Where to invest a roth IRA?

[david rigby]

Get one of these: http://www.irs.gov/pub/irs-pdf/p590.pdf

1-800-TAX-FORM.

See page 58.

[Guest Exivate]

www.vanguard.com

[John G]

You are to be commended to be thinking about investing and your options at your age. And commended more for the success in accumulating significant assets.

Many questions - let me address a few.

First, you have not given any indication of your current income or filing status. You need to satisfy the income and filing status guidelines to consider a 401 to IRA to Roth conversion. If you do meet these requirements, both this year and the next, then you could do 1/2 conversion in each year. However, qualifying in one year does not mean you will automatically qualify in the next.

Second, you said " I'm looking for the most aggressive investment for my Roth IRA that I can find. My goal is to earn as much as possible in the Roth IRA, since I won't be paying taxes on the gains."

What do you consider aggressive and why do you think you need to be aggressive to reach your goals?

Part I - What is aggressive? For planning purposes, a lot of folks use a predicted average 10% annual return. Using your $31K and age 32.... these assets would grow to about 1/2 million by age 60, or one million by age 67 if you averaged just 10% a year. That is growth of just the $31k, no additional contributions. Now add your likely contributions over the next 30 years... I don't know what the assumptions would be but you could probably equal the accumulation of 1/2 to 1 million if you kept contributing. While these future amounts do not take into account inflation, you would have substantial retirement assets before counting any pension or social security income.

Part II - Is 10% reasonable? I think the answer is yes. I would actually argue that 10% is not at all aggressive. I would expect you to average 10% if you had a mix of 80% stocks and 20% bonds with the stocks slightly biased toward growth (less railroads and utilities, more technology or medical). I am not talking betting the farm on biotech, internet, dot.com or any gadget investments.

I would agree with you on many points, including that you have a long time to go before you will be drawing down upon your IRA assets. But, when you ask "where to invest" and follow-up with a comment on being aggressive, I get a little concerned. Perhaps is a semantic issue. I would not classify owning index funds as being overly aggressive for someone age 32. If you understand the general concepts of stock market investing and have a long term view, I would be supportive of owning a modest portfolio of individual stocks... but you would need to commit a lot more time to research, analysis and tracking of individual stocks.

Age 59 1/2 - this is a regulatory distinction regarding IRAs. It is rarely a significant date for individuals. Some folks retire earlier. Some continue working for much longer.... because they enjoy their jobs, need the money, have few non-work hobbies, etc. If you have been reading other posts on this message board, you probably realize that your investing life does not stop at the age you retire. Someone who stops working at age 59 1/2 may live for another 30 years. If you get extremely cautious with your retirement assets, you may not stay ahead of inflation.

I would like to know a little more about you before posting some suggestions. I am hoping you can post a little about your approximate income, marital status, tax filing status, academic training and investment experience.

(My daughter is getting married in less than a week, but I may be able to post again when I am not running around on chores!)

[Guest andyandy]

Thanks to each of you for your replies.

John, congratulations to your daughter! I hope the wedding is wonderful!

To answer a few of your questions about my current status, I am married and will be filing jointly. Our 2004 AGI will be be about $75,000. As far as academic training, I have a bachelors degree (in Accounting) and an MBA.

My parents taught me the value of saving, so I've always saved as much as I could. My 401(k) with my current employer (which is at Vanguard) is a little over $21,000. Around 50% of it is in small cap stocks funds, 30% in an index fund, 10% in a foreign equity fund, and 10% in my company (DuPont) stock fund. I'm currently saving 15% of my salary in my 401(k).

The 401(k) with my former employer (the $31,000 that I mentioned in my first post) is invested at Securian in roughly the same asset mix.

However, I've not done much investing outside of my 401(k)...I've done very little investing in individual stocks (just a little in my former employer's stock through the employee stock purchase plan).

For the Roth, should I take the time to educate myself on which stocks to invest in, or should I continue investing in mutual funds? If I go with investing in individual stocks, can I use Ameritrade? Or some other broker? Any recommendations? Can a broker do the conversion process from 401(k) to traditional IRA to Roth IRA?

Also, are there any other options besides mutual funds or individual stocks for a Roth IRA? I'd like to think through all of the possibilities before I proceed.

