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6 Top Picks for Your IRA

Jason Stipp

Jason Stipp: I'm Jason Stipp for Morningstar.

Investors have until April 15 to fully fund an IRA for the 2013 tax year, which may be easier said than done for some investors.

Luckily, three Morningstar strategists--Christine Benz, Josh Peters, and Ben Johnson--are here to offer their top ideas for your IRA.

Christine Benz: One core fund I really like for an IRA is Vanguard Balanced Index. It's the ultimate utilitarian boring fund. Those types of funds can be really effective building blocks in investor portfolios for a couple of key reasons.

One is that there are moving parts going on behind the scenes, but investors don't tend to see the highs and lows in the portfolio. So, they tend not to react by mistiming their purchases and sales.

The other thing I like about any sort of balanced product that regularly gets back to a fixed asset allocation is that at those times the fund is rebalancing, the investor may not feel like doing that rebalancing themselves. Think back to 2008, for example. If you had this or some other type of balanced fund in your portfolio, the fund was quietly buying stocks for you at a time when you probably didn't feel like buying stocks yourself. And over time, that sort of contrarian effect that you can get through regular rebalancing can be very, very beneficial.

One of the reasons I like this particular fund is that its costs are very low, and it's really minimalist. It invests about 60% of the portfolio in a total stock market index, and the other 40% is in a total bond market tracker.

It doesn't include international exposure. If you want that in your portfolio, you will have to add it separately, but otherwise I think it's a nice, sturdy, core, all-in-one fund that you can safely add to over a period of years.

A more opportunistic IRA pick is Tweedy, Browne Global Value, but you could also hold as a core fund in an IRA as well. Its recent performance hasn't looked that great. It's had a couple of things dragging on performance. For one thing, the managers have had quite a bit of cash, because they haven't been able to find a lot to buy. They have also been building out a position in energy stocks, which have underperformed recently. And they also tend to hedge their [foreign currency] exposure, which has hurt it recently as well.

So near-term performance won't be too exciting, but I do like what this fund has to offer for the long term. For one thing, it has a really experienced management team. They are looking for companies that they think look inexpensive currently, and they are looking for quality franchises. So in a lot of ways, it's a Warren Buffett-type strategy in play here.

I like that their focus is on foreign stocks, which are arguably more attractively valued than U.S. companies right now. For people who are concerned about putting money to work in the U.S. stock market because they think that U.S. stocks are potentially a little bit overvalued, a fund like this could make a lot of sense.

Josh Peters: One of my all-time favorite stocks is also one of my top IRA picks this year. It's a company called Realty Income; the ticker symbol is O.

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This is a very simple real estate business. They will typically purchase a piece of real estate, usually a single tenant retail property, from the operator of the store, and then lease it back to that owner over 15 to 20 years. It's a relatively straightforward financing transaction.

But Realty Income makes sure that even if the tenant's parent company, some big retailer that might be burdened with a lot of debt and could potentially have some financial difficulties down the road, that that specific location, that individual retail store, continues to generate enough income within its four walls to cover those rent payments. So even if the tenant passes through bankruptcy, which happens a fair amount of the time during recessions, Realty Income still gets the vast majority of the rent that it's owed.

This stock typically yields around 5%, plus or minus. It's actually been yielding a little bit more than that recently, and over the long run, we expect it to grow its dividend 4% or 5% a year. And as a REIT, there is actually an advantage to owning this stock in an IRA. REIT dividends are taxed as ordinary income--not at the lower 15% or 20% top marginal rate that would apply to qualified dividends in a taxable account.

So if you have the opportunity to own a REIT like Realty Income in an IRA, you are actually going to be a little bit better off from a tax perspective by sheltering that higher tax rate income within your tax-deferred account.

My second pick hails from the energy sector, where lots and lots of investors really like master limited partnerships or MLPs. One of the most important things you need to know about an MLP, though, is that it's generally not suitable to be held in an IRA. The type of income that master limited partnerships provide is considered non-passive income and can cause all kinds of headaches--including additional taxables for your IRA--if you own enough and collect enough income from master limited partnerships.

But while that might seem to shut MLPs out of people's IRAs, there are other avenues for getting exposure within a tax-deferred account, and Spectra Energy Corporation, ticker symbol SE, is also one of my favorites. It does operate a master limited partnership called Spectra Energy Partners--it's a security I like, but I wouldn't own it in an IRA. But Spectra Energy Corporation, as the general partner of Spectra Energy Partners, is a tax-paying corporation, and the dividends that it pays are qualified for those low tax rates. Also, it doesn't present any of the unfriendly tax consequences for somebody's IRA.

The yield on Spectra Energy Corporation is a little bit lower--about 1 percentage point lower than SEP, the partnership. But because of its leverage, the type of leverage it has in that general partner relationship with Spectra Energy Partners, we expect its dividend to grow about 2 percentage points faster over the next couple of years. So even though you give up a percentage point in yield--a yield in the high 3% range as opposed to the mid- to high-4% range--you should more than make up for it with extra dividend growth.

Ben Johnson: Warren Buffett has said that it's far better to buy a wonderful company at a fair price than a fair company at a wonderful price. My strategic pick, the Vanguard Dividend Appreciation Fund, ticker VIG, represents a portfolio of wonderful companies trading at what our equity analysts currently believe to be fair prices.

VIG targets U.S.-listed firms that have raised their annual dividends for at least 10 years running. Additionally, embedded in the index methodology is a bit of secret sauce that looks to weed out some firms that could potentially cut their dividends at some point in the future. The result is a portfolio of very high-quality companies: Companies that are profitable, cash-generative, have squeaky clean balance sheets--all bits of evidence that point to the existence of an economic moat, or a durable competitive advantage.

Indeed if you look at the underlying portfolio of securities that VIG holds, we see that 94% of its assets are invested in stocks of companies that Morningstar analysts deem to have an economic moat.

And last but certainly not least, this fund is dirt cheap. At just 10 basis points, its annual expense ratio is extremely low by virtually any standard.

My opportunistic pick is a very risky one, best suited for those with very strong stomachs and very long time horizons. iShares Core MSCI Emerging Markets Fund, ticker IEMG, offers a very broad and very low-cost way to access emerging-markets stocks. Emerging-markets stocks suffered in 2013 and have stumbled out of the gates again in 2014. For the week ending Feb. 14, emerging-markets equity funds had witnessed 16 consecutive weeks of outflows. This clearly is a contrarian play.

IEMG differs from some of its predecessors in that it offers a much broader exposure to emerging-markets stocks. Its underlying benchmark seeks to cover 99% of the investable market capitalization of emerging-market equities. Its parent index, the MSCI Emerging Markets Index, looks to cover about 85% of the investable market capitalization of these various markets. This broadening of the portfolio offers greater exposure to smaller-cap names, which in turn could ratchet up the volatility of the fund a bit relative to those funds tracking its parent. But simultaneously, it offers better exposure to those firms that are more firmly entrenched in their local markets and more likely to benefit from local growth trends.

What's more, with an expense ratio of 18 basis points, this fund is extremely cheap relative to both other ETFs as well as traditional actively managed mutual funds in the diversified emerging-markets category.

All told, I think this fund is an interesting option for risk-tolerant investors who are looking to add emerging-markets equity exposure.