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Author: Pooksterish One star, 50 posts Two stars, 250 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 75379  
Subject: IRA capital gains convert to ordinary income!!! Date: 4/12/1998 12:51 PM
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In my research to decide if I should go Roth or not, and convert or not, I uncovered a tid bit I didn't realize. I had already decided to go Roth when I found this out and now I'm more convinced.

In a regular IRA you are converting capital gains (which are taxed at a lower rate) into ordinary income (taxed at a higher rate). When you withdraw from the IRA, the income is taxed as ordinary income even if it comes from capital gains! What a rip off! I guess it's the damn governments way of taking back some of the benefits of IRA's. Maybe they did it because they knew most people wouldn't realize this dirty little secret!

So for those who don't qualify for a Roth or for another reason are better off not in a Roth, they would actually have to figure out if they are better off in a taxable investment rather than in an IRA! Which could be a very difficult calculation since it would involve forcasting the future!

I'm in what seems to be a rare position, which makes it fairly easy to know that a Roth would be best. My future tax rate is likely to be HIGHER than current. When I retire I may very well be in a HIGHER tax bracket since I'm in the 15% bracket now and, with the growth of my investments and the capital gains I'll have to pay later, my income may be pushed into the next bracket. So it makes sense to not take the deduction now and take the money out tax free then.

Did most Fools know this about the conversion of capital gains into ordinary income?

Pooksterish
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Author: silicon One star, 50 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 2754 of 75379
Subject: Re: IRA capital gains convert to ordinary income Date: 4/12/1998 1:47 PM
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<< So for those who don't qualify for a Roth or for another reason are better off not in a Roth, they would actually have to figure out if they are better off in a taxable investment rather than in an IRA! >>

Unless you can hold your stocks until retirement (30+ years in my case) the IRA will win. Unless the cap gains tax is removed, which would change *everything*...

It's hard enough to make these tradeoffs based on current law, but who can say what the law will be 30 years hence?

It's maddening. Sometimes I think the only sensible strategy is to minimize current tax liability.

Will taxes be higher or lower in the future? Are you an optimist or a pessimist? Do you feel lucky punk, well do ya? <g>


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Author: Pooksterish One star, 50 posts Two stars, 250 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 2755 of 75379
Subject: Re: IRA capital gains convert to ordinary income Date: 4/12/1998 2:20 PM
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Yes, it's true!

A person might actually be BETTER off with a taxable account than an IRA!!!

How? If a person,for one reason or another, invests in a traditional IRA instead of a Roth IRA, the withdrawals are taxed at the higher ordinary income rates rather than the capital gains rates. So what is the advantage of investing in a traditional IRA versus a taxable account? Tax free compounding over time. So one would have to calculate which scenario would be better. That would be a damn tough calculation, wouldn't it? But one thing seems certain: if you invest in a taxable account using the long long term buy and hold strategy, (Cash King approach, for instance) you would get tax free compounding anyway. Thus, in this case you are getting the best of both worlds -- tax free compounding AND getting the capital gains tax rate upon withdrawal instead of the ordinary income tax rates!

Ta Da!

What do you think of that!

Pooksterish

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Author: Pooksterish One star, 50 posts Two stars, 250 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 2757 of 75379
Subject: Re: IRA capital gains convert to ordinary income Date: 4/12/1998 2:30 PM
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Quote from Web site: http://www.fairmark.com/IRAs/Roth/taxfeat.htm

Conversion of Capital Gains

Here is a point that is elementary to savvy investors, but
overlooked by a surprising number of people who own IRAs:
earnings you withdraw from an IRA are taxable as ordinary
income. This is true even if the IRA's earnings came from
long-term capital gains. The IRA converts those capital gains into
ordinary income — and causes them to be taxed at a higher rate.
This fact is more significant now than it was a few years ago for
several reasons:


There has been an explosion of investing in recent
years as baby boomers save for retirement.

Much of that investment has moved into the stock
market, which has performed admirably so that many
investors have achieved significant amounts of capital
gains.

The 1997 tax law reduced capital gains rates, making
it more costly when capital gains get converted to
ordinary income.