My thought is that during retirement, depending on what the tax brackets are, I can minimize my tax burden by taking money from my current employer's 401(k) up to one of the lower tax brackets and then take money from the Roth IRA.

Oh, one last thing...my wife and I recently launched a small home-based business (care packages for college students). When I say small, I mean very small. However, our goal is that in around 5 years, we could grow it to the point where I could stay home. If the business grows and brings me home, I'd like to have my retirement assets in place at that time (although I definitely won't withdraw any until at least age 59 1/2). I'm not saying I would stop contibuting to my retirement at that time...I have no idea how well the business will do or what my retirement options will be then.

Any thoughts or ideas are greatly appreciated!

[John G]

Married and will be filing jointly. 2004 AGI about $75,000, bachelors degree (in Accounting) and an MBA.

If these are your circumstances for 2004 and 2005, you are eligible to start Roths or do a one step or two step conversion. The benefits of conversion are complicated and are often based upon weak assumptions about future income, tax rates, and even the state in which you will live in future years and its tax policy.

My parents taught me the value of saving, so I've always saved as much as I could. My 401(k) with my current employer (which is at Vanguard) is a little over $21,000. Around 50% of it is in small cap stocks funds, 30% in an index fund, 10% in a foreign equity fund, and 10% in my company (DuPont) stock fund. I'm currently saving 15% of my salary in my 401(k).

Sounds like this 21 is a separate pool of retirement assets. The mix of funds looks ok, I am assuming that these are all in low expense Vaguard options.

The 401(k) with my former employer (the $31,000 that I mentioned in my first post) is invested at Securian in roughly the same asset mix.

I don't know anything about Securian. You need to read the 401k documents from the prior employer to determine the circumstances under which you can do a rollover. You also should review the performance and fees/expenses of Securian.

However, I've not done much investing outside of my 401(k)...I've done very little investing in individual stocks (just a little in my former employer's stock through the employee stock purchase plan).

For the Roth, should I take the time to educate myself on which stocks to invest in, or should I continue investing in mutual funds?

Investing in individual stocks takes more time for research and tracking. You also have the problem of a narrow base if you only hold a few stocks - the diversification issue. The third issue is how well do you tolerate ups and downs - some folks prefer the mutual fund appoach. Mutual funds give you "instant" diversification and you can bias your portfolio towards growth or more conservatively towards bonds or dividend paying stocks, while keeping your research and tracking time committment manageable. The two paths (funds vs individual investments) can both achieve good results. Which you choose is more related to your interests, available time and more control vs simplicity. If you are raising a family and starting a business, I might put off the individual investing for a while.

If I go with investing in individual stocks, can I use Ameritrade? Or some other broker? Any recommendations? Can a broker do the conversion process from 401(k) to traditional IRA to Roth IRA?

There are many choices for brokerages, and many of the internet based (or internet supporting) ones are good. Etrade, Ameritrade, ScottTrade, TD Waterhouse, Schwab, etc all have plusses and drawbacks. If you live in a city that any offices related to these, that might make a difference.

Also, are there any other options besides mutual funds or individual stocks for a Roth IRA? I'd like to think through all of the possibilities before I proceed.

While there are some other options, I think you should restrict your choice to either funds or individual investments until you know a lot more about investing.

My thought is that during retirement, depending on what the tax brackets are, I can minimize my tax burden by taking money from my current employer's 401(k) up to one of the lower tax brackets and then take money from the Roth IRA.

You can probably convert to a Roth this year or next given your filing status and income. BUT, it is not clear that you should convert to a Roth. Do not assume that because you can convert that it is a great idea. In many cases, both scenarios are similiar. It is much better to do a conversion in a year when your income is very low such as if you wife stops working to raise a family. It is better to do a conversion if you know that your income is likely to go much higher in the future (when you become a partner in a law firm) and your future tax rates are going to be much higher. Conversion might make sense if you are looking to avoid minimum annual withdrawals. Often, a hybrid stategy (partial conversion) gives you many of the benefits without the killer initial tax impact. Do NOT do a conversion without the benefits of you accountant or tax advisors advice.

Oh, one last thing...my wife and I recently launched a small home-based business...

Good for you. You will learn a lot. If this idea does not pan out, try something else. Owning a business increases your chances to make some serious money.

You did not use the word "aggressive" in your second post. That is probably a good thing. A lot of successful investing is grinding out a decent return each year and letting time be your ally in building assets.

