By Eric Dutram
With IRA contribution deadlines right around the corner, many investors are scrambling to decide how best to allocate their money. ETFs are a relatively new vehicle for many investors, but they are becoming increasingly common choices for IRA accounts. Admittedly, some of the benefits traditionally associated with ETFs don’t translate completely to an IRA. Tax-efficient ETFs rarely distribute capital gains, so they make the most sense in a taxable account. But there are still a lot of reasons why ETFs make a lot of sense. For long-term buy-and-holders, the compounding of costs can make a big difference on bottom line returns, and ETFs have the potential to significantly reduce management fees.
In addition, since ETFs offer greater levels of diversification than buying individual securities, they can be less prone to risks that impact individual securities. All of the ETFs below generally focus on small and mid sized companies that can continue growing for years to come. In addition, these funds all payout dividends (also see How To Find The Right Dividend ETF) which could lead to substantial gains over a long time horizon, making them intriguing picks for an IRA.
PowerShares International Dividend Achievers Fund (PID)
Most U.S. investors have a severe lack of foreign stocks in their portfolios. While some have moved to correct this imbalance by beefing up emerging markets exposure, portfolios generally remain light in foreign developed markets. This ETF includes some emerging markets exposure, but is tilted heavily towards stocks listed in developed markets. PID is heavily weighted towards stocks in the United Kingdom and Canada, which make up 47% of the total assets of the fund. Other major allocations include Spain and France. This ETF tracks the International Dividend Achievers Index, which is designed to follow companies that have increased their annual dividend for five or more consecutive fiscal years. As such, PID can be expected to have a relatively high dividend yield going forward.
Claymore/SWM Canadian Energy Income Index ETF (ENY)
A play on rising oil prices, ENY offers investors the chance to invest in a fund that tracks the Sustainable Canadian Energy Income Index, which focuses on Canadian firms that are either royalty trusts or oil sands producers. The fund offers investors a tactical allocation which allocates more assets to oil sands companies when oil is in a bull phase and more to income trusts when oil is in a bear phase. With the heavy focus on income trusts, the fund offers investors a robust yield of 3.36% while also allowing for price appreciation. This combination could allow investors to grow their portfolios through dividend reinvestment as well as through general price appreciation. The fund charges an expense ratio of 0.65% and has produced a return of close to 10% this year.
iShares Russell 2000 Fund (IWM)
This fund tracks the Russell 2000 Index, which consists of the smallest 2000 companies in the Russell 3000 and represents roughly 10% of the total market capitalization of the more broad-based index. Many investors believe that small caps outperform large caps in the long run, and there is a fair amount of evidence to back up this theory. According to T. Rowe Price, in the 12 months following the previous nine recessions, small-cap stocks gained 24%, versus 17.6% for the S&P 500, suggesting that this fund could be an interesting choice in this post recessionary environment. Moreover, small cap ETFs are more likely to make some capital gains distributions, since the underlying indexes generally have a higher turnover rate than large cap benchmarks.
PowerShares Dynamic Food & Beverage Fund (PBJ)
Many firms must constantly reinvent themselves in order to stay on top of their industry. But the holdings of PBJ usually do not suffer from this problem, and are among the most likely to be around fifty years in the future regardless of how the economy turns out in the short-term. PBJ focuses on the food and beverage sector of the economy and contains quality names such as Yum! Brands (5.5%), Starbucks (5%) McDonald’s (5%), and Coca-Cola (4.8%). As such, PBJ offers investors a relatively safe selection of companies that are likely to weather any storm and provide value to investors for decades to come.
WisdomTree Emerging Market Small Cap Fund (DGS)
While emerging markets investing has grown in popularity over the past decade, investments have usually been limited to large cap and mega cap companies. While many of these securities have experienced rapid growth, few are truly representative of their home markets and reflective of growth in domestic demand. For investors with a long term focus and tolerance for a bit of risk, DGS offers a compelling choice. The fund offers sizable allocations to Taiwan (32.4%), South Africa (11.2%), and Thailand (8.3%). It also focuses on industrials and information technology firms which combine to make up two-fifths of the total assets (see our Guide To Small Cap International ETFs for more on small cap ETF options).
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Author's Disclosure: long ENY, IWM, and PID.