taxes on distribution, but to minimize taxes over a lifetime,” said Chen.

Financial experts say Roth IRA has advantages

Some financial experts say that Roth IRAs have a benefit. He said that even though Roth IRA holders have to pay taxes up front when they open an account, they can make tax-free withdrawals in retirement.

“Most people are better off taking a tax hit now,” said Frazier.

Steven Elwell is a certified financial planner and partner with Level Financial Advisors. He believes that as a person’s income increases, the lack of withdrawal taxes make Roth IRA’s more attractive.

“If you expect your income to go up, then something like a Roth might make sense,” said Elwell.

As financial expert Ed Slott noted, Frazier agrees that the Roth may be a better option for younger people saving for retirement.

“If you’re looking for flexibility, the Roth is the superior saving vehicle for the younger generation,” said Frazier.

Clayton Alexander is a registered investment advisor and founder of Teton Wealth Group. He said that starting a Roth IRA has benefits for people open one at an early age.

“One of the benefits of starting a Roth at an earlier age is the concept of compounding interest that can occur inside the investment, tax-free,” says Alexander.

Compound interest impacts comparison of Roth IRA vs. traditional IRA

Elwell isn’t sure that a traditional or Roth IRA is better.

“I don’t think there is a hard and fast rule that (one) is better,” said Elwell.

Jeannette Bajalia is president and principal advisor of Petros Financial. She said either option is good for investors saving for retirement.

“It’s not whether you should take a Roth over a traditional 401(k), but what is the right mix of savings to achieve your life and retirement goals,” says Bajalia.

Financial expert Chris Hogan says to consult a tax professional before opening a traditional IRA.

“If you have the money to pay the taxes on that money, it is a fantastic thing to do each and every year,” said Hogan.

Financial experts say people can use Roth to save

For many people who are struggling with finances, some withdrawals may be acceptable if they held the accounts for at least five years. Mark Jaeger is the director of tax development at TaxAct. He said that Roth IRA’s can be used as emergency funds in emergency situations.

“People are starting to be laid off, and it’s difficult to find that money when you start being put out of work. But you can always get your basis back from the Roth IRA,” said Jaeger.

Financial experts recommend Roth vs. traditional IRA

Another financial expert for Roth IRAs is retirement expert Jeanne Fisher. She is the managing director at Strategic Retirement Partners. She says that Roth IRA’s are beneficial for its low federal tax rate.

“If they are in a very low effective federal tax rate, or even a negative tax rate, the Roth is very beneficial. Finally, it can be used as a flexible bucket in retirement for high-income, high-net-worth clients,” Fisher says. “We consider all things like: How is the rest of the nest egg saved? Is it all tax-deferred? Are they expecting a pension? Do they need all of their retirement savings or do they intend to pass it to the next generation? Will they need all of their projected RMDs? I’m not exaggerating when I say—especially particular to the 401k—that eight out of 10 times I will recommend a Roth contribution,” said Fisher.

Fisher and other financial advisers show how Roths help people save on taxes.

“We illustrate the total growth of the portfolio and what the cumulative account balance could be in retirement. We also educate to how it affects their paycheck. Electing the Roth in the 401k isn’t going to result in a big tax bill when you file your taxes. Instead, the tax withholdings are adjusted on your paycheck, and in most cases, you are seeing only a minor adjustment each pay period,” said Fisher.

Fisher also touts the tax-free growth in Roth IRA’s.

“For one, investors always decide how much they want to save first, and then we talk about taxes. I have never, in my 12-year career, had someone walk back in my office with their ‘tax savings’ and ask to invest it. It just doesn’t happen. Also, most people max out the IRA contributions, which completely negates the argument,” said Fisher.

Financial experts say to talk to advisors before converting to Roth vs. traditional IRA

Jennifer Weber is vice president of financial planning at Weber Asset Management. She said that it’s key to consult a financial advisor before choosing a Roth vs. traditional IRA.

“It’s important to understand the following: what your company offers, does your company offer a match on retirement contributions and are you eligible to contribute directly to a Roth IRA (based on income limits),” said Weber.

Clark Howard is a financial expert that recommends traditional IRA’s because of potential rising tax rates.

“Our tax rates today are unusually low because we’re running a massive budget deficit. At some point, those tax rates will increase. That means there’s a good chance tax rates will be higher when you go to spend your nest egg in 25 or 30 years,” said Howard.

Howard said that Roth IRA’s may be taxed at a higher rate later, so people should choose traditional retirement accounts.

“Remember, in general, tax rates are likely to go higher over the years no matter which political party is in power. That means it may make more sense to skip the deduction of a traditional IRA now to avoid tax later with a Roth IRA,” said Howard.

Financial experts say Roth IRAs have tax benefits

Financial expert Suze Orman said Roth IRA’s could be best for investors while tax rates are low. She suggests people should invest in a Roth before taxes increase to pay off the increasing national debt.

“Do you really think that tax brackets aren’t going to have to go up five, 10, 15 years from now in order to pay for all the debt that we’re carrying? Of course, they’re going to have to,” said Orman.

While Suze Orman recommends Roth IRA’s, there are financial analysts that disagree with the world-renowned financial analyst. Monica Dwyer is vice president at Harvest Financial Advisors. She thinks that Orman’s advice may be too general. Dwyer said people should pick a traditional IRA or Roth based on their own financial situations.

“I think that Suze is concerned that future taxes will be much higher because we cannot continue on the spending parade that we have been on, our deficit is ballooning and, just like someone with a lot of credit card debt, this debt will have crushing consequences at some point,” said Dwyer.

“Does that mean her advice is good? Not necessarily. It just depends on the person,” added Dwyer.

Roth IRAs have advantages for young investors

Thomas Scanlon is an adviser at Raymond James. He said that a Roth IRA can give tax-free advantages to young investors.

“Folks just starting out might have almost 40 years of tax-free growth. What a great way to build wealth,” said Scanlon.

Financial Experts can help people decide between Roth vs. traditional IRA

Mark Beaver is a financial adviser at Keeler and Nadler. He said that a favorable tax code can help investors save more money.

