Financial Q&A: Retirement savers can benefit from a diversified tax strategy

Q:
What are the best long-term investments to save for retirement: IRA, mutual funds, stocks, bonds, or something else?

P.K., via e-mail

A: Bryan Beatty, a certified financial planner in Vienna, Va., recommends mutual funds that are kept in tax-favored accounts such as a 401(k) or IRA. But one must consider taxes, says Mr. Beatty. They are a constant, yet they are constantly changing. So just as you don't put all your money into one stock, you must diversify your tax strategy to complement a diversified investment strategy.

In that case, you would likely put pretax investments into a 401(k) plan as well after-tax investments into a Roth IRA, he says. Unlike a 401(k), which avoids current taxes but will be taxed upon distribution, a Roth gets no upfront break. The Roth, however, doesn't face any taxes when you withdraw money as long as you are at least 59-1/2 years old and have held the account for five years.

Q:
If investors expect the same cash flow from Companies A and B, but are more confident that Company A's cash flow will be close to expected value, which would have the higher stock price, and why?

O.C., via e-mail

A: Assuming that both companies are in the same type of business, Nick Massey, regional vice president at Householder Group, says that Company A should have the higher stock value due to its higher price/earnings (P/E) ratio.

Alas, in real life it's far from that simple. Even similar companies can carry different P/E ratios due to a variety of circumstances. Are they in different parts of the country? Do earnings come from sales in the United States, internationally, or both? Are profit margins better for one company versus the other?

But a more important question might be which company's stock is the better buy? If Company A's cash flow is more certain, then Company B is probably cheaper, i.e., carrying a lower P/E ratio. Although slightly riskier, Company B's stock could move up even more if they achieve, or even exceed, the expected cash flow. Of course, it could go the other way if Company B did not live up to expectations.

Lastly, Mr. Massey says that all bets are off if the companies are in different businesses and different sectors. That introduces a whole different set of variables. Some sectors naturally carry higher P/E ratios than others (biotech versus steelmakers, for instance). Some sectors may be currently in or out of favor as preferred areas of investment. Under this scenario you really can't compare stock prices of the two companies at all.

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