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By Jeremy Glaser | 02-10-2011 10:14 PM

Dividend Picks for Your IRA

Morningstar's Josh Peters shares his top dividend-paying retirement picks, including a tax-efficient way to buy MLPs in an IRA.

Jeremy Glaser: For Morningstar, I'm Jeremy Glaser. I'm here today with Morningstar DividendInvestor editor Josh Peters to look at some dividend-paying stocks for your IRA.

Josh, thanks for joining me today.

Josh Peters: Good to be here, Jeremy.

Glaser: So, from the big picture does it make sense to be holding dividend-paying stocks within a qualified account like an IRA?

Peters: I think it absolutely does, when people are in contribution mode, and they have a good 20, 30 years, perhaps before starting to make withdrawals from their accounts, they might be thinking growth, growth, growth, growth. Well, that's actually not the right answer. Just as if you are in retirement, income, income, income isn't the whole answer either. It's always going to be total return.

If you do have that long time horizon toward retirement, you shouldn't try to figure out what's the next Apple, what's the next Google, trying to chase some high-growth stock. Instead you should figure out how you can get a combination of both growth and a decent dividend yield that can grow over time and allow you to compound that total return. How can you get that working for you early, so there is a lot more money there at the end of day.

Glaser: Do you have any specific securities that might work well in an IRA?

Peters: Well, if you think about my universe, I mean a lot of the time I am really looking to maximize the current yield, but subject to some constraints. I still want the dividend to grow, I still want it to be safe, still want some diversification. That's really my Dividend Harvest strategy in DividendInvestor, one my two model portfolios.

But really if you are thinking about IRAs and having that long-time horizon, then something that's more along the lines of my Dividend Builder model portfolio is kind of what I have in mind. And there my mental model is, I still want a good dividend yield, got to remember the S&P 500 only yields about 1.8% right now, so a 2.5% or 3% yield is actually quite good by market standards.

What I am more concerned about, though, than the immediate amount of income is what is the company doing with the rest of its earnings. To use an example, a company like McCormick, one of my favorite businesses, stock is a little expensive right now, but I think it's definitely one to watch. Ticker symbol is MKC. They typically are going to pay out maybe about 40%, give or take, of their earnings as dividends.

Well, that's going to give you right now yield that's in the mid-2% range or so, but what about the rest of the earnings, the other 60% or so of earnings that aren't being paid out? In McCormick's case, they have the opportunity to reinvest a lot of those earnings into what we think is a wide-moat business, where they have the opportunity for small incremental investments in the business, whether its new products, expansions of capacity say in emerging markets, to get a really strong bang for the buck, a very high return on those incremental capital dollars.

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