With an investment strategy that emphasizes long-term capital
gains, it is sometimes possible to do better in a taxable savings
account than an IRA. Of course this doesn't apply to a Roth IRA
if you qualify to take the earnings out tax-free.

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Author: TMFPixy Big gold star, 5000 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 2758 of 75379
Subject: Re: IRA capital gains convert to ordinary income Date: 4/12/1998 3:36 PM
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Greetings, Pooksterish, and welcome.

<<Did most Fools know this about the conversion of capital gains into ordinary income?>>

I can't speak for most Fools, but I certainly hope most readers of this folder do. The point has been made repeatedly that previously untaxed money withdrawn from traditional IRAs are taxed at ordinary income tax rates in effect in the year of withdrawal. I guess you're not a frequent reader here from your surprise at discovering this fact. But I'm certainly glad you did. It will make you a more Foolish investor.

Regards…..Pixy



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Author: TMFPixy Big gold star, 5000 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 2759 of 75379
Subject: Re: IRA capital gains convert to ordinary income Date: 4/12/1998 3:37 PM
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Silicon,

<<Will taxes be higher or lower in the future? Are you an optimist or a pessimist? Do you feel lucky punk, well do ya? <g> >>

Well, Clint, ya get three guesses and none of them count.

Regards…..Pixy




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Author: TMFPixy Big gold star, 5000 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 2760 of 75379
Subject: Re: IRA capital gains convert to ordinary income Date: 4/12/1998 3:39 PM
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Pooksterish ,

<<What do you think of that!>>

LOL. But don't forget that a little knowledge can be a dangerous thing sometimes.

Regards….Pixy



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Author: TMFPixy Big gold star, 5000 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 2761 of 75379
Subject: Re: IRA capital gains convert to ordinary income Date: 4/12/1998 3:41 PM
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Pooksterish,

I certainly hope you asked KAT in Chicagoland for permission before lifting his copyrighted material and posting it here. As a lawyer, he may not take kindly to such pilferage even if I agree with it. If he sues, you get the bill. <g>

Regards….Pixy


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Author: Tiggertoo One star, 50 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 2765 of 75379
Subject: Re: IRA capital gains convert to ordinary income Date: 4/12/1998 5:51 PM
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>>>Did most Fools know this about the conversion of capital gains into
ordinary income?<<<

I guess I don't understand your problem with this. I knew of it, and its true of 401ks and 403bs too. The point is that if you keep your funds in tax advantaged vehicles long enough, you will more than make up for the difference between ordinary income and capital gains.

Like it or not, this is still the best game in town, and to pass it up would be foolish, and it is a lot better than anything we had in the past. I wish I was just starting out with these options, I could retire at 45 and have plenty of money to live on the rest of my life.

Don't discourage people from using this tool, for some it is all they will have.

LOL...TiggerToo

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Author: Pooksterish One star, 50 posts Two stars, 250 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 2768 of 75379
Subject: Re: IRA capital gains convert to ordinary income Date: 4/12/1998 7:12 PM
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Tiggertoo: Don't discourage people from using this tool, for some it is all they will have.

I'm certainly not discouraging people from using IRA's. But people should give much consideration to what is best. And apparently sometimes a taxable account IS better than an IRA, although it would be rare.



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Author: Rayvt Big gold star, 5000 posts Top Favorite Fools Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 2780 of 75379
Subject: Re: IRA capital gains convert to ordinary income Date: 4/13/1998 12:34 PM
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<<It's hard enough to make these tradeoffs based on current law, but who can say what the law will be 30 years hence?>>

I can safely say that the tax laws 30 years from now will be vastly different than today's.

<<It's maddening. Sometimes I
think the only sensible strategy is to minimize current tax liability.>>
Of course! In order to make valid decisions, you must discount the future into today's dollars. And you can't do this if you can't make approximately accurate assessments of the proper discount rate to apply. And this, I would submit, is unknown and unknowable. As you say, "Who can predict the future tax laws."