[dh003i]

Adding a little bit to what previous posters have said. Regarding investing in individual stocks, it takes considerable time and research. If you want superior results, you have to engage in superior research/work from a position of superior knowledge. You also have to be willing to resist the latest thing (currently, REITs are pretty hot stuff, even though the real-estate market is in an enormous bubble). I suggest books by Graham and Dodd and Philip Fisher as a basis for how to find good companies.

You should also remember that the 10% assumption is just that: an assumption. There's no law saying that the stock market has to go up 10% each year (in fact, without inflation, the stock market as a whole would rarely have such increases in "value"). And you have to consider the effects of "inflation". Because of this, as I'll explain, I'd recommend considering keeping some portion of your portfolio in precious metals (gold, silver). If rapid inflation occurs, or if hyperinflation occurs, if a great depression occurs, etc, the value of the dollar (and other forms of fiat-money) will plummet, and the stock-market will crash. However, gold and silver have retained their value for thousands of years through the worst disasters.

When John says inflation, he's probably talking about the CPI, like most people are when they think of inflation. However, the CPI is heavily managed, and really only measures one result of inflation (as classically defined): increases in consumer-prices. Another result of inflation is increases in producer-prices, and increases in the stock-market. Without inflation (the increasing of the monetary supply, by printing out money) the price of all goods would tend to decline over time. Most of the time, when you hear about inflation, what you're really hearing about is the results of inflation; a better measure of inflation is the money supply.

To see the effects of inflation, consider the fact that a nickel would buy a large lunch 50 years ago; today, there isn't anything I can think of that you can get for a nickel. On the contrary, in the 1920s, an ounce of gold bought a nice suite, and today it still does. Thus, aside from thinking about investing aggressively, you should also be thinking about preserving the value of your wealth. Gold is real money that never depreciates over the long-run in value. Dollar bills always do.

You should also remember that saving money and investing money are not the same thing. Investment is a form of consumption. You are using your money to buy a stock, bond, mutual fund, REIT, etc hoping that the value of that will increase. However, it is no-longer "money" that you own -- but a stock, bond, mutual fund, REIT, etc. Of course, over the past 20 years or so, leaving your money in cash would have resulted in it depreciating in value due to inflation, while investing would have allowed it to better keep up with inflation; but again, there's no law of economics that says the stock market, bond market, or real-estate market has to go up.

Gold and silver are not without risks, though they do hold their value over the long run. These precious metals are highly volatile in the short-run, and there is much interference from Central Banks (which often take measures to try to artificially keep the price of gold low). Furthermore, precisely because of the wealth-preserving power of these metals, there are other risks: confiscation. In 1933, FDR ordered that all gold (aside from collectors coins) be confiscated from citizens. Leaving aside potential constitutional arguments against this, it is obvious that if such could happen in 1933, it can happen again in the future.

Nor are collector's coins immune: simply because FDR didn't have them confiscated doesn't mean that they aren't confiscateable. Collectors coins are not a normal investment in gold, and are valued significantly above their gold-weight. Collector's coins, however, have been an interestingly impressive investment vehicle since 1970 (since 1970, the CU3000 has averaged 9.6% a year, while the Dow has averaged 8%), and the economics of it suggests they'll continue to be so (because there is never going to be an increase in the supply of a coin minted in 1876). Collector's coins enjoy tax-deferred status, so when their value increases, you owe nothing (until and if you sell them). Investing in collector's coins is also a skill (just like investing in the stock-market), and unless one knows the field, one should not do it (just as with stocks, there are also professionals to handle this).

PS: Because of the tax-advantage that rare-investment coins enjoy, they should never be bought within a retirement plan. They already appreciate in value tax-deferred. This is just an application of a rule: you don't place tax-favored investments inside of tax-favored retirement plans, because you're wasting the tax-advantage of the retirement plan.

[Guest andyandy]

My mom (who happens to be a CPA and a CFP) is recommending that I roll the money to a Roth IRA in an equity-indexed annuity. Specifically the Amerus Multi-Choice 10 annuity.

I did a google search to see what I could find out about it and it looks pretty good. You can't lose money in a year when the S&P does poorly and the cap is a 15% return if the S&P does well. I'm not afraid to take a risk (fluctuation doesn't bother me). However, if I don't have to risk a loss of principal and can still have good reward potential, that would be the best of both worlds!