“The tax code today is about as favorable as it’s ever been and the likelihood of that changing (to be higher) in the future is pretty good. Because of that, we look to add to Roths directly or do things like backdoor Roth contributions or conversions where it makes sense,” said Beaver.

Financial experts recommend Roth IRA for young people

Because Roth IRAs don’t have age withdrawal limits, young people can let money grow tax-free. Ryan Marshall is a New Jersey-based certified financial planner. He said young investors should consider a Roth IRA.

“This is an area most young people don’t consider. We have seen a lot of clients who are withdrawing more from their 401(k) account than they actually need to live on in retirement. The Roth IRA currently does not force you to withdraw funds and continues to grow tax-free so long as you leave money invested,” said Marshall.

“It is great to build up those Roth funds when you are younger because you may not qualify when you are older,” added Marshall.

Pete Hunt is a certified financial planner and director of client services at Exencial Wealth Advisors. He recommends Roth IRA’s for most of his clients. However, he doesn’t recommend Roths for high-income clients.

“I recommend it to all my clients, unless they are in a situation where they think they will make significantly less income in the future,” said Hunt.

‘I like having a Roth IRA, if they are eligible for it, just because it gives a lot of flexibility that if they need that money, they can pull the contributions at any time for any reason,” Hunt said.

What are the disadvantages of a Roth IRA vs. traditional IRA?

While the Roth IRA can have benefits, there can be a tax downside. Dwyer said Congress can still add increased taxes to Roth IRA’s.

“Congress can get pretty creative about where they are going to collect taxes from and there is no guarantee that they won’t someday go after Roths,” said Dwyer.

How can a person make a Roth conversion?

Since many people want to save money on their Roth IRA’s, there can be an advantage with reduced required minimum deductions. Maria Erickson is a financial adviser. She said taxpayers can save on taxes without a required minimum distribution.

“This year is an unprecedented opportunity. The numbers are pretty compelling. You can reduce your tax bill by 30% to 40%,” said Erickson.

How can Roth IRA’s help with homeownership?

In addition to Roth IRA’s helping people save for retirement, Roths also can be used for another purpose. If a person meets certain requirements, they can withdraw $10,000 from their Roth IRA’s to purchase a home. Daniel Galli is the principal of Daniel J. Galli & Associates. He suggests that young people can use their Roth IRA’s to buy a home.

“We’ve long suggested that young people use a Roth IRA to save the considerable amount needed for a first-time home purchase,” said Galli.

“As long as we can meet the five-year rule, they can use all contributions plus up to $10,000 of gain, free of tax and penalty,” Galli said.

While people can use their Roth IRA’s to buy a home, Galli notes that people have to aggressively invest to fund the accounts in the future.

“This strategy requires some market risk in order to enjoy some gains, but the rewards can balance that,” said Galli.

While Galli is for people using the Roth IRA for buying homes, some financial planners are opposed. Certified financial planner and CPA Jeffrey Levine is the director of advanced planning at Buckingham Wealth Partners. He said that Roth withdrawals should be rare and reduced over time.

“You might want to make it more conservative over time,” Levine said.

Financial experts advise caution witth Roth IRA home ownership

In addition to Levine, there are other experts who think that people should save their Roth IRA funds. Shon Anderson is president of Anderson Financial Strategies.

“These accounts are designed to help people accumulate as much money as possible for retirement,” said Anderson.

“You can obtain a loan for a home, car, business venture, college tuition … but no one will ever receive a loan to retire,” said Anderson.

Galli said some younger account holders should use Roths to buy homes.

“If the person is contributing to a 401(k), getting a decent match, they’re on a good track for retirement and the Roth is just a nice addition, I might consider it,” said Galli.

However, he doesn’t advise Roth IRA’s for home ownership if people are closer to retirement.

“But if their only retirement savings is the Roth and they’re, say, in their 40s, I probably wouldn’t,” said Galli.

IRS lets people take more from IRAs

With the current economic volatility, the IRS has stepped in to help IRA holders. The IRS lets people withdraw up to $100,000 from their retirement accounts. The CARES(Coronavirus Aid Relief and Economic Security) Act says that spouses of account holders can also withdraw up to $100, 000 from their accounts. Jeffrey Levine is CPA and director of advanced planning at Buckingham Wealth Partners. He notes that the changes are helpful to account holders’ spouses.

“The spouse thing is pretty big. I had a lot of people in that camp, where the spouse was out of work and didn’t have significant retirement account assets,” said Levine.

Retirement plan consultant Denise Appleby says eligibility can help people who encounter economic difficulties.

“If you experience adverse financial consequences, because a member of your household, related to you or not, had their income adversely affected by COVID-9, you are eligible for the $100,000 coronavirus-related distributions,” she said.

Some financial advisors against extra Roth borrowing

While some financial advisors want their clients to take advantage of the new IRS rule, some disagree. Certified public accountant Ed Slott doesn’t think people should take extra funds out of their Roth IRA’s. He says the withdrawal now will lead to more taxes later.

“Remember, it’s still not a good thing: You’re taking your own money and you’ll owe the taxes,” said Slott.

Financial planner Mark Scribner also wants people to borrow from Roth IRA’s as a last resort.

“If you have investment accounts, you should think about liquidating taxable accounts first, traditional IRAs and 401(k)s second, and Roth IRAs last,” said Scribner.

“Consider taking money first from pre-tax accounts or traditional retirement accounts before Roth IRA accounts,” added Scribner.

“Evaluate a personal loan, depending on what type of interest rate you might build a qualify for,” said Poppy.

Poppy still advocates for IRA’s over other online trading apps.

“You have a little bit more flexibility since you can take out different shares, and you can really control the tax consequences a little bit better,” said Poppy.

While Poppy is against Roth IRA borrowing, he says people can borrow tax-free if they meet certain requirements.

“If taking from a Roth IRA, it can be beneficial since you can access your basis or contribution tax-free without penalties,” said Poppy.

Poppy says people should consult financial planners before borrowing from a Roth.