I think that the _only_ sensible thing to do is minimize the current taxes. And voluntarily paying a tax now, on the fervent hope that you will avoid the equivalent tax in the future seems to be to be the height of "triumph of hope over experience."
Ray

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Author: Rayvt Big gold star, 5000 posts Top Favorite Fools Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 2784 of 75379
Subject: Re: IRA capital gains convert to ordinary income Date: 4/13/1998 1:33 PM
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<<I'm certainly not discouraging people from using IRA's. But people
should give much consideration to what is best. And apparently sometimes
a taxable account IS better than an IRA, although it would be rare.>>

You guys are missing the real point. You need both an IRA and a taxable account. Use a tax-efficient strategy in the taxable, and a high-tax strategy in the IRA. For the first, a DDA with 18-month update period is good. For the latter, use one a Growth strategy, such as UG, Formula90, etc.

Ray

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Author: gmaxwell Big red star, 1000 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 2793 of 75379
Subject: Re: IRA capital gains convert to ordinary income Date: 4/13/1998 9:16 PM
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You guys are missing the real point. You need both an IRA and a taxable account.>>>>

Gotta go with Rayvt on this one ... How do you retire at 45 if all your funds are in an IRA which you can't get for 14 1/2 years??? My brother is 52, has breeched the magic million, but won't take the 10% ding ( on top of regular income taxes). Since his marginal rate is rather *up there*, early retirement is not really a possibility since he would be taxed at super bracket rates.

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Author: KATinChicagoland Three stars, 500 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 2810 of 75379
Subject: Re: IRA capital gains convert to ordinary income Date: 4/14/1998 11:38 AM
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<<I certainly hope you asked KAT in Chicagoland for permission before lifting his copyrighted material and posting it here. As a lawyer, he may not take kindly to such pilferage even if I agree with it. If he sues, you get the bill. <g>>>

Of course I'm pleased to have a limited quote posted here with proper attribution. And I wouldn't think of suing a person who wears a jester's cap.

On the main topic, my own experimentation with spreadsheet projections indicates that it's hard to come up with reasonable assumptions that make a deductible IRA come out worse than a taxable account based on conversion of capital gain into ordinary income (assuming no penalties on withdrawal, etc.). The benefit of deferral generally outweighs the disadvantage of converting capital gain into ordinary income.

But it's not hard to project a taxable account doing better than a nondeductible (non-Roth) IRA. If you assume a buy-and-hold strategy with low dividends and only a small amount of turnover, you can get a noticeable advantage in the taxable account.

Before the middle of last year, this was an issue for only those investors in the 31% tax bracket or higher, and not a terribly significant issue until you reached the 36% bracket. But now that capital gains rates are lower it affects everyone. Food for thought.

KAT in Chicagoland
http://www.fairmark.com
Tax Guide for Investors
Includes a complete guide to Roth IRAs

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Author: Tiggertoo One star, 50 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 2814 of 75379
Subject: Re: IRA capital gains convert to ordinary income Date: 4/14/1998 2:24 PM
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>>>You guys are missing the real point. You need both an IRA and a taxable account.>>>>

Gotta go with Rayvt on this one ... How do you retire at 45 if all your funds are in an IRA which you can't get for 14 1/2 years??? My brother is 52, has breeched the magic million, but won't take the 10% ding ( on top of regular income taxes). Since his marginal rate is rather *up there*, early retirement is not really a possibility since he would be taxed at super bracket rates<<<

All this points out is that you have to have good goals and objectives to get where you are going. No matter how savy or smart you are, if you are using the wrong road map, you will not get to where you want to go.

The problem is for some people, it will be too late by the time they figure it out, for others, they may never know it.

Sometimes it does help to get professional advice to look at things a little differently.

TTFN...TiggerToo

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Author: TMFPixy Big gold star, 5000 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 2822 of 75379
Subject: Re: IRA capital gains convert to ordinary income Date: 4/14/1998 5:19 PM
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KAT,

<<And I wouldn't think of suing a person who wears a jester's cap.>>

Probably because you know we'd make the suit something out of Alice In Wonderland or The World According to Garp, right? <g>

<< But it's not hard to project a taxable account doing better than a nondeductible (non-Roth) IRA. If you assume a buy-and-hold strategy with low dividends and only a small amount of turnover, you can get a noticeable advantage in the taxable account.