Here's the site I went to from Google:

http://www.douglasscapital.com/MultiChoice10.htm

Does anyone have any experience with this type of investment? Would you recommend it for someone in my situation (as I described in an earlier post)? Where can I get more information on the web about the Amerus Multi-Choice 10 annuity?

I always trust Mom to have my best interests in mind, but I figure it couldn't hurt to get a second opinion this time!

Thanks again for any words of wisdom!

[dh003i]

andyandy,

I'm sure your mom does have your best interests at heart; however, I would have to strongly disagree (and I suspect that most other posters here, such as John G., appleby, and mbozek would agree, based on past posts).

Short answer: Absolutely not!

Why?

Reason 1: Most annuities allow tax-deferred growth (you can't take a deduction on the contrib, and the money is taxed at normal income tax brackets when you take it out).

You should never place one tax-advantaged investment inside of a tax-advantaged plan. When you do that, you're wasting the benefit of the tax-advantage! You gain nothing by investing in something that's

Reason 2: Nothing in this world is free. Annuities have to go through some fancy hoops to be considered "insurance", thus get tax-deferred growth. They have to provide some kind of a "death benefit". For this, you are charged some kind of mortality fee (which is a percentage). This adds on top of the normal expense ratio, making these more expensive to hold. The result is that your net return is lowered.

Reason 3: You shouldn't be against yourself. If you're going to be paying someone money so that they will cover the downsides of your investments, and limit your own potential upside, what you're really saying is that you don't have confidence in your own investment. In that case, you shouldn't be invested in whatever it is you don't have confidence in.

Reason 4: Retirement plans are long-term deals. You should be in this thing for 40, 50 years. Thus, you should not be particularly concerned with yearly fluctuations.

If you are concerned about the stability of your portfolio, you should diversify among things that have little or no correlation to one-another: stocks, bonds, precious metals, and real-estate, for example, are things that do not correlate much with eachother.

Annuities should not be something you bother with, unless you've maxed out other retirement options (401ks, 403bs, Roth IRA's). Only then should you consider them. And you should be considering them as separate from (an in addition to, not in replacement of) the better retirement plans.

There is one particularly useful function an annuity serves: when you retire, you can invest in an annuity where you make one contribution, and then they pay you a fixed amount of money (preferrably indexed for inflation) every year for the rest of your life. You can use this to allow yourself to obtain a baseline standard of living. If you live to 120, you got the good end of the bargain (money-wise); if you die 1 year after you get this annuity, the company you bought it from got the good end of the bargain (money-wise). For yourself, you have to consider if the security you'd be purchasing would be worth the possible price.

[John G]

I know very little about annuities and the specific investment... and since I am on the road (recovering from my daughter's wedding) I just glanced at the web reference.

My general reaction is that I don't think this approach is all that great. There are many years when the stock market goes up over 15% (see following comment on 7% vs 15%) and you won't participate in any of the upside beyond 15%. You are a very young guy. You should be thinking about investing over a very long term. Good years out number negative years by about 5:1 and the best years are huge (about 2 in ten years the gain is above $35% for funds with a slight bias towards growth). I think if you understood more about investments and the risk/rewards you might not be excited about the idea your mom has suggested.

The web reference is pretty confusing. It looks like there are multiple catagories. Did I read it right that some of these have 2.5% and 3.5% annual asset fees? If true, that is really ugly and would be a reason to deep six the idea. You may not be understanding the "caps" and how they apply - it sure looked to me like the 15% referred to a 2 year period, because there was a reference to 7% being the max cap for a 1 year equity. If the max is 15% in two years or 7% in one year - then you are talking ugly ugly ugly. Did you note there are also early withdrawal charges? Thats another negative. Earnings are credited at the end of the year or end of two years? That clips more from the potential return because you are not compounding for the full period. Another negative - an inexcuseable approach that it sure looks to me like they are just trying to slip by consumers.

Keep in mind that I am no big fan of annuities and don't like complicated insurance products that imbed all sorts of extra features.... but your web reference had what you might call "double speak". It is hard to know what you are actually getting.

I am against extra charges, limitations on switching, high annual fees, and all sorts of shell/pea games aimed at selling your "peace of mind" but giving you meager performance. You mom is suggesting a pretty awful Roth IRA selection.

