Given the limitations of various savings account types, which ETFs (and other investments) should get dibs on becoming retirement assets, and which are best deployed elsewhere? Follow these four primary principles, and you can’t go too wrong:
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Any investment that generates a lot of (otherwise taxable) income belongs in your retirement account. Any of the bond ETFs, REIT ETFs, or high-dividend ETFs are probably best held in your retirement account. Note: Value stocks generally yield more in dividends than growth stocks.
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Keep your emergency funds out of your IRA. Any money that you think you may need to withdraw in a hurry should be kept out of your retirement accounts. Withdrawing money from a retirement account can often be tricky, possibly involving penalties if done before age 59 ½, and usually triggering taxation.
You don’t want to have to worry about such things when you need money by noon tomorrow because your teenage son just totaled the family car.
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House investments with the greatest potential for growth in your tax-free Roth IRA. This may include your small cap value ETF, your technology stock fund, or your emerging markets ETF. Roth IRA money won’t ever be taxed (presuming no change in the law), so why not try to get the most bang for your ETF buck?
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Foreign-stock ETFs are perhaps best kept in your taxable account. That’s because the U.S. government will reimburse you for any taxes your fund paid out to foreign governments, but only if you have that fund in a taxable account.
Over the long run, this “rebate” can add about half a percentage point a year to the returns you get on these funds; it doesn’t sound like a lot, but it can add up over time.
Tax laws change all the time. For example, the current low rates on capital gains and dividends, unless Congress steps in to intervene, are subject to a boost in 2013. Because of the constant changes in tax laws, you should to review your portfolio every year or two to make sure that you have your assets in the right “vessels.”
Of course, there are other good reasons to review your portfolio, as well.