Before the middle of last year, this was an issue for only those investors in the 31% tax bracket or higher, and not a terribly significant issue until you reached the 36% bracket. But now that capital gains rates are lower it affects everyone. Food for thought.>>

As long as the new capitial gains rates continue, it's definitely food for thought. It pertains to both non-deductible traditional IRAs and 401k contributions beyond the employer's maximum match.

Regards…..Pixy




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Author: KATinChicagoland Three stars, 500 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 2833 of 75379
Subject: Re: IRA capital gains convert to ordinary income Date: 4/15/1998 7:08 AM
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I wrote that although a deductible IRA should outperform a taxable (non-IRA) account because it provides deferral, a taxable account can outperform a nondeductible IRA under certain assumptions because the IRA converts capital gain into ordinary income. Pixy responded:

<<As long as the new capitial gains rates continue, it's definitely food for thought. It pertains to both non-deductible traditional IRAs and 401k contributions beyond the employer's maximum match.>>

I think that's a little misleading. Making a 401k contribution beyond the employer match is roughly equivalent from a tax standpoint to making a contribution to a *deductible* IRA, so it shouldn't be equated to a nondeductible IRA. With equivalent investment performance, the 401k should beat the taxable account because of the deferral the 401k provides. The taxable account may win versus the 401k for a different reason, though: many 401k plans offer lousy investment alternatives, so you may feel that it's appropriate to project a higher return for your taxable account. And that higher return, together with the conversion of capital gain into ordinary income, can produce a better overall after-tax return in the taxable account than in the 401k.

KAT in Chicagoland
http://www.fairmark.com
Tax Guide for Investors
Includes the latest information on
Roth IRA technical corrections


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Author: TMFPixy Big gold star, 5000 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 2842 of 75379
Subject: Re: IRA capital gains convert to ordinary income Date: 4/15/1998 9:12 AM
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KAT,

<<I think that's a little misleading. Making a 401k contribution beyond the employer match is roughly equivalent from a tax standpoint to making a contribution to a *deductible* IRA, so it shouldn't be equated to a nondeductible IRA. With equivalent investment performance, the 401k should beat the taxable account because of the deferral the 401k provides. The taxable account may win versus the 401k for a different reason, though: many 401k plans offer lousy investment alternatives, so you may feel that it's appropriate to project a higher return for your taxable account. And that higher return, together with the conversion of capital gain into ordinary income, can produce a better overall after-tax return in the taxable account than in the 401k.>>

Good thing you added that last part because I was all set to pounce all over that statement. For a 401k to be better beyond the maximum match, the plan must offer some halfway decent options. Too many don't, thus making it fairly easy to outperform them in a taxable investment. I always suggest everyone make those comparisons prior to proceeding further within the 401k. The options are just too broad outside those plans not to evaluate the picture very carefully.

Regards……Pixy



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Author: PSUEngineerFool Big funky green star, 20000 posts Top Favorite Fools Top Recommended Fools Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 2847 of 75379
Subject: Re: IRA capital gains convert to ordinary income Date: 4/15/1998 12:09 PM
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TMFPixy says

<<For a 401k to be better beyond the maximum match, the plan must offer some halfway decent options. Too many don't, thus making it fairly easy to outperform them in a taxable investment.>>

I have concerns with this statement. From my observations, most companies offer an index mutual fund. The taxable account needed to try to outperform the index would probably be several stocks (in essence creating your own mutual fund).

You make the assumption that most people will have the time and ability to be able to pick their own stocks and beat the S&P 500 when most professionals of managed mutual funds can't.

I think alot of people are blinded by the high flying tech stocks of this bull market. Today's darlings are Compaq and Dell. If you remember from the 1980's, Zeos and Wang were top computer companies. Zeos was bought out at a low price by Micron and Wang struggled until converting to a computer services company. Of course you can say the computer market is more mature today.

