With a little over two weeks until the tax filing deadline of April 18, investors still have some time to make contributions to their individual retirement accounts (IRAs) for the 2015 tax year. While some prefer traditional IRAs, many others favor Roth IRAs; both these retirement products provide amazing tax benefits.
IRAs allow investors to buy individual stocks, bonds, ETFs or mutual funds. ETFs are becoming increasingly popular with investors thanks mainly to their low cost, transparency and tax efficiency. Many investors now hold ETFs in their taxable accounts as they are more tax efficient compared with mutual funds. (Read: Most ETFs are Tax Smart; Is Yours?)
At the same time, diversified, low-cost ETFs are great investment options for IRAs too. Both diversification and costs should be important factors for retirement investments and ETFs score high on both these. Further, income paying ETFs are better placed in an IRA as income is sheltered from taxes.
Before investing for retirement, investors need to assess their investing goals, time horizon and risk tolerance. They need to remember that performance of an investment portfolio depends mostly on asset allocation, i.e. how an investor allocates money among major asset classes such as stocks, bonds, alternative assets and cash. (Read: The Safest Stocks and ETFs for Momentum Investors Right Now)
Below we have highlighted some ETFs and stocks that are excellent long term investments for retirement accounts.
Schwab U.S. Dividend Equity ETF (SCHD - Free Report)
High dividend stocks are excellent holdings for IRAs as dividend income sees tax-deferred or tax-free growth in these accounts. Dividend paying companies are usually high quality companies with steady cash flows and huge cash balances. These companies do pretty well in uncertain markets and are thus excellent investments this year.
SCHD provides a low cost, diversified exposure to high dividend paying stocks. It holds 124 high quality stocks that have a record of consistent dividend payments. Stocks in the underlying index are selected on the basis of four fundamentals-cash flow to total debt, return on equity, dividend yield and five-year dividend growth rate and also screened for dividend payment consistency, size and liquidity. The fund charges just 7 basis points for annual expenses.
Consumer Staples, Industrials and Information Technology are the top three sectors the fund has invested in currently. (Read: Top ETF Stories of the First Quarter 2016)
iShares Core U.S. Aggregate Bond (AGG - Free Report)
Income from bond ETFs is subject to high ordinary income tax rate and thus placing these investments in an IRA makes more sense. The strength in bond markets continues to defy skeptics and with rates now expected to stay lower for longer, investors should continue to allocate some money to bonds. Bonds also add stability and diversification to a portfolio. Deciding how much of your portfolio should be in bonds and how much in stocks depends on your investment horizon and risk tolerance.
AGG provides a low cost, diversified access to the entire US investment grade bond market in a single ETF. The fund has highest allocation to US Treasury bonds (38%), followed by MBS pass through bonds (28%) and Industrial bonds (15%). It charges an expense ratio of just 8 basis points for a broad, diversified exposure to more than 5,000 bonds. More than 72% of its holdings are AAA rated making the fund very safe from the credit risk perspective.
Vanguard REIT ETF (VNQ - Free Report)
REITs are required to distribute at least 90% of their taxable income to shareholders annually in the form of dividends and in turn, they can deduct those dividends paid from their corporate taxable income. An improving economy and low interest rates make REITs particularly appealing to investors.
REITs should preferably be held in a tax deferred account because a major portion of their dividend payout is treated as income for tax purpose and subject to a higher tax rate compared to qualified dividend tax rate.
VNQ holds a diversified portfolio of 153 REIT companies that invest in office buildings, hotels, and other real property. More than a quarter of its assets are invested in retail REITs while residential and specialized REITs round out the top three spots in terms of sub-sector exposure.
The product charges 12 basis points in annual expenses and has a dividend yield of 4.36%.
Apple (AAPL - Free Report)
Apple shares have rallied about 17% from lows seen in January this year. Shares had sold off earlier due to worries over slowing iPhone sales. In fact, many analysts estimate that iPhone sales will decline for the first time ever this fiscal year, with the decline starting in the current quarter. In the recent conference call, CEO Tim Cook said iPhone units sold are expected to decline in the current quarter because of tough comps from the year-ago quarter.
This short-term weakness is already priced into the stock which currently trades at a very attractive valuation of 12.16 times forward earnings.
The company generates billions of dollars of cash flows every quarter and returned more than $9 billion to investors during last quarter. With almost $216 billion in cash on their balance sheet, they will continue to return a lot of capital to their shareholders via dividends and buybacks. In fact, the company is expected to unveil a new buyback and dividend program in April.
Johnson & Johnson (JNJ - Free Report)
JNJ is arguably the most well-known healthcare company in the world. It is one of the only three American companies that have the coveted triple A credit rating from S&P. The company has faced currency headwinds in the past few quarters as it derives about half of its revenues from outside of the US but longer term growth picture remains very bright. Global population is growing older at a fast rate and healthcare sector is a direct beneficiary of the trend. JNJ’s significant presence in fast growing emerging markets will also drive growth in the coming years.
JNJ is a dividend aristocrat with 53 consecutive years of dividend increases. Over the past 10 years they have returned almost 70% of free cash flow to shareholders. The stock currently has a solid dividend yield of 2.8%.
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Disclosure: I own shares of AAPL in my personal long term portfolio and JNJ in Zacks Income Investor service.