ROTH Investment Still Worthwhile?

[Guest wobber]

I am thinking about investing for the first time in a ROTH IRA, with the possible maximum of $3,000 for myself, and possibly another $3,000 for my wife. I assume that I would need to do this sometime this month, in order to get in a contribution in for the year 2002, then I could even repeat this next month for the year 2003? Over the last 1-2 years, what has been the average rate of return (or loss) on these investments?

I am really wondering if this would be an investment that would be worthwhile for my particular situation. I am 36 years old, and currently own and operate two small businesses, which I have done for the last 10 years. My adjusted gross income usually runs in the 90k bracket, but has gone well over 100k for several years. I presently own around 350k in commercial real estate, which is 100% debt free, 200k+ in inventory, along with collectables investments of 150k+.

I recently sold off a piece of commercial real estate and made a pretty hefty profit. I used this profit to pay off my only existing debt...my house, which added another 300k to my assets. After this was done, I was still left with 175k cash. I plunked all this money into a monthly renewable bank CD, and after 7 months (at 2.35%) I am still wondering if this was a wise move. I like the security of knowing the money won't lose any principle, but I do hate the low rate of return it is bringing!

I am very conservative in nature, and do feel safe with my present situation. I was thinking though, that a ROTH IRA might be a "plan C," if you may, in providing another alternative source of income, if my assets every got lost/taken, or if I ever decide to sell the businesses and real estate in later life.

My old college buddies, whom invested in stocks and mutual funds, over the past 10 years, are now crying the blues. I feel I took the right path over them, by investing in real estate. Also, while they were leisurely playing many games of golf and trying to keep up with the Jones by acquiring the latest stock market offerings, I was steadily and methodically devoting my time & energy to my businesses. Oh no, I am talking myself out of this IRA again! Am I beyond financial help?

Thank you for any suggestions to my original questions.

[John G]

First, congratulations on your achievements. You are probably in the top 3% of all people your age in terms of networth. That you are wondering about other options is good.

Lots of questions - I will try to answer them.

Timing: You can make the 3K contribution in a Roth now, but you can also make the contribution as late as April 15 of next year. Your choice. Yes, you can also make next year's contribution in January. You need to make sure that the custodian designates the funds to the proper years. Now or January will avoid the IRA department congestion around tax filing time. I assume that your income in both years does not erase you eligibility, that you have "earned income" and that you file a joint return if you are married. (spouse can contribute based upon your earned income too) Since you are successfully running a business, you have other pension/profit share type options in addition to Roth IRAs. I think you should take your accountant to lunch and ask him to tell you about some of your choices.

Average rate of return in last 1-2 years: Not sure the question is relevant and answer would clearly depend upon what type of investments people made. While the stock market has been down for 2+ years, investors in bonds have done very well. CDs have more or less kept pace with inflation. All of this is highly irrelevant to the long term performance of various asset classes in the future. You should not make investment decisions based upon the instant snapshot of market conditions. Neither you nor I can have any certainty where real estate or stock market values will be 1 year later, but we should have a good sense for 20 years down the road. The long term annual rate of return in the stock market is in the 9-12 % with the low end being a balanced portfolio with some bonds and the upper end being a mix biased towards growth. Some people beat that range, some don't.

Worth while? You seem to be doing well with your businesses. You did not say what you were doing about retirement funding or if there were children and college bills in the future. The real estate investments appear to be working and you seem confortable with those decisions. No problem there. However, I would suggest that you should put a third leg on that biz/bldg stool. It looks like you may be fairly dependent upon the local economy and your able bodied skills of running things. Going 100% local in real estate and business may work just fine and lots of folks do this, but I like the idea of a "third leg" to broaden your investments. Funding a Roth for you (and your wife) should probably not put much of a dent in your finances. Also: Have you considered what would happen if you could not run your business or real estate holdings? At some point, you may want to consider some insurance options for life or disability.

"I recently sold off a piece of commercial real estate and made a pretty hefty profit. I used this profit to pay off my only existing debt...my house, which added another 300k to my assets. After this was done, I was still left with 175k cash. I plunked all this money into a monthly renewable bank CD, and after 7 months (at 2.35%) I am still wondering if this was a wise move. I like the security of knowing the money won't lose any principle, but I do hate the low rate of return"...

If this profit shows up in 2002, then you may have erased your eligibility for a Roth.

Also - why do you think paying off all your debt is a great idea? You may be held captive by some old family attitudes about the role of debt and burning the mortgage. Money is "On Sale" right now. I am more interested in buying what is on sale, and if you think about it your probably have the same view. You can get an extremely low interest rate on mortgages. Normally you want to pay off high cost debt like credit cards. I found it interesting that you made comments on being debt free but said nothing about growing your business. You may have a lot of peace of mind about no-debt, but your return on investment (commercial, home, etc) would be better off if your investments were leveraged. I am not talking about going hog wild, but just prudently using debt in your real estate and business areas.

"I am very conservative in nature, and do feel safe with my present situation."

