by Charles Sizemore | February 27, 2014 12:11 pm
I take a somewhat contrarian view on what assets you should hold in an IRA. Conventional wisdom would tell you to put your safer, more conservative investments in their IRA, and avoid putting riskier assets in taxable accounts with the thinking that IRA dollars are more precious and should therefore be treated more carefully.
While I understand this thinking, it’s very bad retirement planning and it can be woefully tax-inefficient.
If you are like a lot of investors, you probably have a decent-sized portion of your assets in index funds or index ETFs — such as the popular SPDR S&P 500 ETF (SPY) — and you augment those baseline index investments with individual stocks or ETFs, some of which you might trade actively. Conventional wisdom would have you put the index funds in your IRA and the more speculative positions in a taxable trading account.
But think about it for a moment. If you’re buying and holding an index fund or ETF for years or decades … it really doesn’t matter where you hold it because other than dividends or the occasional capital gains distribution, you’re not generating any taxable income. It makes all the sense in the world to hold the index funds in your taxable account and reserve your IRA for stocks and funds that are less tax efficient.
With no more ado, here are three popular but tax-inefficient stocks that you should consider for your IRA:
I’ll start with mortgage real estate investment trust Annaly Capital (NLY). I’m normally not the biggest fan of mortgage REITs because, unlike equity REITs, their dividends are highly variable. If you’re depending on the dividend stream for your current living expenses, that can be a major problem.
Ideally, you want to own mortgage REITs when two conditions are in place:
Today, both conditions are in place for Annaly Capital. The Fed has promised to keep short-term rates at or near zero for the foreseeable future, and long-term rates — while still very low — are significantly higher than they were a year ago. Meanwhile, NLY trades for just 86% of book value.
Why should you hold NLY in an IRA? Because its attractive 11% dividend is not considered “qualified,” meaning that it is taxed as regular income — and that you could be paying 43.4% in a taxable account if you are in a high tax bracket (39.6% + the 3.8% Medicare surtax).
One last sweetener on NLY, by the way: Its insiders have been aggressively buying the stock.
There is a time and place to own high-yield, or “junk,” bonds — or a junk bond ETF such as the SPDR Barclays High Yield Bond (JNK). When spreads between junk bond yields and Treasuries are wide, as they generally are during and after recessions when investors fear default most, junk bonds offer attractive yields and the potential for “equity like” price returns.
But when investors start to chase yield and the spread between junk bonds and Treasuries shrinks — as it did in 2007 — you don’t want to be anywhere near this asset class.
So, where are we now?
Junk bonds are looking a little on the expensive side. The spread has dipped below 4%, and across the asset class, many junk bonds are trading above their call prices, meaning the companies issuing them can legally buy them back for less than the current market price.
So, right now, you’re better off avoiding junk bonds. But if at any point you decide that junk bonds might be a good match for your portfolio, buy them within your IRA account. Bond interest is taxed as ordinary income.
I should start by saying that I hate gold as an “investment.” Gold can be a spectacular trade and, under the right set of circumstances, it can be a decent hedge against inflation and geopolitical tensions. Due to its long history as a monetary asset and its relative scarcity, gold is considered to be an all-purpose crisis hedge.
My advice on gold is actually the same as my advice on firearms. By all means, own some … just in case. Keep some in a lockbox or buried in your backyard. But think of it more as insurance and not as an investment. Investments should either pay you an income or should represent an ownership interest in a growing enterprise. Gold does neither of these things … which is why I believe you should consider it separately from your investments.
But if you insist on owning gold as an investment allocation, such as via the SPDR Gold Shares (GLD), then I would recommend you hold it in an IRA rather than in a taxable account. Precious metals are woefully tax-inefficient because they are taxed as “collectibles.” And this does not only apply to coins with numismatic collector’s value, but to generic, raw bullion as well.
The long-term capital gains tax rate on collectibles is 28%, and there is absolutely no reason to pay this if you don’t have to.
Charles Lewis Sizemore, CFA, is the editor of Macro Trend Investor and chief investment officer of the investment firm Sizemore Capital Management. As of this writing, he did not hold a position in any of the aforementioned securities. Click here to receive his FREE weekly e-letter covering top market insights, trends, and the best stocks and ETFs to profit from today’s best global value plays.
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