“Input from a good CPA and a good financial planner is really helpful. [They can help] you model it out in terms of what the impact long-term will be,” said Poppy.

Poppy also wants people to consider whether they can afford to replace the withdrawn funds later.

“The key thing to remember is that you are reducing your future retirement income. Do you have a plan to replenish that?”

Can a new administration change traditional IRAs?

The new election may bring new changes to traditional IRA’s. Presidential candidate Joe Biden has promised to reform traditional IRA’s in a new plan. His website had these details:

“Under current law, the tax code affords workers over $200 billion each year for various retirement benefits—including saving in 401k-type plans or IRAs. While these benefits help workers reach their retirement goals, many are poorly designed to help low- and middle-income savers—about two-thirds of the benefit goes to the wealthiest 20% of families. The Biden Plan will make these savings more equal so that middle class families can enter retirement with enough savings to support a healthy and secure retirement,” noted Biden’s website.

J. Mark Iwry is a nonresident senior fellow at the Brookings Institution. He said that the changes may not affect traditional IRA’s.

“Don’t assume the private pension tax expenditure would necessarily be a deficit reduction target in a Biden-Harris administration. The private pension system plays a unique role in our economy,” said Iwry.

The Tax Foundation noted that Biden’s plan will “shift some of the benefits of tax deferral in traditional retirement accounts toward lower- and middle-income earners with the goal of encouraging additional saving by those taxpayers.

Would auto-IRA’s replace Roth or traditional IRA’s?

Biden’s plan would also implement auto-IRA’s for workers whose employers don’t offer retirement accounts. Iwry said the new system will help traditional IRA’s.

“The pension tax expenditure will be even easier to defend when auto-IRA makes the system far more inclusive and progressive,” said Iwry.

Iwry noted that partisan politics hurt the chances of enacting the auto-IRA program.

“The Obama-Biden administration made auto-IRA the centerpiece of their retirement proposals, but then Obamacare was enacted,” Iwry continued. “The ensuing divisive politics and toxic partisanship meant it was no longer the right moment.”

However, Iwry believes that the idea can grow with some states enacting auto-IRA’s and have “been steadily acquiring proof of concept as seven states have enacted it; others are considering it, and three of those seven states have begun implementation, which is going smoothly,” Iwry said.

Iwry hopes that an act of Congress to enact nationwide auto-IRAs will help compliment Roth and traditional IRA’s.

“Congress can achieve nationwide uniformity with a federal auto-IRA that builds on, preserves and integrates the state auto-IRAs”, said Iwry.

Top 5 stocks for Roth IRA vs. traditional IRA

No matter which IRA a person chooses, they can choose these top stocks for investment.

1. Amazon

If some people want to invest their IRA, Amazon (NASDAQ:AMZN) is the best stock choice. During the pandemic, Amazon has become the go-to online marketplace. The e-commerce giant’s latest line of products, including its new Amazon Fire TV stick, will bring in new revenue. Amazon’s vice-president, Sandeep Gupta, spoke about the new Fire TV features.

Amazon stock is a top choice for Roth IRA vs. traditional IRA investment

“Today, you can search for comedies, or stuff by Tom Cruise, but we’ve tried to make a landing spot for when you don’t know what you want to watch. This shows you stuff that’s free, movies and TV shows, broader categories, apps and more,” said Gupta.

Financial expert Puja Tayal noted that Amazon’s varied revenue streams like grocery delivery and cloud technology make it an attractive investment for Roth vs. traditional IRA’s.

“AMZN’s biggest win was its entry in grocery. Grocers were reluctant to go online. But the lockdown forced people to buy almost everything online. AMZN increased its grocery delivery capacity by over 160% to cater to the threefold surge in online grocery demand,” wrote Tayal.

“The e-commerce giant also saw a 29% year-over-year surge in Amazon Web Services (AWS), as companies shifted their work to the cloud to facilitate remote working. Moreover, it saw a 29% uptick in its subscription services like Amazon Prime videos,” added Tayal.

CNBC financial analyst Jim Cramer also rates Amazon as a buy for retirement accounts.

“I don’t care that it’s up 50% for the year, it has more catalysts than nearly any other stock under the sun: new revenue streams, great balance sheet, stay-at-home economy exposure and, of course, 5G. Now that it’s come down from its highs … I think you have to buy it,” said Cramer.

Amazon is a top stock for Roth and traditional IRA’s.

2. Netflix

Netflix( NASDAQ: NFLX) is a growth stock that is a great investment for Roth or traditional IRA’s. Because of the worldwide quarantine, many people stayed home and binge-watched Netflix shows like Tiger King. Netflix’s chief financial officer, Spence Neumann, spoke about the streaming company’s future.

“So Netflix 2021 is going to be a much better service than Netflix 2020, which gives those newer members and existing members even more reason to stay highly engaged and stick around and also to entice future members to join. So we think that the growth opportunity is as big as ever. There’s just that kind of near-term pull forward that you’re seeing,” said Neumann.

Financial analysts bullish on Netflix stock

With Netflix’s popularity and international expansion, Jefferies analyst Alex Giaimo says Netflix stock is a buy.

“While the soft third-quarter outlook may put the stock in the penalty box near-term, there is no change to our positive long-term thesis. We view Netflix as a consistent high double-digit growth story with sizable margin expansion over time,” said Giaimo.

Netflix is a top stock for Roth and traditional IRA investment because of its growth.

3. Apple

In addition to Netflix, Apple (NASDAQ:AAPL) is a stock that outperformed during the COVID-19 crisis. Apple’s chief financial officer Luca Maestri touted the tech company’s Q2 2020 results.

“So the revenue for the quarter was $58.3 billion, up 1% from a year ago, despite the extreme circumstances from the impact of COVID-19 and a headwind of 100 basis points from foreign exchange,” said Maestri.

Maestri also spoke about Apple’s growing Services profits.

“Services revenue followed a different trend with very strong year-over-year growth of 17%. We set a new all-time revenue record of $13.3 billion, with all-time records in many of our Services categories and in most countries we track,” said Maestri.

