3 Good Ideas for IRAs

Jeremy Glaser: For Morningstar, I'm Jeremy Glaser. With the April 15 deadline to fund a 2018 IRA fast approaching, many investors might be wondering what types of investments they should put inside this wrapper. I'm here with Christine Benz--she is our director of personal finance--with three ideas.

Christine, thanks for joining me.

Christine Benz: Jeremy, it's great to be here.

Glaser: The first category of investments that are good for IRAs are high-dividend-paying stocks. Why is this?

Benz: I think investors might be a little confused by this, but dividends are currently taxed the same as long-term capital gains. You might say, well, why do you make such a big deal about putting the dividend payer inside of an IRA. The key reason is that if you own a dividend-paying company or if you own some sort of a fund that focuses on dividend-paying companies, you get those dividends year in and year out regardless of anything that you might do to try to control the receipt of those distributions. If you do like dividend-paying securities and you have room in your tax-sheltered accounts, I would prioritize them there rather than putting them in a taxable account. Taxable account is great for that plain-vanilla index fund that might happen to have some dividends. But if you are prioritizing a high-dividend-payer, I would house it inside of a tax-deferred account.

Glaser: If you were looking for a dividend fund for this year, what would be a good choice?

Benz: One that our team likes is called Schwab Dividend Equity, the ETF. The ticker is SCHD. This is a fund that is neither extremely high-dividend-focused nor focused exclusively on dividend growth, which tends to lead to a lower dividend payout. It's somewhere in between. It's a very low-cost product. We think it's a really nice option for investors who do want to receive some sort of regular income from their products.

Glaser: The second category to think about are Treasury Inflation-Protected Securities, or TIPS. Why would these be a good choice for an IRA versus other bonds?

Benz: Generally speaking, other bonds are also a good fit for an IRA. Anything that's kicking off high levels of current income in the neighborhood of 3.5%, 4%, that's a security type that you want to think about housing inside some sort of tax-sheltered accounts. TIPS, in particular, I think, are worth a look inside an IRA. For one thing, they tend to not frequently be found on 401(k) menus. This might be a slot that you have open because you are not fulfilling it through your 401(k). The other key reason relates to the taxation of TIPS. When you own a TIPS bond, you own tax on not just the coupon payout but also the inflation adjustment. TIPS are generally a security type that you want to house inside of a tax-sheltered account.

Glaser: Your third category is also in fixed income and that's those higher-yielding bonds will be more aggressive bond funds?

Benz: That's right. The interesting thing is, Jeremy, I was just doing a little prep for a presentation a couple of weeks ago, and I saw that yields have really popped up on some of the lower-quality stuff. I hadn't been paying close attention. But you don't have to stretch for a high-yield bond fund that is yielding 6% today. Same with emerging-markets bonds. We've seen yields pop up quite significantly over the past six months. To the extent that you have some of these higher-income--some of the lower-quality bond types--the yields are significant, especially these days and so, you want to make sure that to the extent that you own them, you are housing them inside a tax-deferred account.

Glaser: If you are looking for a TIPS fund or a higher-yield bond fund, what would be some of your top choices?

Benz: When it comes to TIPS, our analysts have concluded that keeping things really plain-vanilla is a good way to go. They generally find that the index products are very effective and active managers have a hard time adding value.

The funds that I recommend again and again would be Vanguard Short-Term Inflation-Protected Securities. It's one I've got in my model portfolios. Vanguard Inflation-Protected Securities--it has more interest-rate sensitivity, but it's also another good option. In terms of higher-yielding products, one fund I often recommend because it bundles together a lot of different lower-quality fixed-income types is Loomis Sayles Bond. It will hold lower-quality junk bonds. It will hold emerging-markets bonds. It sometimes holds a little bit of equity exposure. It's definitely not for the faint of heart. You'd want to have a nice long holding period for it. But that's a product I like because it keeps you from having to hold a lot of 3% or 4% or 5% positions. It lets you bundle those types together.

Glaser: Christine, thank you.

Benz: Thank you, Jeremy.

Glaser: For Morningstar, I'm Jeremy Glaser. Thanks for watching.