Eight Great Funds for Your IRA

IRA season is upon us, and we're here to help. Christine Benz, Morningstar's director of personal finance, tackled the tricky topic of converting traditional IRAs to Roth IRAs a couple of weeks ago and spelled out an array of Dos and Don'ts.

Today, I'll tell you about some of the best funds to put in your IRA. One of the things that gives investors headaches is figuring out what type of mutual funds to put in their IRAs. Because they are tax-sheltered, it can make sense to put funds that are not tax-efficient in them. Taxable-bond funds are among the least tax-efficient options, but the catch is that they are also generally better for intermediate investment needs. Because you may not be tapping the money in your IRA for decades, an equity fund might be a better fit even though they are generally more tax-efficient.

I'd suggest that you let your circumstances dictate your fund selection. If your next IRA contribution is going to be a small piece of your overall investment pie or you are years away from the date at which you expect to start withdrawing money, then go with something tax-inefficient. On the other hand, if your IRA is a big piece of your portfolio and you are a long ways away from retirement, forget about tax inefficiency and focus on finding a great core holding. Here, then, are four from each bucket.

Four Inefficient IRA Funds
 Vanguard Convertible Securities  
Convertible-bond funds combine debt features with an equity option so that you get greater risk and reward than most bond funds. Vanguard's convertible fund is a nice diversified low-cost entry to the category. Over the past 10 years manager Larry Keele of Oaktree Capital has put up top-decile returns. The fund requires a $10,000 minimum investment, so it works if you are moving more than your annual contribution in. If not, consider  Calamos Convertible  (CCVIX) which has a $2,500 minimum investment.

 Dodge & Cox Income (DODIX)
Corporate debt looks pretty cheap by most measures, and you don't even have to venture into junk to get a decent yield these days. Dodge is an attractive play on corporate debt with about 40% of assets in corporates. The firm has excellent credit analysts, and the fund is cheap.

 Harbor Real Return 
Treasury Inflation-Protected Securities are quite inefficient because you have to pay taxes on upward adjustments to the bonds' value when inflation rises. Today, TIPs are a fairly cheap way to protect yourself against inflation if all the stimulus should have the effect of leading to a spike in inflation. Harbor Real Return is run by PIMCO's Mihir Worah to great effect. The fund's 0.57% expense ratio is cheaper than PIMCO's own TIPS fund for retail investors.

 Fidelity New Markets Income (FNMIX)
It's a bond fund, but you certainly wouldn't want to treat it as a low-risk investment. Consider that it lost 22% in 1998 and gained 37% in 1999. This fund shows that you don't need to own stocks to get strong returns (or losses) out of emerging markets. The fund is yielding nearly 11% from its holdings of government debt from the likes of Brazil, Turkey, and Venezuela.

Four Good Core Funds
 Sequoia (SEQUX)
This recently reopened fund is an outstanding choice in the Warren Buffett mold. Today, it's run by the second generation of managers at the firm, David Poppe and Bob Goldfarb. They run a focused portfolio aimed at buying great companies at reasonable prices. Specifically, they look for companies with strong returns on equity and healthy balance sheets.

 Masters' Select International (MSILX)
This makes a great core fund because it diversifies among six good managers. Thus, you get a little style diversity with smaller-cap value managers such as Amit Wadhwaney of Third Avenue and large-growth investors such as James Gendelman of Marsico. It's also got a fair slug in emerging markets, so you might not need a separate emerging-markets fund.

Vanguard Target Retirement Funds
These are great low maintenance funds for a couple of reasons. First, the asset allocation is adjusted over time to a more conservative mix, thus saving you the hassle of doing it yourself and the agony if you did it wrong. It's also full of dependable low-cost index funds that won't require you to spend a lot of time with continuing research.

Fidelity Spartan Total Market 
This fund is so cheap that it beats even the cheapest exchange-traded funds when you factor in commissions. It charges just 0.10%, and, in return, it gives you exposure to the whole stock market.

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