Dear Dagen

Return to Article

What's the Best Bet for Your IRA?

Dagen McDowell

When the subject of retirement planning comes up at a cocktail party, people head for the shrimp.

Dull as it may seem, you should care about your IRA and other retirement accounts -- unless you plan on retiring to a home with wheels.

Arguably, the most important question is: What should you buy for your IRA?

For most investors, an aggressive stock fund may be the investment of choice.

Traditional thinking is that less tax-efficient investments should go in your IRA.

But taken to its extreme, that approach would suggest that a bond fund is a better bet than a stock fund. Bond funds, after all, receive a larger share of their returns from income, which is taxed at higher ordinary income tax rates (up to 39.6%). Stock funds get the majority of their returns from capital appreciation, and long-term capital gains are taxed at 20%.

So on the surface, bond funds look like the better IRA choice.

But it's not so.

A T. Rowe Price study from last year shows just the opposite.

"Essentially, the disadvantage of subjecting the stock funds' earnings to higher ordinary income tax rates at retirement is offset by the advantage of deferring taxes for many years on their higher compounded earnings growth," the study says.

"To determine the best strategy, an investor needs to take into account not only tax brackets but investment time horizons."

The lower your tax bracket in retirement and the longer your investing period, the more likely it is that a stock fund will be the better option for your IRA. The advantages of buying a stock fund are even more obvious with a Roth IRA, where earnings aren't even taxed when you make withdrawals at retirement -- assuming you're 59 1/2 and the account is 5 years old.

If you've got more than 10 years, you can be aggressive.

"You have the time to make up for any mistakes," says Bryan Olson, director of research at Charles Schwab's Center for Investment Research.

"If you're older and in a high-octane fund, you no longer have time to make up for these mistakes."

Too, your time horizon might extend way beyond 59 1/2, when you can start taking money out of your IRA, or the general retirement age of 65. Even if you're turning 65 in 10 years, you may be investing way beyond that date, which would let you make more aggressive investments. "On day one of the 10th year, you don't take your money," says Olson.

If you're desperate to buy a blazing tech or biotech fund, your IRA might be the best place for it. The same goes for Internet funds.

If you experienced a fantastic run-up -- like the triple-digit returns witnessed last year -- you can sell within the IRA without incurring any capital gains taxes.

You could also buy stocks. Your brokerage firm might even let you buy initial public offerings and options in your IRA.

Frankly, if you are actively buying and selling stocks or funds, you can do that in your IRA without triggering any capital gains taxes.

If you're partial to index funds, they should probably go into your taxable account. Index funds are already so tax efficient, you'll reap few if any benefits from keeping them in your IRA.

I'm interested to hear what you own in your own IRAs -- the funds and fund families that you think are the best IRA investments. Email me at deardagen@thestreet.com.

Cheaper WEBS

World Equity Benchmark Shares, or WEBS, are getting cheaper.

The expense ratios on these exchange-traded mutual funds are expected to fall to 84 basis points (0.84%) for all 17 of the existing WEBS, which each track a specific MSCI country index and trade on the American Stock Exchange.

Currently, the annual expenses on the products range from 94 to 143 basis points. Although the expense ratios are falling, the 12(b)-1 marketing fees - part of the expense ratio -- are going up on each product by 5 basis points, from 0.20% to 0.25%.

Barclays Global Fund Advisors manages the portfolios and is bringing the sales and marketing of the WEBS within the firm, according to a Barclays spokesman. Remember, Barclays is also preparing to launch more than 30 exchange-traded funds this spring. As a separate initiative, Barclays is planning to introduce 11 new WEBS that cover the emerging markets.

These lower fees could attract more investors to the WEBS. The products have been around for close to four years and have attracted relatively little in assets.

The 17 WEBS combined hold $1.97 billion in assets as of Feb 11, according to the Amex. And the Japan WEB (EWJ Quote) garners the bulk of that with $928 million in its portfolio.

Compare those figures to the combined $1.5 billion that Merrill Lynch's Telecom HOLDRs (TTH Quote) and Pharmaceutical HOLDRs took in before they even started trading.

Barclays will need to back up this expense reduction with some heavy marketing to spur investor interest in these products.