With its potential bundling of services like Apple TV+ and Apple Music, Morgan Stanley analyst Katy Huberty rates Apple stock a buy.

“We have long argued that bundling services is a unique tool that Apple has at its disposal,” said Huberty.

UBS analyst David Vogt says Apple stock could rise if the revenue increases in the future.

“If several of Apple’s under monetized Services live TV+, and News mature and contribute to a segment revenue reacceleration back to 17% growth the next three year FY23, consolidated revenue could come in $13 billion higher than our forecast,” added Vogt.

With Apple’s new products, Apple is a stock that can be an impressive investment for Roth or traditional IRA’s.

4. Microsoft

With its established reputation in tech, Microsoft (NASDAQ: MSFT) is a top stock for Roth or traditional IRA investment. The company wants to increase its gaming division with its purchase of Bethesda Softworks’ parent, ZeniMax. Joost van Dreunen, founder of video game investment firm New Breukelen, said the deal will help Microsoft’s stock.

“The ZeniMax acquisition instantly increases the value of GamePass and closes the content gap between Xbox and [PlayStation]. It raises the barriers to entry for aspiring new contenders like Amazon and Google,” said van Dreunen.

Wedbush’s Dan Ives also believes the acquisition will boost Microsoft stock.

“While Xbox and gaming have been successful, [Microsoft] recognizes its need for consumer based revenue growth, which we believe this deal will directly help drive along,” wrote Ives.

In addition to Wedbush, Amana Mutual Funds also rates Microsoft a buy.

“Microsoft has done an excellent job building its Azure cloud services business, while we believe a strong period of semiconductor demand will arrive in the new decade supporting Microchip and Taiwan Semiconductor. Whether the rally starts in 2020 or 2021 remains to be seen but recent signs have been positive,” said Microsoft.

Microsoft is a top stock for Roth and traditional IRA investment.

5. Spotify

In the music streaming world, Spotify (NYSE:SPOT) is king. The streaming service’s growth during the COVID-19 pandemic helped the company increase its subscriber growth. Spotify spoke about its Q2 2020 results.

“After making adjustments to help us weather the pandemic in Q1, consumption returned to normal levels this quarter. Monthly active users increased to 299 million, and subscribers grew to 138 million, both exceeding our expectations. Advertising revenue, which took a significant hit in Q1, improved notably throughout the quarter, and we feel good about our momentum as we enter Q3,” said Spotify.

Financial analysts say Spotify could be top stock for Roth or traditional IRA

Bernstein analyst Todd Juenger said Spotify’s stock should rise with the addition of popular podcaster Joe Rogan. His Joe Rogan Experience podcast will be part of Spotify’s podcast collection.

“The market has added $20B of value to Spotify since the Joe Rogan podcast announcement…However, the analyst continue to believe it is unlikely that Spotify will generate much earnings from podcasts. He sees 37% potential downside in Spotify shares at current levels,” said Juenger.

In addition to Joe Rogan and former first lady Michelle Obama’s podcasts, Spotify’s ad revenue should drive its stock up as well.

“The stock is up sharply since the Joe Rogan podcast deal in mid-May, but there is further upside as podcasts help Spotify drive ad revenue on owned and licensed content, premium subscriptions and gross margins,” said Juenger.

Spotify is a stock with great potential in a Roth or traditional IRA.

Roth vs. traditional IRA’s can be good choice for investors

Whether a person chooses a Roth vs. traditional IRA, investors can sure that either retirement account will help increase wealth. If a person wants to choose the best stock for retirement account investment, they can practice trading those stocks on TradingSim. TradingSim’s blogs and charts can help people find the best stocks for their Roth or traditional IRA investments.

There are many ratios to measure a stock’s performance. That is especially true with mutual funds. The COVID-19 crisis caused the current bear market. With that uncertainty, traders want to use the most precise formulas to determine the best mutual funds for investment. The Treynor Ratio is one formula that can measure a mutual fund’s performance.

This TradingSim article will provide an overview of the ratio and then explain how investors can use the ratio to measure the top 10 mutual funds.

What is the Treynor Ratio?

The Treynor Ratio is a reward-to-volatility formula. The ratio measures an investment’s performance per unit of risk.

In the Treynor formula, beta is measured in risk. Beta is the measure of a stock’s volatility in relation to a benchmark like the S&P 500. The ratio calculates beta and the returns on risk-free returns.

With the Treynor formula, The S&P 500 usually has a beta of one. Stable stocks have a beta below one. Volatile stocks have a beta over one.

In the Treynor Ratio, the formula is: (Ri-Rf)/B, where:

Ri=return of investment

Rf= risk-free rate. That’s typically the yield on short-term Treasury bills.

B-= the beta of the portfolio.

Beta is considered to be measured against a key benchmark. It’s measured with the return that could be earned on a risk-free asset like the Treasury bill in the reward-to-volatility ratio. The risk-free rate is subtracted from the portfolio’s return of investment. The result of that equation is divided by the portfolio’s beta. A higher Traynor ratio means that there is a better return.

The S&P500 and the Dow Jones 30, since 1970’s — The S&P 500 and the Dow Jones 30, since 1970s

What do the numbers in a Treynor ratio mean?

A high Treynor Ratio means an investment has added value related to its risk. In addition to that result, a negative Treynor Ratio means the mutual fund performed worse than a risk-free asset.

Who created the Treynor Ratio?

Jack Treynor was the economist who created the method. He was one of the first economists to discover the capital asset pricing model (CAPM). That CAPM model codified investment return risks that became the basis for the Treynor Ratio.

How can investors use the Treynor formula?

Matt Ahren is a financial advisor with Integrity Advisory in Overland Park, Kansas. He notes how the Treynor Ratio is used to justify risks in investments.

“I manage the portfolios for our firm, so if I am reviewing an individual fund then I first look at the fund’s beta to see how much market risk that manager is taking,” said Ahrens.

Aherns inspects a mutual fund’s Treynor formula to see if a portfolio’s performance justifies its risk.