It sounds to me like you need to devote some time to understanding investments. If you would devote 2 hours a month to reading books or magazines you would have a good start. You might want to see if there is a local college offering classes. Some of the websites for brokers and mutual funds have good tutorials. You might also find a local investment club useful. There are many ways to learn - find the approach that works best for you. One of the big trends in investing is "self help". The number of options where someone does all your thinking for you are declining and getting more expensive, while the number of do-it-yourself options are both growing and, with the emergence of the internet,

getting much cheaper. The crux of this is that more people need to learn how to manage their own money and make their own investment decisions. Those that do will benefit substantially from the huge array of choices.

If you feel the primary issue in investing is never taking a loss, then your concept of risk and reward is way out of balance. The web reference investment is like buying a 2005 Lexus that only goes 10 mph. You are embarking of a multi-decade trip and that car is not going to get you where you need to go. I am not encouraging you to take on extraordinary risks and roll the dice with each investment. But someone who will be investing for many decades needs to understand the difference between short term risks and long term results.

[joel]

andyandy Posted: Oct 29 2004, 04:13 PM

Registered User

Posts: 3

Joined: 22-October 04

My mom (who happens to be a CPA and a CFP) is recommending that I roll the money to a Roth IRA in an equity-indexed annuity. Specifically the Amerus Multi-Choice 10 annuity.

=====================================================

This product is distributed by salespeople be they CPAs, CFPs, etc. I assme your mother is licensed by a broker/dealer that has a sales agreement with the distributor of the "Amerus MultiChoice 10 annuity". If this assumption is accurate your mother will be receiving a commission for "selling" you this annuity.

I for one would like your mother, as a professional in this business, to participate in this thread and tell us why she recommends an annuity for pre-tax investing. If we are missing something it behooves her in your best interests to set the record straight.

Peace and Hope,

Joel L. Frank

[John G]

A good idea Joel. The web reference looks like it was supposed to be a summary and it is not easy to understand a complex set of options from a very simple outline.

[John G]

UGLY UGLY UGLY

I drove accross the country to get back to Colorado and had some time to think about the fund that limits upside but erases negative years. I have now set up a spreadsheet to evaluate these kinds of proposals. I can change the assumptions about negative years, install a mimum performance, change the max earnings percent, substitute other data sets, and compare proposals against the classic buy and hold strategy.

I currently set up the model with the 69 year history of ICA, a loaded mutual fund that began in 1934. I could readily load the S&P500 or DOW data, but I thought this fund represented a slight bias towards large cap growth stocks which I believe is appropriate for long term Roth/IRA investing. This fund averaged 12.7% over that time period and the performance included 12 down years and 57 up years. Three times they recorded back to back negative years. Data from this fund is used for illustrative purposes only, I specifically do NOT recommend it. (past performance is not indicator..., it is a loaded fund)

Preliminary results:

Putting a limit on your upside potential is definitely a fools wager. Accepting a 15% cap in performance affects 36 years using ICA data, over half of the years! Over the 69 years, the classic buy and hold approach produces 8 times more earnings then an approach with a 15% ceiling and no down years. The CB&H is 4 times better than a product that offers a minimum of 3% annual but imposes a 15% annual cap on earnings.

Now subtract fees, sales commissions, termination charges, and annual expenses..... ugly, ugly, ugly.

The benefit to the company offering the "safety" is huge. The investor gives up a tremendous amount of earnings for assurances of no negative years. I ran about 20 different scenarios and found none that were better for the investor than the long term common stock porfolio. You give up a massive amount of money for "peace of mind".

[Guest gstipps4]

John G, could you make available the spreadsheet that you used in making this analysis of Equity Indexed Annunities. I attend many senior seminars and EIAs are one of the favorite topics presented to senior citizens to protect their retirement dollars. I am a leader of a retirement & estate planning study group and we have been discussing EIAs in our meetings. I do not like annunities in general because of all of their expenses and the inability to do good estate planning. In particular, the lack of being able to stretch out the distributions for your heirs.

Glen

[dh003i]

That's kind of what I would figure off-hand. If you're going to be investing in something, you invest in it because you think its a winner. If you think you need someone to cover down-years, you don't have confidence in your investment.