How about investing in established companies instead. You would lose to the S&P 500 with Sears and McDonalds. Everybody bought a Zenith TV when I grew up in the 70's. But I wouldn't want their stock.

Maybe everyone thought Borland would be like Microsoft since they dominated database software in the beginning. Poor choice there.

To beat an S&P 500 index fund in a 401(k), you must
1) do thorough research on each stock
2) constantly keep track of stock and company performance
3) always buy low and sell high
4) hope something unforeseen in the market doesn't screw up the first 3 steps.

Just an opinion.


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Author: TMFPixy Big gold star, 5000 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 2858 of 75379
Subject: Re: IRA capital gains convert to ordinary income Date: 4/15/1998 3:07 PM
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Greetings, PSUEngineerFool, and welcome.

<< From my observations, most companies offer an index mutual fund. The taxable account needed to try to outperform the index would probably be several stocks (in essence creating your own mutual fund).>>

Not really. I'm willing to wager at least 40% of 401k plans do NOT offer an S&P 500 index fund as an option. If you doubt that, just look at the numerous posts in this folder where folks complain about not having that option. In my own firm it wasn't until two years ago we were finally able to browbeat our investment committee into adding one. As I said, far too many have a poor selection. Over the long term, most managed funds come out woefully behind the vanilla index fund.

<<You make the assumption that most people will have the time and ability to be able to pick their own stocks and beat the S&P 500 when most professionals of managed mutual funds can't.>>

No, I don't. Only those who are interested in how their portfolios will do will venture beyond the 401k options or mutual fund environment. Sad ,that, but true. Fortunately, that doesn't pertain to the majority of the readers of this or other folders within Fooldom. It is NOT rocket science, and with but a modicum of knowledge virtually anyone can outperform the vast majority of stock funds out there. We aren't pressured to churn our portfolios chasing the "hot" idea of the moment. In stead, we use a buy and hold strategy that produces much better results. Ever look at the turnover ratio of stock funds? Of the roughly 3540 stock funds started in 1995 or earlier, the median turnover rate is 67%. The highest is 1,378.1%!! It's no wonder they have a hard time performing.

<<To beat an S&P 500 index fund in a 401(k), you must
1) do thorough research on each stock
2) constantly keep track of stock and company performance
3) always buy low and sell high
4) hope something unforeseen in the market doesn't screw up the first 3 steps.>>

Or you could probably just use one the various Dow strategies discussed elsewhere and still fare better than with a fund. Regardless, it's a personal issue. Each of us have to examine what we are willing and able to do. If we are Fools, we'll make the comparisons and go with the one we think will give us the biggest bang for our buck.

Regards…..Pixy



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Author: Tiggertoo One star, 50 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 2893 of 75379
Subject: Re: IRA capital gains convert to ordinary income Date: 4/16/1998 9:49 PM
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Thanks for your comment PSUengineerfool:

>>>You make the assumption that most people will have the time and ability
to be able to pick their own stocks and beat the S&P 500 when most
professionals of managed mutual funds can't.<<<

You have hit on the one major item that bothers me about the gung ho Motley Fool contributors. They make people feel demeaned and debased because they choose to use index funds. Its like "you all are just so stupid, why can't you be smart like me and make all kinds of money by choosing individual stocks."

Some people just don't want to do it, and that does not make them bad, stupid, ignorant, chicken...you get the point.

The Motley Fool has great value to all readers, not just those that want to get into individual stocks. Give us a break?

Everyone talks about the home runs, but you never hear about the duds.

TTFN...TiggerToo

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Author: Factotum Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 2895 of 75379
Subject: Re: IRA capital gains convert to ordinary income Date: 4/17/1998 12:45 AM
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"TiggerToo-Everyone talks about the home runs,but
you never hear about the duds."
You are correct-all the people who put their money
in Vanguard's 500 Index, are out living their life,having fun on their terms, while Vanguards
computer adjusts the fund and makes lots of money
for them. All the people you talk to in the chat groups
don't have anything else to do , or this IS their fun.
Very few will talk about their losses, only their winners.
So-get out of here-go have fun. Trust me.
Factotum-

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Author: JeanDavid Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 2897 of 75379
Subject: Re: IRA capital gains convert to ordinary income Date: 4/17/1998 9:02 AM
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<Everyone talks about the home runs, but you never hear
about the duds.>

OK: Honesty Department:

I bought 380 OXHP 4/11/97 @ $64 1/2
I sold    60 OXHP 9/09/97 @ $75 3/8
I sold   320 OXHP 2/10/98 @ $15 1/2

However, I had around 19 other stocks that did better,
so that my present IRR for the last 12 months is just
slightly under 45% according to Quicken.