“Then I look at the Treynor ratio to see how much return am I getting per unit of risk. Basically, am I getting bang for my buck?” said Aherns.

What is the Treynor Ratio’s legacy?

Robert Merton knew Treynor well. He is a Nobel Prize-winning economist at the Massachusetts Institute of Technology. Merton credits Treynor with bringing more mathematical analysis to finance.

“It wasn’t that he just did a particular theory,” he said. “He was very creative and also was a leader in bringing the quantitative finance science to finance practice. That was his bridge.”

Bruce I. Jacobs is a principal of Jacob Levy Equity Management. He also credits Treynor for bringing mathematical formulas to better analyze stocks and mutual funds.

“Jack had incredible insights about the markets and models and helped bring quantitative finance into practical application,” said Jacobs.

How Treynor Ratio is vital to analyzing risk

MIT finance professor Andrew Lo also praised the Treynor Ratio and CAPM. He also credits the Treynor Ratio with acknowledging the importance of beta when analyzing a stock.

“In part, it acknowledges that there’s a trade-off between risk and return and CAPM quantified what the trade-off is. That relationship is what gave rise to the notion of beta,” said Lo.

In addition, Lo also noted that the beta of a mutual fund can be crucial to measuring a mutual fund’s risk.

“So, when we talk about the beta of a stock, that comes out of that framework. When we do discounted cash flow analysis, we’re using some kind of cost of capital. CAPM is the tool we use to calculate that cost of capital,” added Lo.

Treynor Ratio builds on work of Sharpe Ratio

The Treynor formula builds on the work of fellow economist William Sharpe. Lo noted that the capital asset pricing model championed by economists is vital to the mutual fund industry.

“CAPM is also the basis of the mutual-fund industry, particularly for passive investing. You ought to just buy and hold the market, and you’ll do just fine,” said Lo.

“Vanguard[ a large mutual fund corporation] and all of the index funds out there came about because of the contributions of Sharpe, Treynor, and others made in finding the capital asset price model. The multi-trillion-dollar passive-index business — we can thank Sharpe and Treynor for that wonderful gift,” added Lo.

Michael B. Miller, CEO of Northstar Risk, also noted the importance of the Treynor Ratio in evaluating the performance of mutual fund portfolios. While he’s critical of the method, he still praises the Treynor ratio as effective.

“The ratio is motivated by two important concepts First, you should care about risk-adjusted returns, not absolute returns,” said Miller.

“Second, in a well-diversified portfolio, you should worry more about the macroeconomic factors that could impact your portfolio and less about the risk from individual securities,” added Miller.

What is the difference between the Sharpe ratio and Treynor Ratio?

The Treynor formula builds on a previous measurement of the Sharpe Ratio. Both formulas can be beneficial to an investor to assess mutual fund investments. William Sharpe created the formula to help investors understand the risk of an investment in relation to its return.

The Sharpe Ratio is similar to the Traynor Ratio because they both assess risks of portfolios. While both formulas have similarities, there are differences between the two ratios.

The Treynor Ratio assesses a systemic risk of a portfolio against a benchmark like the S&P 500. However, the Sharpe Ratio measures the performance of a portfolio based on the overall total risk of a portfolio.

William Sharpe creator of Sharpe ratio, a counter to Treynor Ratio

What is the Sharpe Ratio formula?

The Sharpe Ratio equation is:

(Rp – Rf)/σ , where:

Rp= return on portfolio

Rf= risk-free rate

σ =standard deviation on the return of the portfolio

The Sharpe Ratio subtracts the risk-free rate of return from a portfolio’s return. The result is divided by the investment’s return’s standard deviation. A standard deviation measures the investment risk in a mutual fund. It’s applied to an investment’s annual rate of return to calculate risk.

The higher the Sharpe ratio, the better for a mutual fund. A Sharpe Ratio of 1 and over is considered good for a mutual fund. A negative Sharpe Ratio means the expected return may be negative. The negative quotient could also mean that the portfolio’s return is worse than the risk-free rate.

Which is better to measure mutual funds, the Sharpe Ratio or Treynor Ratio?

Both formulas can effectively measure the performance of a mutual fund. However, there are two differences between the measurements. The Sharpe Ratio can be applied to all portfolios that are in specific sectors.

In specific sectors, specific mutual funds may have unsystematic risk as to the best measure of risk. In that case, the Sharpe Ratio may be the better formula because it measures overall risk.

However, with the Treynor Ratio, there is a difference. The Treynor Ratio measures systematic risk. Unsystematic risk is not a factor with diversified mutual funds.

Because of that, the Treynor Ratio can measure systematic risk. The Treynor Ratio can be a better metric to evaluate the performance of a well-diversified mutual fund portfolio.

What are the downsides to the Treynor ratio?

While the Treynor Ratio can be an effective measure of a portfolio’s performance, it’s not perfect. Some financial experts say that the metric has a downside.

S. Michael Sury is a lecturer in finance at the University of Texas at Austin and studies the Treynor index. He noted that the Treynor formula isn’t perfect. Sury because it only looks at past performance.

“Treynor ratio does have some drawbacks. Importantly, by definition, it is a backward-looking ratio. Thus, it tends to be more useful for its evaluative – rather than its predictive – power,” said Sury.

Some financial experts like Aherns believe that a mathematical analysis may not be the best way to analyze stocks for beginning traders.

“The trap do-it-yourselfers fall into is being unable to decipher where outperformance is coming from,” said Ahrens.

In addition, Aherns also noted that taking on more risk may benefit them more than using the Treynor formula to calculate risk.

“A manager may be performing well versus their peers just because they are taking on more market risk,” said Ahern.

Is the Treynor Ratio helpful to investors?

While many financial advisors use the Treynor Ratio, there are financial managers that aren’t fans of the formula.

Paul Ruedi of Ruedi Wealth Management doesn’t believe that the Treynor formula is best for the average investor. He believes that two factors are more crucial to evaluate mutual funds.

“At the end of the day, over 90 percent of an investor’s lifetime return is a result of two things. The first is their allocation to equities versus fixed-income,” said Ruedi.

