If you've opened an IRA, you've taken one of the most important steps toward building the retirement of your dreams -- but it's important to know what to do with that IRA. Choosing investments to hold in an IRA is the most intimidating part of the process for many people, but it doesn't need to be. There's a general type of stock that works best in an IRA, and three great examples are Procter & Gamble (NYSE:PG), Realty Income (NYSE:O), and ExxonMobil (NYSE:XOM).
Here's what makes each of these a great IRA stock, along with some tips on how to find more of your own.
What makes a great IRA stock?
The ultimate goal when choosing stocks for your IRA is to pick companies that will be great investments from now until you retire -- and preferably throughout your retirement years.
What should you look for in a "forever" stock? First, the business should be relatively simple, easy to understand, and somewhat recession-proof. Most companies will be negatively affected by a recession, but those that do better during the tough times tend to do better over the long run as well.
Next, the company must operate in an industry that will be around 100 years from now. For example, 100 years from now people will still need groceries, medical care, and secure places to put their money. Will they still need tablet computers? Maybe, but maybe not. Finally, you want to look for companies with a certain competitive advantage that should help them withstand the test of time.
If a company meets all of these criteria, it could be a good candidate for your IRA.
Brand power and a huge footprint
Two of the best advantages a company can have are strong brand names and a diverse global footprint. Procter & Gamble has a whole lot of both.
Strong brand names give a company pricing power. Consumers are willing to pay a premium for brands they know and trust, which is why, say, Gillette razors cost more than generic ones. This allows the company to produce higher margins and gives it a better ability to make money even in tough times.
In addition to Gillette, Proctor & Gamble has a diverse assortment of brand names, including Head & Shoulders, Old Spice, CoverGirl, Pampers, Bounty, Febreze, Tide, Oral-B, and many more.
Geographical diversity means the company is not too vulnerable to the economic conditions of any one region, or to currency fluctuations. Sure, Procter & Gamble's earnings suffered a bit due to currency headwinds, but it was a minor speed bump from a long-term perspective.
Procter & Gamble operates in 180 countries, and no single region accounts for the majority of the company's sales. In other words, if there is an economic crash in one part of the world, the majority of Procter & Gamble's revenue would be safe.
A business model that works in good times and bad
Perhaps the best example of a business model that works in good times and bad is commercial real estate. One of the best real estate investment trusts (REITs) specializing in commercial properties is Realty Income Corp.
Unlike residential tenants, commercial tenants sign long-term leases of 15 to 20 years or more, usually with annual rent increases built in. They also pay most of the variable expenses, such as property taxes, insurance, and building maintenance. Altogether, this makes for a growing, predictable income stream with very little turnover for Realty Income.
Realty Income's strength is its size (about 4,300 properties), which means its management expenses and other costs are lower than those of smaller companies, and the company is not too dependent on any single property or tenant. For example, if a REIT owns 50 properties, unexpectedly losing a tenant could seriously impact earnings. However, with 4,300 properties, Realty Income would barely notice. And given the company's occupancy rate of more than 98%, it's a safe bet that most of its properties will be full for at least another few years.
For a more thorough description of Realty Income and why it works so well as an IRA investment, read this other recent article.
Economies of scale can work great in your IRA
ExxonMobil is the largest publicly owned integrated oil company, which gives it a big advantage over lesser rivals, especially with the price of oil at depressed levels. The term "economies of scale" refers to the cost advantages companies experience due to their size, and there is no better way to take advantage of this principle than with the largest company in its industry.
In addition to its size, ExxonMobil has more access to capital than its peers, as my colleague Matt DiLallo pointed out recently. The company actually has a better credit rating that the U.S. government, which it recently used to issue $8 billion in new debt. Not only does this give the company the ability to acquire rivals at a discount during tough times, but it provides the financial flexibility to undertake pretty much any venture it wants to, no matter what the market or economy is doing.
Finding your own
These three stocks are simply meant to be good examples; hundreds of other stocks could make great additions to your IRA. Just apply the criteria I discussed here to any stock you're considering. Can you explain its business in a sentence or two? Will it still be needed in 100 years? And, most importantly, what sets it apart from its competition?
So long as you follow this formula, the majority of the stocks you choose for your IRA will serve you well for decades to come, no matter what the rest of the market is doing.