FMD Capital Management

Best Funds to Hold in a Roth IRA

Written by Michael Fabian, April 20th, 2015

What’s interesting about managing other people’s retirement assets is how often I get asked about how I manage my own. While, my immediate response is usually: “not unlike how I manage your portfolio!” there are always individual considerations such as goals, objectives, and acquired taste for volatility.   Yet, above all I think it’s very important that managers remain as transparent as possible and always eat their own cooking.

For the purposes of this discussion, I would like to focus on how I have carved out a rather unique strategy within my Roth IRA that I feel others could benefit from.  Since I am still in the accumulation phase of my life-cycle being in my mid-30s, it’s important to mention that my goals are aggressive, my expectations are high, and my allocation sizes are concentrated.  However, I still stick to the core beliefs that risk should be managed, low cost ETFs are an excellent tool to achieve diversification, and income producing assets are a great way to build wealth.

Beginning with my overall asset allocation, I have 58% of my portfolio dedicated to equities, and 57% of my portfolio dedicated to fixed income and alternative income assets.  Now obviously I realize that those figures don’t add up to 100%; but I’ll be getting to how that is possible in an IRA.

Taking a closer look at the equity component of my portfolio, I have roughly half of my total stock asset allocation dedicated to dividend and income themes.  This portion is equally allocated amongst the Vanguard High Dividend ETF (VYM), The Vanguard Dividend Growth ETF (VIG), and the First Trust NASDAQ Technology Dividend Index (TDIV).  While this approach may seem conservative for someone in my age category, I think these three funds offer a good mix of growth, value, and quality stocks.  Furthermore, they make great long-term positions within a Roth IRA because you can simply reinvest dividends as you go.  That way you can avoid the arduous task of rebalancing with cash on a quarterly basis.  In my opinion, whether your goals are met through income or capital appreciation, it all appears the same on a year-end investment report.

The other half of my Roth IRA equity sleeve is dedicated to more “growthy” market capitalization based strategies and international stock holdings.  Here I chose to own additional low-cost Vanguard Funds such as the Vanguard Mid-Cap ETF (VO) and Vanguard Small Cap ETF (VB).  I purposefully have chosen to weight these funds in relatively equal amounts due to the superior growth that can be achieved over decades by investing in smaller companies.  Finally, I have chosen a simple one-size-fits-all allocation to the iShares Core International ETF (IXUS), for both ease of use, and to round out my relative underweighting in foreign equities as this current time.

The key takeaways of my equity holdings are the obvious tilt toward ultra-low cost and diversified ETFs.  This will further bolster compounded growth over time in addition to a relatively balanced approach between growth and value.

Moving on to the fixed-income sleeve, I have chosen to exclusively allocate to closed-end funds (CEFs) for the increased income, exotic strategy matrix, and higher total return prospects.  In fact, my experiences with evaluating intermediate to long-term results have shown that well managed closed-end funds almost always outperform other fixed-income strategies offered at NAV (or net asset value).  The key is selecting the appropriate fund managers and strategies.

In addition, the best part about investing in closed-end funds within a Roth IRA is that there are no tax considerations for the large 8+% income streams almost all of my funds payout on an annual basis.

Even with aggressive CEF allocations, I have still chosen to stick with a tried-and-true allocation to both quality and credit sensitive fixed-income assets to further offset inherent underlying NAV volatility.  The quality side of my portfolio, which accounts for roughly 20% of my bond sleeve, is dedicated to the DoubleLine Opportunistic Credit Fund (DBL).  Despite its name, DBL’s underlying NAV price fluctuations more closely exhibit duration and credit quality that resembles a portfolio of high quality mortgage backed securities.

Examining the credit side of my fixed-income sleeve, I have opted for flexible multi-sector strategies such as the PIMCO Dynamic Income Fund (PDI) and DBL’s sister fund the DoubleLine Income Solutions Fund (DSL).  Both funds carry a very high weighting toward emerging market and non-agency MBS. Yet PDI uses a very sophisticated but effective derivative overlay strategy to control interest rate and credit risk, whereas DSL uses more traditional allocations in other sectors such as CLO’s, Agency MBS, bank loans, and corporate high yield.

In my opinion, one of the best qualities of owning CEFs in a Roth IRA is the benefit of leverage to achieve long-term results.  Consequently, the funds I have within my bond sleeve have pushed my asset allocation from what would be a 43% weighting in traditional ETFs, to a 57% weighting as a result of underlying CEF leverage.  This strategy allows a long-term investor to capitalize on a larger asset base over time without the use of a margin facility.

However, investors should be aware that the lack of traditional fixed-income assets traded at NAV within my retirement portfolio can open it up to significant volatility in a down market.  In fact, I am fond of saying that all CEFs will trade as risk assets in a down market.   While that adds a layer of risk, I’ve still found the strategy to perform effectively in the midst of volatility as a result of manager expertise and a sensible mix of funds.

In my opinion, the low interest rate environment has created unique opportunities for total return in CEFs.  Alongside the correct mix of equities, a Roth IRA can post market beating returns while still maintaining a balanced asset allocation.

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