“And second to that, but probably just as important – or maybe even more important – how they behave when the portion of their portfolio that is invested in the great companies of the U.S. and the world is temporarily down 30 percent or 50 percent,” added Ruedi.

In addition to that, Ruedi also believes that the Treynor ratio return is not an accurate measurement of a mutual fund’s return.

“Nobody goes into the grocery store with their Treynor ratio return, they go into the grocery store with their actual return,” said Ruedi.

While the Treynor Ratio may not be for every investor, the Treynor formula could be a good option for measuring risk. In the rest of the article, I will analyze comparisons of 10 mutual funds. I will look at their financial statistics to compare the Treynor Ratios of the assets.

Comparison: Fidelity Advisor Series Growth Opportunities Fund vs. Morgan Stanley Insight Fund Class A

Fidelity Advisor Series Growth Opportunities Fund ( FAOFX) is a mutual fund that tracks growth stocks. The mutual fund has tech holdings like Tesla (NASDAQ:TSLA) and Uber (NASDAQ:UBER). Because of those stocks, Fidelity Advisor Series Growth Opportunity Fund had a high 1-year annual return of 12.55%.

Tesla stock rises after reopening factory

Tesla stock helps Fidelity Advisor Series Growth Opportunities Fund increase its annual return. The corporation’s controversial founder, Elon Musk is famous for his comments. Musk gets as much attention for his tweets as much as his company’s electric cars.

Musk defied California’s shelter-in-place orders to increase production at Uber’s Fremont factory. He recently tweeted about resisting the order on Twitter.

“Tesla is restarting production today against Alameda County rules. I will be on the line with everyone else. If anyone is arrested, I ask that it only be me,” tweeted Musk.

Tesla stock jumped 4% after the factory recently reopened after gaining county approval.

With that boost to its production and bottom line, Tesla’s HR head, Laurie Shelby, touted the re-opening of the factory.

“We have local support to get back to full production at the factory starting this upcoming week. We’re excited to continue to get back to work,” said Shelby.

The growth of Tesla stock helped Fidelity Growth Opportunities Fund have a strong annual return.

What’s the Treynor Ratio of Fidelity Growth Opportunities Fund?

I will explain the Treynor Ratio of the fund with a risk-free rate of 0.16%. This risk-free rate I chose is based on the yield of the one-year Treasury rate as of May 6.

The average annual return on the Fidelity Growth Opportunities Fund is 12.55%. Once that is calculated, the risk-free rate of 0.16% is subtracted from the return. After that, the result is divided by the beta. The beta, in this case, will be 1.1, the current benchmark of the S&P 500.

With those statistics, the Treynor formula would be:

12.55%-0.16%/1.1=0.01.

With that equation, The Treynor index would be 0.01. The quotient is below 1, which could potentially be a low number for potential investors. However, in comparison to other similar figures in the 0-1 range, the Treynor formula can vary in its risk-to-reward quotient.

As a result, the risk is increased with this portfolio if compared with other mutual funds. However, I will now examine the Treynor Ratio comparison to the Morgan Stanley Insight Fund Class A.

Morgan Stanley Insight Fund Class A

As a potential investment, Morgan Stanley Insight Fund Class A(NYSE: CPOAX) is a mutual fund that has a high annual return of 19.37%. Along with the high annual return, the risk-free rate is 0.16%. The beta will be 1 in this example.

With that risk-free rate, the Treynor formula would be:

Ri-Rf/B

19.37%-0.16%/1=0.19.

Spotify stock helps Morgan Stanley fund

With well-performing holdings, the Morgan Stanley fund has less risk. Spotify(NASDAQ: SPOT) is a holding that has helped Morgan Stanley’s Insight Fund Class A grow. The streaming company’s Q1 revenue increased to $1.90 billion because of many people being quarantined.

With many people sheltering in place, Spotify noted that the number of paid subscribers climbed to 130 million.

Because may people are at home, Spotify has been a background soundtrack.

In the quarantine era, Spotify listeners are more devoted to the service. “Listening time around activities like cooking, doing chores, family time, and relaxing at home have each been up double digits over the past few weeks,” noted Spotify in a statement.

Joe Rogan signing sends Spotify stock soaring

In addition to a positive earnings report, Spotify’s stock surged by 8% . That jump came after popular and controversial podcaster Joe Rogan moved his program to the streaming service.

After Joe Rogan joined the streaming service, Spotify spoke about the acquisition in a statement.

“The Joe Rogan Experience, one of the most popular podcasts in the world, is coming to Spotify via a multi-year exclusive licensing deal. The talk series has long been the most-searched-for podcast on Spotify and is the leading show on practically every other podcasting platform,” said Spotify.

With this new addition to its podcast stable, Spotify has become a holding that helped lessen the risk of the Morgan Stanley Insight Fund Class A.

Which Treynor Ratio is higher: Fidelity or Morgan Stanley?

In comparison between the Fidelity mutual fund’s 0.01 and Morgan Stanley’s 0.19, the Morgan Stanley Insight Fund Class A has a higher Treynor Ratio.

In that equation, the Treynor Index would be 0.19. Even though they’re both below one, the Morgan Stanley Ratio has a higher Treynor index than the Fidelity mutual fund. Because Morgan Stanley Insight Class Fund A has a higher Treynor ratio, it has less risk than the Fidelity Growth Opportunities Fund.

T. Rowe Price Global Technology Fund vs. Janus Henderson Global Technology

With tech stocks, the T. Rowe Price Global Technolgy Fund ( NASDAQ:PRGTX) and the Janus Henderson Global Technology mutual funds have performed well this year. Though they’re in the same sector, the T. Rowe Price fund has been singularly praised as of the best mutual funds of the decade.

T. Rowe mutual fund a top investment

The T. Rowe Price Global Technology Fund “invests primarily in companies we expect to generate a majority of revenue from development, advancement, and user of technology.” With that mission statement, the fund has an annual return of 12% with its tech holdings like Facebook and Netflix.