You have been apparently successful in both real estate and running a business. The above comment seems overly cautious for an entrepreneur. Feeling safe often comes at a price of opportunities not taken. The toughest question I have faced in business and consulting is "am I taking the right level of risks?" A zero risk environment is a illusion. But if you strive for ultra low risk you may be settling for weak returns.

"My old college buddies, whom invested in stocks and mutual funds, over the past 10 years, are now crying the blues. I feel I took the right path over them, by investing in real estate. Also, while they were leisurely playing many games of golf and trying to keep up with the Jones by acquiring the latest stock market offerings, I was steadily and methodically devoting my time & energy to my businesses."

If your friends were investing over the past 10 years, they are probably just fine. Two bad years hardly erases a decade of good returns. If they were emersed in dot.coms and IPOs and chasing unrealistic returns..... then perhaps they did not know very much about investing. It sounds like you are starting to craft a myth akin to the tortoise and the hare. I applaud you successes in biz and bldgs, but be careful about self deception about other types of investing. My guess is that you would also be a good investor for exactly the same reasons you have been a good builder of wealth in the other two areas. If you can successfully continue on the path of commercial real estate you will have some nice capital gains down the road. The same would be true in investing. I don't think the issue is choose one... you can do both.

Post again if you want to talk about investment choices.

[Guest wobber]

John, I really appreciate your time, and expertise answering my questions. You are very astute in your assessments of my situation and mindset. You have also brought up some very good points, which I had not even considered. I am sure to have erased my eligibility for a Roth this year, of which I did not even consider!

I do have an innate fear of security type investments, that I will need to wean myself of. I know this comes from my personal lack of knowledge in these areas, along with my unwillingness to trust others with my money. Then, when I factor in the current state of the last couple of years, along with the numerous options available, it is a bit mindboggling for me to come to a clear solution.

[John G]

If you are talking about just 3k per year for the next ten years, you will not even have 10% of your assets in a Roth. I really urge you to talk with your accountant about the various other retirement plan options that anyone who owns a business can develop. You shelter a lot more than 3K... more than 25% of your income, and the income limitations of Roths do not apply.

Initially, I would not expect you to invest your Roth or other retirement account in individual stocks. A much more likely investment would be in an NO LOAD index fund that would hold 300 to 5000 stocks and be extremely low cost.

Perhaps you should check out a couple of general investment books from the library or subscribe to Kiplinger Financial mag.

I am absolutely NOT telling you to shift away from your real estate and business activities. You seem to have a good personality match and are doing well. What I am recommending is that you start developing a third area of building wealth - some kind of tax sheltered retirement account. If you are going to exceed the Roth limits, then you clearly should look into your other options. Over the next few years, you can build up your investment knowledge with a couple of hours of month devoted to reading. The index fund approach is relatively low direct involvement... just looking over periodic statements. That should appeal to you since I would imagine you don't have a lot of "spare time".

[Guest creative investor]

Hi, in my opinion you should go ahead and open a Roth IRA for both you and your wife, if you qualify this year. However, taking into consideration your successful activities in real estate, you should open a self-directed Roth IRA.

My story sounds a little similar to yours concerning investment activities....I've done very well with real estate the past few years. To be specific, I have increased the value of my Roth IRA fifty-fold in less than three years by investing in real estate options. These investments were not risky because I controlled the real estate even though I didn't own and my Roth IRA derived all of the benefits of increased value and appreciation which were realized when it was sold. Best of all, this money was created in a tax-free environment!

I know that there are many financial advisors, some who call themselves experts in the retirement planning field, that don't even know that you can buy or sell real estate options with your Roth IRA. Well, I challenge them to show me where it specifically prohibits this type of investment in IRS Pub. 560.

There are several people in this country who are creating very large profits in their Roth IRA using real estate options. I know one gentleman who turned a $1500 investment into over $220K in less than three years by purchasing an option on a mobile home park. He leased the park from the owner at the same time the option was created and spent the next two years upgrading and increasing the value of the park. When he found a buyer for the park, the option was sold for a large profit.

Sorry for the long post, but I think you can see the benefit of a Roth IRA, especially with your real estate background. You just need to chose the right custodian who is knowledgeable and familiar with creative investments available through your Roth.

If you would like some more information on the type and structure of the real estate deals available, just send me an email.

[John G]

The above post says "To be specific, I have increased the value of my Roth IRA fifty-fold in less than three years ". The BS imbedded in this statement is best illustrated by doing the math:

Investor starts with $1,500 and gets 50x return every three years. After three years $75,000. After 6 years $3.7 million. In 9 years $187 million.... after 15 years this lucky person would have assets of $468 BILLION. Move over Bill Gates. {The "gentlemen" example this clown cites says $1,500 became 220k in three years -- that is 146x... what is another 96x over 50 amongst friends. Even Hillary Clinton never did so well with pork bellies!}

If anyone believes this "get rich quick scheme" send me an email and I will tell you about a great bridge for sale in NYC.

