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As with index funds, you may want to concentrate your stock-investing efforts in your taxable accounts. That's because stock-only portfolios tend to be more tax-efficient than those involving funds, because you pay taxes only when you yourself sell a stock in which you have a gain.
You might also think about holding stocks in the sectors and industries that you truly understand. In areas where you have less hands-on experience or where the information flow may be scant -- say, in emerging markets -- you're better off delegating security selection to a portfolio manager who's a specialist.
Our list of Fund Analyst Picks is a good starting point if you're in search of funds run by best-of-breed managers. If you're looking for high-conviction stock ideas, use our Premium Stock Screener to look for those rated four or five stars with a fair value uncertainty rating of medium or lower.
3. Selling versus holding on. I often hear from readers who are wrestling with whether to sell a mutual fund, either because performance is in the dumps or a fund manager has left. The question is usually, "Should I stay, or should I go?"
Sometimes, the answer is pretty obvious. If your tame bond fund has jacked up expenses from 0.5% to 1.5% or if the chief financial officer of a company whose stock you own has fled the country after apparently cooking the books, the answer is pretty easy: Sell it.
But in other situations, the decision is less clear-cut. Even if you have reason to believe that you'd be better off in some other stock or fund than the one you own, you also have to factor in the tax and transaction costs associated with the trade.
If you're not sure that you'll out-earn those transaction costs in the form of higher returns in the future, you may be better off staying put in your less-than-perfect stock or fund.
There is a middle ground, however, yet it's one that many individual investors don't consider. Why not sell a portion of your shares and hang on to the rest? That can be a particularly effective strategy if you've already made a nice profit in a fund or stock. You can sell a portion, effectively locking in your gains, yet hold on to some of your shares to hedge against the possibility that you're selling prematurely.
4. Roth IRA versus traditional deductible IRA; traditional 401(k) versus Roth 401(k). Here's a smaller portfolio-management question but one that's relevant for many investors: Assuming you're eligible for both, are you better off contributing to a Roth IRA or a traditional nondeductible IRA? What about investing in a traditional 401(k) versus a Roth 401(k)?
In both the traditional nondeductible IRA and 401(k), you don't pay taxes on your contributions but are taxed on your withdrawals. If you opt for the Roth IRA or 401(k), you contribute after-tax dollars, but withdrawals are tax-free.
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For this one, I'd go back to my original point about uncertainty. The decision about whether to invest in a traditional 401(k) or IRA versus a Roth rests on two key questions: What tax bracket are you likely to be in when you retire, and do you expect federal tax rates to be higher or lower at that time? Needless to say, those questions are pretty close to unanswerable.
For that reason, I'd say that the right answer to this question is to split the difference, thereby diversifying the future tax treatment of your 401(k) and IRA assets. If you already have a lot of assets built up in a traditional IRA or 401(k), it makes sense to opt for the Roth for your future contributions.
Those who have been unable to contribute to a Roth IRA because they earn too much have a particularly strong incentive to consider the Roth 401(k), because without it, all of their tax-sheltered assets will be taxed upon withdrawal.
5. Paying down mortgage versus investing in stocks and bonds. Similar to the 401(k) question above, this lands in the realm of capital allocation. At the crux of whether to pay down your mortgage aggressively versus investing in the market is an unknown variable:
Will investment returns out-earn your mortgage interest rate?
Because the answer is uncertain, most investors, particularly those who are paying private mortgage insurance or who don't enjoy much of a mortgage-interest tax deduction, should chip away at their mortgage principal on a more aggressive schedule than their lenders require.
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Ken Kam: Wait for your fat pitchMarketocracy's founder discusses why it is important to focus your investments on your own areas of expertise.
If, however, your portfolio is heavy on cash and bonds and you're carrying a big mortgage, extra payments toward your mortgage principal are a better use of your household capital.
This article was reported and written by Christine Benz for Morningstar.
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