Facebook stock part of successful T. Rowe mutual fund

Facebook is a holding that helps the T. Rowe Price fund become a top mutual fund. As part of the fund, Facebook earned $17. 74 billion in its Q1 2020 earnings.

With online shopping growing, Facebook is pushing for more profits with Shops, an upcoming marketplace on the social networking site.

Despite economic volatility, Zuckerberg wants to expand into online shopping to reach more customers.

“I’ve always believed that in times of economic downturn the right thing to do is to keep investing and building the future,” said Zuckerberg.

With Facebook’s Q1 2020 success, “This is really the first very major push that we’re going to be making into that next step around commerce,” said Zuckerberg.

“All these tools are open for business even when your physical storefront can’t be,” added Zuckerberg.

Netflix part of T. Rowe mutual fund growth

In addition to Facebook, Netflix is a strong tech holding in the T. Rowe Price Global Technology Fund. The streaming service has seen a whopping 35% growth in its stock in 2020.

With that success, Netfiix has been a stock that’s helped the T. Rowe mutual fund. Michael Bapis is the managing director of Vios Advisors at Rockefeller Capital Management. He spoke about Netflix’s subscriber growth.

“Demand is off the charts right now, and it’s the integral driver for Netflix. You’re going to have subscriber growth continue to grow. It’s a massive market and people aren’t going to go to the movies. I think they are starting to capitalize on a massive market,” said Bapis.

As Netflix grows, “They’re[ Netflix] going to keep market share at this point because they offer the best product,” added Bapis.

What is the Treynor ratio of T. Rowe Price Global Technology Fund?

With that success, the Treynor ratio of the fund can be calculated, where:

Ri-Rf/B: 12%-0.16%/1=0.12.

In that equation, the Treynor Ratio will be 0.12.

Janus Henderson Global Technology Fund

In contrast to the T. Rowe fund, the Janus Henderson Global Technology Fund(NYSE:JANIX) has a lower annual return. As of May, the Janus mutual fund’s annual year-to-date return is 6.23%. Despite the lower return, the fund has many strong holdings in its portfolio.

Microsoft a strong buy in Janus Henderson Global Technology Fund

As Goldman Sachs analyzes stocks, Microsoft is a strong holding in the Janus mutual fund. Goldman Sachs rated the software giant’s stock as a buy.

“Our partner checks continue to reflect the relative strength in the AWS platform, as incremental demand from customers to accelerate their migration into the cloud,” said Goldman Sachs in a statement.

In its analysis, Goldman Sachs noted that Microsoft can ” provide full virtual-desktop coverage (AWS WorkSpaces), and other work-from-home and business continuity needs.

As a tech stock, Microsoft’s stock rose because of its cloud services. After a positive Q1 2020 earnings report, the software company touted its $35 billion Q1 revenue.

In its earnings report, Microsoft noted that “cloud usage increased, particularly in Microsoft 365, including Teams, Azure, Windows Virtual Desktop, advanced security solutions, and Power Platform, as customers shifted to work and learn from home.”

What is the Treynor Ratio of the Janus Technology Mutual Fund?

As a result of Microsoft’s strong performance, the Janus mutual fund has performed relatively well. With the current statistics, the Treynor formula for the Janus Technology Mutual Fund would be:

Ri-Rf/B, where: 6.23%-0.16%/1.1=0.06.

Which Treynor Ratio is higher: T. Rowe or Janus?

With the comparison between the two tech mutual funds, 0.12 is greater than 0.06. The T. Rowe Technology Fund has a higher Treynor Ratio than the Janus Technology Mutual Fund.

Vanguard Healthcare Fund

In this COVID-19 era, the Vanguard Healthcare Fund(NYSE:VGHCX)has outperformed other mutual funds. The mutual fund’s annual return was an impressive 17.35% in 2020 so far. Vanguard Healthcare Fund’s returns are doing well because of its healthcare holdings. One holding that is helping the Vanguard Healthcare Fund is Pfizer.

Pfizer COVID-19 vaccine trial gives stock a boost

Pfizer(NYSE:PFE) stock grew 35% despite a declining stock market. The pharmaceutical company is working on a promising vaccine for COVID-19. As Pfizer CEO Albert Boula noted, the company is gathering information for its trials.

“We are collecting data as we speak in real time so we know, we are monitoring the safety of the doses,” said Bourla.

BNT162 is the potential vaccine that is being tested later this year. The corporation hopes to have 360 people in a clinical trial. If this vaccine is successful, Bourla hopes that the treatment will be available by the end of the year.

“If things go well, and we feel that the product is safe and efficacious, and the FDA [Food and Drug Administration] and EMA [European Medicines Agency] and other regulatory agencies feel the same, we will be able to deliver millions of doses in the October time frame,” said Bourla.

Pfizer plans to produce hundreds of millions of the potential COVID-19 vaccine by next year. With Pfizer’s promising vaccine, the Vanguard Healthcare Fund has been a reliable mutual fund for investors.

What is the Treynor Ratio of the Vanguard Health Care Fund?

With a high annual return of 17.35%, the equation would be:

Ri-rf/B, where: 17.35-0.16%/1.1=0.16

In that equation, the Treynor ratio of the Vanguard Health Care Fund is 0.16.

Invesco Health Care Fund Class A

The Invesco Health Care Fund Class A (NYSE:GGHCX) had a well-performing one-year return of 15.61%. The portfolio has outperformed because of Abbott Labs, one of its successful holdings.

Abbott Lab stock rises on COVID-19 antibody tests

Abbott Laboratories (NYSE:ABT) is an Invesco Health Care Fund holding that’s rising in the COVID-19 era. The stock rose 8.6% year-to-date with its antibody tests to detect the virus.

As the coronavirus crisis continues, Abbott is developing antibody tests for the virus. The corporation received Food and Drug Administration approval for more antibody tests for COVID-19.

With this second authorization, Abbott hopes to ship 30 million antibody tests to hospitals and potential patients.

“We wanted to provide hospitals and labs with as many broad and reliable testing options as possible during this pandemic,” said an Abbott spokesperson.

