The Roth IRA is one of the greatest tools the U.S. government has ever created to help the average American grow wealthy. Unlike the 401(k) or traditional IRA that simply defer taxes, the Roth IRA allows your money to compound over time and then be withdrawn completely tax-free, so long as you pay taxes on the contributions up front and play by the rules.
That's a huge advantage, and one of the smartest ways to capitalize on the favorable tax treatment is to fill your Roth IRA with dividend-paying stocks. The reasoning is that you won't ever have to pay taxes on the dividends, allowing your returns to truly compound at higher rates over time.
Looking for a few stocks to help you get started? Here's three suggestions for you to consider. The Fool also has a great place where you can learn more about which IRA is right for you.
A wealth-building workhorse
With each passing year, the world's population gets a little bit older, and that trend is expected to continue for decades to come. That fact should ensure that the demand for high-quality healthcare continuously increases over time, which is a great reason to own shares of Johnson & Johnson (NYSE:JNJ).
Johnson & Johnson has become a global healthcare powerhouse, owning more than 250 operating companies that do business around the world. The company holds a leadership position in three main healthcare segments -- medical devices, pharmaceuticals, and consumer healthcare products -- that together are projected to ring up more than $72 billion in total sales this year.
Beyond the favorable long-term demographics, there are plenty of others reasons for investors to love Johnson & Johnson's stock. For one, the company's products stay in demand no matter what's going on in the global economy, which makes J&J's earnings very stable. The company also has a storied history of using its ample financial resources to create shareholder wealth by acquiring new businesses, repurchasing shares, and growing its dividend. In fact, the company's current streak of dividend increases stretches back 54 consecutive years, making Johnson & Johnson truly one of a kind.
Right now, shares are trading for 22 times trailing earnings, which is a slight discount to the S&P 500, and they offer up a 2.7% yield. I'd argue that's a fair price to pay for a wonderful business, which makes this stock a great choice for your Roth IRA.
Returns you can bank on
The banking sector is currently muddling through tough times given the sluggish economy and low interest rate environment. That's helping to keep bank valuations in check across the board, which makes right now a good time to go bargain hunting for high-quality names. I think Wells Fargo (NYSE:WFC) is a great stock to buy right now.
Wells Fargo has methodically grown into one of the largest banks in the U.S., counting almost $2 trillion in total assets under its belt. The company has done a great job of becoming an entrenched part of its customers' lives, which entices them to stick around for the long term.
One reason I favor Wells Fargo over other big banks is that the company is one of the lowest-cost operators. Last quarter, Wells' efficiency ratio clocked in at 58.1%, which is a number few other banks can match. That low rate helps the company price its products competitively, but still produce high enough profits to show good return on equity.
With bank stocks out of favor with investors, Wells Fargo's shares are currently trading for less than 13 times trailing earnings, which has pushed the company's dividend yield up above 3.1%. That's a market-beating yield, and with analyst's forecasting greater than 8% earnings-per-share growth over the next five years, I think this is a great time to pick up a few shares of this longtime winner.
A future dividend aristocrat
With a current dividend yield of only 0.7%, you might be scratching your head as to why I'm including Visa (NYSE:V) on this list. Given the puny payout, you might think it makes sense to hold Visa in a regular brokerage account and pay the taxes instead of putting it in a Roth, but hear me out.
My logic isn't based on saving money on taxes today, but instead on sliming down your tax bill when you retire. I'm a big believer that Visa's revenue, profits, and dividend will grow at above-average rates for decades to come, so investors who buy today stand a great chance of earnings huge dividend checks and high capital appreciation from Visa in a few decades' time. If that proves to be true, then taking action now to shelter those future dividends and capital gains from taxes might make sense.
Why do I think Visa is primed for growth? My long-term thesis is simple. Right now, 85% of global transactions occur using cash or check, but I'm a firm believer that that number will slowly come down as consumers and merchants worldwide embrace the benefits of using credit and debit cards. That should provide Visa with a long tail of revenue growth opportunities. Mix in the company's scalable business model and habit of buying back shares, and I think EPS is primed for double-digit growth for years to come.
Over the past five years, Visa has grown its modest dividend at an annual compound rate of 29%, and yet the dividend only consumes about 23% of Visa's profits. That gives the company ample room to keep growing its dividend at an above-average rate for years to come, especially since profits are expected to grow by more than 16% annually over the next five years.
Those figures give me high confidence that Visa will one day turn into a dividend aristocrat, which makes this company an ideal choice for your Roth IRA.
Brian Feroldi owns shares of Visa and Wells Fargo. Like this article? Follow him on Twitter where he goes by the handle @Longtermmindset or connect with him on LinkedIn to see more articles like this.
The Motley Fool owns shares of and recommends Johnson and Johnson, Visa, and Wells Fargo. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.