The Four Best Mutual Funds For Your IRA

Yesterday, I gave some examples of mutual funds that would be ideal for your taxable account. Today, we’ll explore the other side of the coin and find out which type(s) of mutual funds would be ideal for your tax-advantaged IRA. If you don’t already have one, I suggest signing up for a free Morningstar account. I believe Morningstar is one of the best free resources on the web for small investors to research potential investment ideas, including mutual funds (they also have a premium paid membership which might be worthwhile if you’re managing a large portfolio).  Using Morningstar’s extensive database of expense ratios, performance numbers, and risk attributes to make investment decisions can greatly improve your portfolio’s risk/return profile. Sign up for a free Morningstar account and see what I mean.

Criteria For Funds Best-Suited For Your IRA

• Funds that derive a significant part of their long-term return from interest or dividend payments taxable in the current year such as taxable bond and REIT funds.
• Funds with high portfolio turn-over that tend to generate a lot of capital gains every year
• Most actively-managed mutual funds

The Four Best Mutual Funds For Your IRA

Vanguard Total Bond Market Index Fund (VBMFX) - Here’s your one-stop intermediate-term bond fund. It invests about half its portfolio in Treasury and agency bonds and the rest in corporate bonds. With a current effective duration of only about 4 years, this fund should perform decently even in periods of moderately-rising interest rates.

Third Avenue Value (TAVFX) - This fund has taken a hit along with the rest in the past year, but it’s 10-year performance record is still well above-average. Veteran value hound Marty Whitman (author of the investment classic The Aggressive Conservative Investor) is a slave to his “cheap and safe” investment philosophy, which above all else aims to minimize loss. No strategy works all the time, but over the decades Whitman’s has worked far more often than it hasn’t. The one caveat is that at 1.11% of assets, expenses are a bit high. Still, in the past Whitman has more than earned his fee.

Dodge And Cox Stock (DODGX) - Dodge and Cox employs a conservative, team-based approach to value investing that has served it well over the years. Started in 1965, this is one of the older and more successful funds around thanks to its strong performance. Unlike Whitman of Third Avenue, Dodge and Cox employ a more traditional value approach and often hold more dividend-oriented portfolios. While this fund is quite tax-efficient for an actively-managed fund, it’s 20% turnover is still higher than is preferable in a taxable account, especially when you have such high-quality index funds to choose from. At 0.52% of assets, expenses are extremely reasonable for the caliber of management.

Vanguard REIT Index Fund (VGSIX) - Real estate has taken quite a beating of late, but this funds 7+% 10-year returns are far, far, far greater than you’d have gotten in the broader market. Since REITs are required by law to distribute 90% of their earnings to shareholders each year and those distributions don’t qualify for the favorable 15% dividend tax rate, this fund definitely belongs in a tax-advantaged account. That said, real estate provides powerful diversification benefits and should be a part of every balanced and diversified portfolio.