What is the Treynor Ratio of Invesco Health Care Fund Class A?

As Abbott Labs raises the Invesco Health Care Fund’s annual return, the Treynor ratio can be calculated. The formula is:

Ri-rf/B, where:

15.61-0.16/1.1=0.14

In this quotient, the Treynor Ratio is 0.14.

Which Treynor ratio is higher: Vanguard or Invesco?

In this comparison of the healthcare mutual funds, Vanguard’s 0.16 is greater than Invesco’s 0.14. The Vanguard Health Care Fund has a higher Treynor Ratio than Invesco’s Health Care Fund Class A.

JP Morgan Large Cap Growth Fund

The JP Morgan Large Cap Growth Fund( NYSE:OLGAX) is a large-cap mutual fund with a healthy 12% annual yield. The mutual fund has some of the fastest-growing companies in its portfolio.

AMD recession-proof stock in JP Morgan portfolio

AMD(American Micro Devices)(NYSE:AMD) is a holding in the JP Morgan Large Cap Growth Fund that is performing well during the recession. The semiconductor company is performing well as its computing revenue grew.

In AMD’s Q1 2020 earnings report, revenue surged 40% to $1.79 billion. The corporation touted its positive results. Dr. Lisa Su, AMD’s CEO, noted the results in a press release.

“While we expect some uncertainty in the near-term demand environment, our financial foundation is solid and our strong product portfolio positions us well across a diverse set of resilient end markets,” said SU in a statement.

“We remain focused on strong business execution while ensuring the safety of our employees and supporting our customers, partners and communities. Our strategy and long-term growth plans are unchanged,” added Su.

What is the Treynor Ratio of the JP Morgan Large Cap Growth Fund?

When finding the Treynor index of the JP Morgan Large Cap Growth Fund, this is the equation:

Ri-Rf/B, where:

12-0.16%/1.1=0.11

In this case, the Treynor Ratio is 0.11.

Glenmede Quantitative U.S. Large Cap Growth Equity Portfolio

Fidelity’s Glenmede Quantitative U.S. Large Cap Growth Equity Portfolio(NYSE:GTLLX) is another large-cap mutual fund. The fund has large-cap holdings, but has a small one-year return of 1.86%.

Accenture a vital part of Glenmede portfolio

In the Glenmede portfolio, Companies like Accenture (NYSE:ACN) is a valuable holding. Accenture is a technology consulting services company. The corporation has an expected 10% growth rate over the next three years.

Financial analyst Ben Castillo-Bernaus rates Accenture as a buy for investors.

“Accenture remains ‘best in class’ and the recent weakness is an opportunity to gain a position in this IT Services global leader delivering 40% returns on capital,” stated Castillo-Bernaus.

“Accenture has been a pioneer in developing ‘the New’ with 65% of revenues now coming from high growth Digital, Cloud and Security services,” added Castillo-Bernaus.

What is the Treynor Ratio of the Glenmede mutual fund?

In the equation Ri-Rf/B, where:

1.86%-0.16%/1.1=0.02.

The Treynor formula shows the Glenmede mutual fund’s ratio is 0.02.

Which Treynor Ratio is higher: JP Morgan Chase or Glenmede?

When contrasting the JP Morgan Chase and Glenmede’s Treynor indexes, the JP Morgan Chase Large Cap Growth Fund has a higher Treynor Ratio. The Glenmede Quantitative U.S. Large Cap Growth Equity Portfolio has a lower Treynor Ratio, so it may have a lower reward.

State Street Institutional Premier Growth Equity Fund Service Class

The State Street Institutional Premier Growth Equity Fund Service Class mutual fund (NYSE:SSPSX) that features small and medium cap companies. Its annual rate of return is high at 12.80%. United Health is a holding in the portfolio.

United Health a strong holding for State Street

Since healthcare stocks are outperforming, United Health(NYSE:UNH) is a robust part of State Street’s portfolio.

Financial analyst Michael Wiederhorn touted United Health as a buy.

“Overall, UNH produced strong results and seems well-positioned to navigate the COVID pandemic due to a relatively stable top-line, a diversified business mix and a dominant position across its businesses, ” wrote Widerhorn.

What is the Treynor Ratio of the State Street Institutional Premier Growth Equity Fund Service Class?

In the State Street mutual fund equation, where:

Ri-rf/B: 12.80%-0.16/1.1=0.11.

Baron Fifth Avenue Growth Retail Fund

The Baron Fifth Avenue Growth Retail Fund (NYSE:BFTHX) is a mutual fund that invests in large-cap companies. The mutual fund has a hefty 12.70% annual return. One of the Baron Fifth Avenue holdings is the legendary credit card corporation Visa (NYSE:V).

Visa a reliable Baron Fifth Avenue holding as it expands into data

Visa is a strong holding as the credit card company invests in Good Data, a global analytics company.

“With insights from data, we can help sellers, financial institutions and Visa’s extended global business network better understand and meet consumer needs, especially when those needs are changing fast,” said Melissa McSherry, head of Visa’s Data, Security, and Identity products.

Oppenheimer’s Glenn Greene rated Visa a buy because of its recent stabilization in April.

“While the depth/duration of COVID-19 headwinds are hard to handicap we remain confident in V’s intermediate/long-term potential, wrote Greene.

What is the Traynor formula for Baron Fifth Avenue Growth Retail Fund?

In this equation, where Ri-Rf/B, where:

12.70%-0.16%/1.1= 0.11.

Which Treynor Ratio is higher: State Street or Baron Fifth Avenue?

Since both funds have very similar annual returns, the Treynor Ratios of both funds are the same at 0.11. The State Street Institutional Premier Growth Equity Fund Service Class and Baron Fifth Avenue Growth Retail Fund have equal risk-to-reward ratios.

Treynor formulas can be determined by small differences

The Treynor Ratios of mutual funds can be determined by small factors like decimal points. However, the decimal points in a Treynor formula make a big difference in figuring out a mutual fund’s risk-to-reward ratio. TradingSim charts and analysis can help investors find the best mutual funds with the least risk.

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