As of today, you have a little more than two weeks to contribute to an IRA for the 2018 tax year.
Of course, the heaviest lift in funding an IRA is finding the money to invest: While your 401(k) contributions likely go into your account on autopilot, most of us don’t have an extra $5,500/$6,500 (the 2018 IRA contribution limits for savers under/over 50, respectively) lying around. It’s no wonder so many people rush in their contributions at the last possible minute, just before their tax-filing deadlines. (Bear in mind that you can make smaller contributions than the full contribution amount.)
But some investors also clearly struggle over getting their IRA assets invested. According to Vanguard research, the percentage of IRA contributions allocated to money market funds spikes between January and April. In other words, investors are focused on getting the money into the account--not on getting the money invested. Combined with the fact that many investors are operating with a one-year delay on their IRA contributions--making their 2018 contributions in spring 2019, for example--the delay in investing assets can drag on returns.
If you’ve been among investors who have made the IRA contribution but not the investment or if you plan to fund an IRA in short order, here are some specific goals for funding that might resonate with you. You can then map your goal to an appropriate investment.
If retirement readiness is on your mind: If you’re hurtling toward retirement, plumping up your retirement accounts is probably top of mind. Your first question may be whether contributing to a tax-sheltered receptacle like an IRA is even worth it if you’ll begin withdrawing from it soon. After all, you have less time to benefit from tax-sheltered compounding than you did when you made contributions earlier in life. To be sure, money inside an IRA carries strictures that don’t exist with a plain old brokerage account. But the tax benefits usually make contributing to a tax-sheltered account like an IRA worth it later in life, too, especially if you’re making Roth IRA contributions. (The big reason is that Roth IRAs, in contrast with Traditional IRAs, don’t require you to pull your money out on a preset schedule at age 70.5.)
If you’re funding an IRA as retirement approaches and need to determine where to invest those assets, start by looking at your total portfolio’s asset allocation using Morningstar X-Ray. Compare that to a reasonable asset-allocation benchmark, whether a target-date fund geared toward your same age group and/or Morningstar’s Lifetime Allocation indexes. Many people conducting that exercise today may well find that their portfolios’ equity weightings are higher than is ideal given their proximity to retirement, simply because equities have outperformed other asset classes by a big margin over the past decade. At the same time, many pre-retirees’ portfolios are lacking bonds, which have the potential to hold their ground or even gain a bit if the equity market tumbles.
If you’ve reviewed your total portfolio’s asset allocation and you’re in “Uh, I guess, I need some bonds” mode, look for bond funds and exchange-traded funds that are Morningstar Medalists; the short-and intermediate-term bond categories house core-type options that are necessary ingredients in portfolios for retirees and pre-retirees. Among Morningstar’s favorite bond funds are sturdy low-cost index-trackers, such as Vanguard Total Bond Market Index (VBTLX) and iShares Core Total USD Bond Market ETF (IUSB), as well as actively managed funds like Dodge & Cox Income (DODIX), Fidelity Total Bond (FTBFX), and Harbor Bond (HABDX).
If you’re looking to fill holes or address portfolio problem spots: Even if you’re not closing in on retirement, using new IRA contributions to address underweightings or other shortcomings in your portfolio can be a smart strategy. Here again, comparing your portfolio’s actual asset allocation relative to a benchmark is a sensible starting point. A combination of directing IRA contributions to the underweight asset classes and repositioning your other holdings can right your asset allocation. (In contrast with making tweaks to your taxable accounts, you won’t pay any taxes if you reposition your tax-sheltered assets, even if you’ve lightened up on appreciated holdings.)
For investors of all ages, it’s not uncommon for portfolios to be relatively light on foreign stocks versus U.S. right now. After all, the MSCI World ex-US Index has gained just 8% on an annualized basis over the past decade, whereas the S&P 500 has gained almost twice as much. Your portfolio needn’t reflect the U.S./foreign stock split of the global market capitalization, which is 54% U.S./46% foreign today, but foreign stocks do have the potential to add diversification and many market watchers think they’ll outperform U.S. stocks over the next decade. If you’re increasing your foreign-stock exposure, focus on core large-cap options to provide core exposure. Morningstar Medalist funds for mutual funds and ETFs can be a good starting point. Among Morningstar analysts’ favorite core passively managed international funds are Vanguard Total International Stock Market Index (VTIAX)/and ETF (VXUS), Vanguard FTSE All-World ex-US Index (VFWAX)/and ETF (VEU), iShares Core MSCI Total International Stock ETF (IXUS), and Schwab International Equity ETF (SCHF). High-conviction actively managed options include Dodge & Cox International Stock (DODFX), Oakmark International (OAKIX), and American Funds International Growth and Income (IGIFX).
A related issue is if you’ve done your due diligence on your 401(k) plan and found it lacking in one area or another. If that’s the case, think of your IRA as a “completer” portfolio--you can use it to add to categories that aren’t well represented in your company retirement plan. For example, perhaps your plan is chock-full of worthy large-cap stock options but doesn’t have much in the way of small-cap exposure; your IRA would be a good place to add exposure to smaller stocks. Or perhaps your 401(k) plan is simply high-cost. In that case, you should focus on very low-cost products within your IRA, such as ultra-cheap index funds, to bring your average portfolio costs down as far as they can go.
If you’d like to get everything streamlined--and keep it that way: Yes and yes, right? I love the idea of using IRA contribution season as an impetus to streamline IRA assets. I’ve been writing about minimalist portfolios of late, and it’s simple to invest your IRA in that same fashion.
If you’d like to make your annual IRA contribution--this year and in years thereafter--without giving it too much thought, it’s hard to argue with using a good-quality target-date fund for the job. Financial advisors often gripe that target-date funds are “one size fits none,” and it’s true that they’re not customized for any one situation. But target-date funds rely on professional asset-allocation research, and they can be solid choices if you don’t have a lot of time to devote to crafting an asset-allocation plan, selecting individual investments, and keeping the whole plan on track. Vanguard’s Target Retirement series and BlackRock LifePath Index Target-Date series both receive Morningstar Analyst Ratings of Gold from Morningstar’s team. Because target-date funds’ asset allocations become more conservative over time, I prefer them to static-allocation funds for one-stop exposure.
If you’d like to exert more control over your portfolio’s asset-allocation exposure--perhaps you’re an asset-allocation outlier, as discussed here--you can build a diversified portfolio. Because each of these funds is so well diversified, you won’t have to bother with additional moving parts. This article covers minimalist portfolios for savers (people who are still working), and this one is geared toward retirees.
While you might not have time to streamline your IRA accounts prior to making your 2018 IRA contribution, that’s a worthy goal for the year ahead. For example, do you have multiple IRAs and straggler 401(k)s from former employers? If so, you might consider collapsing those accounts into a single mega-IRA. Before you move money from old 401(k) plans into an IRA, however, be sure that making a backdoor Roth IRA contribution isn’t on the horizon, because that could affect the taxation of your IRA conversion. This article delves into the details of the backdoor IRA strategy.
Christine Benz does not own shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.