We must remember however that past results are no guarantee of future results. Simply because the stock-market returned 10% over the past decades -- with most of the gain concentrated -- doesn't mean that it will continue to do that over the next decades. I have a very pessimistic outlook the future of the stock-market, due to concerns about inflation and hyperinflation; Warren Buffet expects much less impressiver returns in the future than we've had, also.

Now, does the index-annuity "protected against downside" hold up any better under a hyperinflationary environment in which the stock-market will be in disarray and stocks will do poorly? No. In a severe economic storm, it will be impossible for these insurance companies to cover your downside. For one thing, the market will be doing so poorly that it'll make it impossible for them to cover your downside; for another, they won't be making enough money to make good on their guarantee.

Insurance companies can only make good on their claims if they have the money to do so. There is no such thing as an absolute guarantee. Really, what you get in these kinds of annuities is a reasonable assurance that in an economic environment that is overall healty, the insurance companies will cover the down years; they can do this because of the profits they've taken from the up-years. However, in an economic environment that is overall bad, it will be impossible for them to cover your down years.

[Guest andyandy]

Thank you so much to all of you for your enlightening posts! I aplogize for taking to long to respond....

After reading the "Ugly, Ugly, Ugly" post from John, I took the time to do a similar analysis. I concluded that you are correct. John, I too would like to see your spreadsheet, if you would be willing to share it.

Although I know my mom has the best intentions and wants the best for me, I think her advice is not the best for me in this case. I "got the ball rolling" to roll my former employer's 401(k) to a traditional IRA at Vanguard. Once it's there, I plan to convert it to a Roth IRA (1/2 in 2004 and 1/2 in 2005) and pick a few good mutual funds.

Thanks again!

Andy

[dh003i]

Glad we could help you, and glad that you decided not to invest in an index-annuity.

[John G]

I saw your requests - about the model. Right now I am immersed in a series of investments involving crude oil tanker companies. If you are interested, you might want to check out FRO and SFL... no advice given, but the 2 year chart sure looks nice.

I did not design the model for outside users, so let me look at it some more and think about what I can do. The model is nothing fancy, just a 69 year stream of historic results and a set of simple options to toggle the max allowed, override on negative results, set a minimum performance and a couple of columns to do the resulting compounding.

[John G]

Qstipps, Below is the time series for the ICA mutual fund, 1934-2002. You don't need to do very sophisticated analysis to note the large number of years where the return exceeded 15% and the few negative years. To build a spreadsheet, you need to be able to write formulas such as: =IF(B4<1,$I$3,G4) to check for a negative result and determine a substitute value. Then just compound the series and compare the new series to the unadjusted series.

The web reference below gives you a 50 year time series for S&P500 which shows 13 negative years (worse -26%) and 37 up years (best +52%) and a 50 year annualized return of 10.96% - and it is unclear if that includes dividends. Nearly half of all years exceeded the 15% gain (24 observations) that would have been the cutoff mentioned at the begining of this thread.

http://www.mutualofamerica.com/articles/Ca...03/SandP500.htm

ICA Mutual Fund Annual Return Including Dividends

1934 18.2

1935 83.1

1936 45.8

1937 -38.5

1938 27.6

1939 0.8

1940 -2.4

1941 -7.4

1942 16.8

1943 32.8

1944 23.3

1945 36.8

1946 -2.4

1947 0.9

1948 0.4

1949 9.4

1950 19.8

1951 17.8

1952 12.2

1953 0.4

1954 56.1

1955 25.4

1956 10.8

1957 -11.9

1958 44.8

1959 14.2

1960 4.5

1961 23.1

1962 -13.2

1963 22.9

1964 16.3

1965 26.9

1966 1

1967 28.9

1968 17

1969 -10.7

1970 2.6

1971 17

1972 15.9

1973 -16.8

1974 -17.9

1975 35.4

1976 29.6

1977 -2.6

1978 14.7

1979 19.2

1980 21.2

1981 0.9

1982 33.8

1983 20.2

1984 6.7

1985 33.4

1986 21.7

1987 5.4

1988 13.3

1989 29.4

1990 0.7

1991 26.5

1992 7

1993 11.6

1994 0.2

1995 30.2

1996 19.3

1997 29.8

1998 22.9

1999 16.6

2000 3.8

2001 -4.6

2002 -14.5