Tuesday, February 06, 2007

How to Spend Your Next Tax Return (Part 2)

The idea of investing in your IRA is very obvious: you are investing in yourself and your future. Early tax return time i.e. February through March also happens to be a very good time to invest. Just after the holiday stock optimism, a cloud of the unknown sets in on Wall Street which generally drives stocks down at this period of the year. This is a good time to buy but you must do so early. Wall Street generally starts feeling the impact of IRA money pouring in from late tax returns in late March which spurs the market before the general May downtown.

Roth IRA remains by favorite investment vehicle especially if they are filled with ETFs (five at the maximum) and below are five classes of investment vehicles and examples of what you should purchase with your next tax returns probably in equal twenty percent measures:

International Fund: A sizeable portion of your portfolio should be devoted to international exposure. You will miss out on explosive international growth if all your investments are directed internally to the Americas- emerging and developed markets can form part of your strategy. CRIB i.e. China, Russia, India and Brazil comes to mind. Understanding the risks is also important in the choice of global investments- for example investment in China and Russia is an investment in commodity growth, while India and Brazil is more service oriented. Currently I love Honk Kong ETFs or may be Australia. These are well positional developed markets with the transparency advantage which have stocks that can take advantage of their proximity to the red hot China and Indian markets. I love EWH (which I own and which contains Honk Kong traded stocks with good exposure to the mainland) and EWA (its Australian Equivalent).

Core Growth Fund: It is necessary to have a core growth portion of your portfolio around which the rest of your portfolio is built. This should be a representative cut of the total market probably an index tracker, like the Russell 1000 or S&P Growth index. This portion of your portfolio will be a steady hand in the storm and should over time constitute a bulwark of your explosive portfolio. An investment in growth and capital gains is an attractive option for younger people. Older folks can substitute this class for a core value play. Currently I like IWF, IWZ (which I own) and RPG.

Small Cap: The worst kept secret on Wall Street is that over time, small cap stocks outperform all other classes of stocks. It is pretty obvious that this will be the case if Wall Street keeps being a growth chase addict; small caps stock have the most headroom for leveraged growth which can come by huge capital gains, market share gains and indeed a buy out by a bigger, threatened competitor. This could me cash machine for owners and without the headache of having to rebalance your portfolio an ETF is the easier way to invest in small caps. Current PWY, RZV and PZI look very interesting to me. By the time you read this, I should own at least one of the three.

Sector of the Future: After playing regional, style and capitalization classes, and the next best hunt is sector classes. In here, you will need to do some homework or rather make a good guess of what the future holds. It simply involves choosing a sector you perceive holds the most promise for the future. To some it might be biotechnology (look into PBE, XBI) which considering the ageing population will be a combo way to play growth, technology and healthcare. To others it might be nanotechnology (look into PXN) and to others it might be alternative energy (PBW is one of the best out there now). Depending on which way to go, it might be necessary to time your entry into this ETF to coincide with a downturn or slowdown in such sectors since you are essentially looking to secure long term gains not ride the current momentum.

Stock of the Future: This is my only non-ETF play in a model IRA portfolio. This is a common stock of a company you have a hunch about. This might be a stock on a rally, one that is beaten down and essentially is in the hand of a guru. This is the next BERKSHIRE HATHAWAY INC and you are basically seeing if the company is in the hands of the next Warren Buffet or Jack Welch of GE. Imagine if you had bought one BRK.A stock at $200 in the early eighties, you did be sitting on $80, 000 plus today. That is humongous! Of all the five classes, this will require more homework than any other. You will not only need to effectively know the company by poring through annual reports and filings as well as website and may be even cold calling their offices, it might require to have an insight into the strategy, managerial style and personality of the man on top. Essentially this is a focused long term value investment in one man, his brain, and his health. Shun companies with old men beckoning on retirement, those that like to spend extravagantly and companies with shaky financials. Cash is king when selecting this stock, because a major weight to your bet is that this company will essentially become a conglomerate if it is not one already which will mean acquiring its way into new businesses. Currently, Sears Holding (SHLD) under Eddie Lampert has every smell of it- yes, I own SHLD and I am not ashamed to say it. Get yours.

To conclude, before investing it is necessary to understand the risks in each of the investment classes, market trend, and your own risk tolerance and how this investment allocation strategy will fit your retirement age target. For example I will personally reduce investment in international funds and substitute the ETF in the sector of the future for income generation fund like a Real estate Investment Trust portfolio if I am five years to retirement. This will also impact my stock of the future, because at ten years to retirement let us be real you don’t have that much of a future ahead- okay, just joking.