Whether your IRA will play a core or supporting role, learn to pick the right investments to stay on track to meet your needs.
By Christine Benz | 03-15-11 | 06:00 AM | Email Article

This article appeared on Morningstar.com in February. In case you missed it (and because April 18, your deadline for contributing to an IRA for the 2010 tax year, is approaching), we're running it again as part ofTax Relief Week.

Christine Benz is Morningstar's director of personal finance and author of 30-Minute Money Solutions: A Step-by-Step Guide to Managing Your Finances and the Morningstar Guide to Mutual Funds: 5-Star Strategies for Success. Follow Christine on Twitter: @christine_benz.

It's easy to see why would-be IRA investors often suffer from analysis paralysis. Once you decide whether to invest in a traditional or Roth IRA, you then have to sort among an overwhelming array of options.

You can put almost anything inside an IRA wrapper: individual stocks and bonds, money market funds, certificates of deposit, or mutual funds. (However, you'll want to take care to keep investments that have tax-savings features themselves, such as municipal bonds and variable annuities, out of your IRA because you may be sacrificing returns for an extra layer of tax efficiency that you don't really need.)

By answering the following questions, you'll be able to cut through the clutter and quickly identify appropriate holdings for your IRA.

Step 1: Evaluate the role your IRA will play in your overall retirement portfolio. Will your IRA take up a big share of your retirement portfolio--either because you're just starting out and plan to make many more IRA investments in the future or because you've rolled over a large sum of money from your company retirement plan? If so, move on to the next step.

If you consider your IRA to be more of a supporting player because the bulk of your retirement assets are elsewhere, either in your company retirement plan or your taxable account, go to Step 3.

Step 2: Identify worthy core holdings.
If you already have a large sum of money stashed in an IRA--or expect that your IRA will grow to be a large share of your overall retirement portfolio in the future--you'll want your IRA to be well-diversified and populated with core investment types such as large-cap-stock mutual funds and high-quality bond funds.

If you have other assets earmarked for retirement, in addition to the money that you're putting into an IRA, be sure to take those holdings into account when deciding what to put in your IRA. Morningstar's Instant X-Ray tool can help you size up your existing portfolio's stock/bond/cash composition and also shows you how well it's diversified across various investment styles. (The Morningstar Style Box provides a visual depiction of a portfolio's investment-style mix.) Simply enter the tickers for each of your holdings into the X-Ray tool, then click Show Instant X-Ray.

Compare the current allocations of your existing retirement portfolio with your asset-allocation targets. (Don't have asset allocation targets? Read this article.) Once you've determined where you need to add, you can select the specific investments. If you're looking for core-type investments to populate your company retirement plan, Morningstar's  Fund Analyst Picks in the large-cap equity (both international and U.S.), intermediate-term bond, world-stock, world-allocation, and conservative- and moderate-allocation categories can provide a good starting point. Some of my favorites are  Dodge & Cox Stock ,  Sequoia , and  T. Rowe Price Personal Strategy Income . This article also highlights some other terrific choices.

Securities mentioned in this article



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Christine Benz does not own shares in any of the securities mentioned above. Find out about Morningstar's editorial policies.
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