High Freq IRA's: Special Issues

[Guest reg_h2b]

John G's recent response on high turnover funds in an IRA brought to mind a few thoughts.

John's response was--I thought-- thoughtful and correct in that for MOST people focusing on the long term with conventional, diversified investment strategies in an IRA is the best policy.

But if one had a succesful short term strategy [a BIG "IF"!!] from soley a growth perspective there would be no doubt that it would be better in the IRA than in a taxable account.

If we take this ST strategy as a given are there any issues in particular that one should be aware of to maximize such a strategy and to avoid any future problems associated with a BIG IRA?

For Example:

1. Leverage. It's intruiging to me that it is a prohib. trans. to use

your IRA as security for a loan (ie to margin your IRA assets) but you CAN have a very similiar effect by buying a mutual fund that uses leverage. In the last 5 years there are a few funds that have come out that have beta's > 1 using swaps and futures on indices that are very popular with ST traders. Does anyone know any other ways to leverage a ST strategy via an IRA?

2. Big IRA's. What's the biggest IRA anyone has seen or heard of?

Are there any case studies that have gotten over say $100M.

This sounds stupid (and trite) but I'm curious as to how big IRA's have become in the past. Since we no longer have to strategize against the excessive accumulation tax are there any other issues that one should be aware when your IRA get's really big?

[by the way, as a whimsical side note how can IRA's get really big? I can think of three key factors and one special situation:

i) growth through a long stretch out (e.g. an inherited IRA by a grandchild)

ii) rollovers from company plans into conduit IRAs (ie taking advantage of the larger contribution in company plans)

iii)asset performance

iv)special loopholes (big FSC dividends)]

3. Obviously, the designated bene. is an important issue and if the IRA was really that significant compared to the over all estate various qual. trust ideas could be proposed. (With a sharp eye on the trust's affect on a sps rollover and the LE to use for MRDs)

Reg Jones

[John G]

Some responses:

1. I am aware of just a few niches that have produced ST stategies that were successfully used to grow IRA assets. These are very rare. They took work, planning and lots of time. Your not likely to find one if you are looking for an ST, the four examples I can think of were accidentally discovered. None involved leveraging of any kind. ST in these cases meant 2 to 15 weeks, not hours or minutes.

2. Big IRAs, I know of a few that have past 5 million and one past 10 million. Since these involve investors who are around 50 years old, they could become mega assets in the future. None were grown purely at 2k a year, all involved 401K or pension/profit sharing plans that rolled over. I would imagine that big IRAs are still extremely rare. Many of these IRAs are regular rather than Roth. As regular IRAs grow, at some point investors are likely to choose the more favorable long term capital gains of traditional taxable accounts. Remember Roths are both new and conversions have had restricted income levels. It takes a lot of creativity to slip under the income limits if you are a high asset / high income household.

And atleast in my experience, high asset households do some great charitable things with their assets.... I view it is an obligation of those who benefit mightily from capitalism act to address some of the individuals and issues that get overlooked in our short planning horizon.

3. "Excess accumulated tax" - don't count out the cleverness of those in Washington when the so called "budget surplus" vanishes. You still have alt minimum taxes and the estate tax comes back in 10 years. The only real protection for Roth IRA accounts to remain tax free is the proliferation of voters who believed in the Roth promise. Like AARP, there is power in large numbers of participants.

4. Restrictions on leverage are related to the inability of an IRA owner to just pump more money into the account to make up for a leveraged loss. You just won't find any investment that has unlimited liability (like short selling) that will be allowed in an IRA.

The issues you have raised are just not very likely to apply to the average investor. You talk about ST strategy as if it was a sure thing. I have never seen a sure thing in investing in 20 years. Sure things mean big red flags to me.

Investors rarely get burned over the stuff they know, its ussually what they don't even think about: "asian flu", war, mgmt fraud (like with overstated earnings at RAD), unexpected technological competition (genetic solutions trumping pharmaceuticals), tylenol tampering, mgmt miscues (Quaker Oats high cost acquisition of a trendy ice tea maker), top gun bolts, etc. If you have high confidence in a ST strategy, you are likely to concentrate your assets which exposes you to much higher risk of failure.

[Guest reg_h2b]

John-

My point is that IF we assume a successful ST strategy (by which I mean a strategy that yields a higher return but the same risk as compared to a buy and hold strategy):

1. What are some optimization strategies on this ST strategy that are allowed within an IRA?

2. And, IF one is successful at producing large asset returns what are some potential opportunities

and/or problems that this potentially BIG IRA can cause in the future?

As to your response:

You conclude by saying that these issues “are not very likely to apply to the average investor”.

I completely agree and said as much in the intro to my original post (“for MOST people focusing….on the long term… is the best policy”). But for SOME investors (10%, 1%, ?%) these issues MAY be very relevant.

Then you say, “you talk about a ST strategy as if it were a sure thing”. What I actually wrote was IF “one had a successful short term strategy [a BIG “IF”!!] ….”. That’s hardly assuming it’s a “sure thing”. I’m simply assuming it to explore the possible opportunities/problems that it could create in the future. I fully realize that this is a BIG assumption, that it is hard to reach, and that some would even claim (not me!) is impossible to attain.

On the specific responses:

1. “Your not likely to find one…” [re: ST strategy]. I agree: the average investor is not likely to outperform a buy and hold, low–cost, diversified mutual fund portfolio (i.e. index funds). Why? Perhaps because, as you probably know, the average investor tends to BE the market.

However, some traders have found statistically significant strategies that have outperformed “buy & hold” benchmarks. I’m one who looked for and found such a strategy. If that is a “very rare” occurrence; so be it.

2. Big IRA’s. Interesting. Does anyone else have a $ number on the biggest IRA balance? Your mention of charity also brings in intriguing opportunities for tax deferral. At some point this becomes a philosophical question as to how much control you have on “giving” (i.e. taxes/little, charities/some)

3. Futures Tax changes: Fair point. But I don’t see how I can control this “risk” with the possible exception being account “type” diversification (TIRA, RIRA, retail etc.).

4. Leverage: I liked your explanation on WHY true margin is not allowed. On short selling it’s interesting that the mutual fund world has even created index funds with –1 beta’s. I use them daily. So you can get the effect of leverage and/or short selling in an IRA and NOT violate any PT rules.

Thanks for the response.

Reg Jones