There is nothing magical about options. Technically it is possible to make huge amounts of money with any kind of leveraged investment like an option. Is it likely? Not even remotely.

Guard you wallet. Guard your email. Do not ask for information about this bogus scheme.

[Guest creative investor]

John, thanks for the quick reply. However, your response is way off on this one. You fall into the vast majority of professional financial advisors who have been trained to guide their clients toward traditional investments likes stocks, bonds, etc. Most are very reluctant to recommend real estate options due to a lack of understanding or placing them in the category of stock options.

I am not advocating real estate options for every investor. However, the gentleman who started this post stated that he has been doing very well with real estate in the past. It sounds like he has the ability and knowledge to use real estate options to create wealth. He may already be using them now in his normal business activities. Why couldn't he use them in his Roth IRA to create tax-free profits?

There was no "BS imbedded in my above statement". In October 2000 I found a rundown mobile home park in my local area. I leased the park from the owner and he sold my Roth IRA an option to purchase this park for $2000. The option price was the current value of the property. I spent the next two years cleaning up the park, putting in more mobile homes and increasing the net income. I sold the park in September of this year for a much higher price than the option price. The buyer paid over $160K for the option and then exercised it with the owner. All of the profit from the option went into my Roth IRA. I have the documentation if you don't believe this.

John, these type of deals are done every day by astute investors who understand how to use real estate options in their Roth IRA's. There was very little risk, I controlled the investment from day one. Compare that risk to giving your money to "professional" who invests in stocks, mutual funds, etc. Now, tell me who is controlling your future?

Of course, I can't exponentially increase my money like you stated in the "$468 Billion" statement. But, I can and will do the same type of deal again using a real estate option. I recently found a single family home that was for sale at well below market value. I leased the home from the owner for a monthly payment and my Roth IRA purchased an option to buy it from him. I found a buyer for the home, only problem is that they have to live in it for six months to show rental history in order to qualify for a loan to purchase. Once they purchase, there will be a $20K profit. So, a $500 real estate option will turn into $20K.

John, there's no reason for anyone to "guard their wallets", I am not selling anything. The reason I made the post was to inform this gentleman about a method to increase the value of his Roth IRA using a medium he is already successful with....real estate. I am not a "professional" financial advisor, as a matter of fact, I am a major in the United States Air Force that flies airplanes for a living. My educational background is in business, finance, and real esate. Believe me, I have extensively studied the IRS publications, rulings, etc. to make sure that these type of investments in the Roth are legal. If you find fault in what I'm doing or advocating, it would be greatly appreciated.

If this type of investing is a "bogus scheme" please let me know. I look forward to your reply.

Thanks,

Steve

[John G]

You are presenting a very misleading example of your own investment. There are at least four problems with your dramatic story.

OK, so you found an undervalued property and wrote an option on it. I am very familiar with this type of transaction. It sounds like you got extremely lucky finding an owner who both failed to recognize the potential and was foolish to tie up his real estate for such a long period for so little. In the 1980s, these kinds of options often cost $2,000 every six month to hold a lot. I read many, proposed many and wrote some. So, the first problem with your example is that you rarely can lock up a property for so little for a long time at a very low rate, the example is an outlier of these kinds of transactions.

Second problem is that you fail to account for the time and money spent to upgrade the facility. All funds spent to upgrade the facility reduce the return on investment. The option owner's time also has a value, often expressed in terms of "opportunity cost" or the amount he/she would have made if those hours were directed towards other money making activities. It is highly unlikely that a token amount of money would improve a facility by that much. It would certainly not be a easily found project.

"There was very little risk" - lets see, you were talking about owning real estate and leveraged investments. Very little risk? That is a highly misleading statement. All investments have risk and leverage investments have high risk. The first risk is that your option expires before you can make it attractive and your investment becomes worthless. In my experience the majority of all real estate options expire. Neither you nor the President "control" the economy and certainly not local property values. Understating risk is the third problem I have with your proposal.

Lack of general applicability is the fourth problem I have with your type of investments. Perhaps you swung a great arrangement. It is clearly possible to find some great deals. But, to paraphase a general rule of thumb in real estate, you walk away from 9 possibilities for every one that is worth seriously trying to implement. Less than 1/2 of all deals seriously worth looking at tend to get done. Great deals are rare and take a lot of time and energy to find.

I leave it to the accountants on this web site to evaluate the technical tax/legal issues you have raised.

And... I am not a professional financial advisor. I used to be a economic analyst, computer modeler and troubleshooter and I still keep a hand in these areas. Your presumptions about me are complete wrong as I have invested in a wide range of investments and consulted on everything from IPOs, real estate, spec construction, straddles, hedging, shorting stocks, currency trading, trading and long term equity investing. I don't talk about the unusual stuff here because this is a general forum. I do no fee based business with any party as a financial advisor and I sell no product to the public. All of my business investment and business relationships are conducted entirely with high net worth people that I have known for 15+ years.