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Author: nonqual One star, 50 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 2899 of 75379
Subject: Re: IRA capital gains convert to ordinary income Date: 4/17/1998 12:41 PM
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I am intrigued by this thread. Prior to the '97 changes on capital gains taxes, we tried to maximize opportunities for tax deferred earnings compounding (i.e. non-deductible IRA's and over-the-limit after-tax 401k contributions up to the plan's maximum) since our marginal rate and the capital gains rate were equivalent. [BTW, it might be appropriate to view 401k contributions in three tiers:
-employer matched, pre-tax
-not matched, pre-tax
-not matched, after tax (only benefit is tax deferral
of earnings for which you pay @ ordinary rates)

But I digress, my question is whether any studies/analyses are planned a la the Roth vs IRA work that would provide a framework for evaluating trade-offs in making decisions about the capital gains vs ordinary income issues i.e. while it seems intuitively obvious that paying lower capital gains taxes as you go may be more economical than paying taxes at the full marginal rate later (presuming no post retirement reduction in marginal rates), how do the various assumptions (i.e. investment horizon, dividend yield, price appreciation, turnover frequency, etc. say for the FF and for an index fund) affect how large an advantage one approach has over the other?

P.S. I tend to agree with PSUEngineerFool and others that one's ability to better index fund returns is a function of the individual's willingness to devote considerable time and effort to individual stock selection and record keeping; in addition, the foreign fund options in our plans allow us to cover that aspect of asset allocation without trying to learn the differences between foreign and U.S. markets.



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Author: PSUEngineerFool Big funky green star, 20000 posts Top Favorite Fools Top Recommended Fools Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 2901 of 75379
Subject: Re: IRA capital gains convert to ordinary income Date: 4/17/1998 2:24 PM
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JeanDavid

Thank you for sharing your story about your dud. I am truely happy for you for your success in attaining a 45% return.

But your financial situation is more the exception than the rule. The average household income is $42,000 per year. I doubt that these people can purchase 20 different stocks like you have. Most probably are limited to 3 to 4 stocks. Therefore the effect is greater on total return if you have one dud.

I am not against stocks or for index funds. Actually I plan to move more of my funds into individual stocks. because I have the interest to do it.

The point of my original post is that many Fools diminish the risks of investing in stock and think it is easy to beat the S&P 500. (I guess I did a lousy job making it.) You can beat an S&P index fund that is in a 401(k) with a taxable account but it takes good research. An S&P index fund can afford some duds but 3 to 4 stock portfolios that many average families have can take a real hit.

By the way, I want to thank Pixy for the equations for determining the return needed in a taxable account to beat the return in a 401(k). An eye opener. (Can be found in this thread)

You can win through hard work, not by reading hot stock tips and throwing darts. The long bull market has convinced people that it is easy.

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Author: TMFPixy Big gold star, 5000 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 2903 of 75379
Subject: Re: IRA capital gains convert to ordinary income Date: 4/17/1998 3:03 PM
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TiggerToo,

<< You have hit on the one major item that bothers me about the gung ho Motley Fool contributors. They make people feel demeaned and debased because they choose to use index funds. Its like "you all are just so stupid, why can't you be smart like me and make all kinds of money by choosing individual stocks."

Some people just don't want to do it, and that does not make them bad, stupid, ignorant, chicken...you get the point.

The Motley Fool has great value to all readers, not just those that want to get into individual stocks. Give us a break?

Everyone talks about the home runs, but you never hear about the duds.>>

Goodness gracious me! Didn't we get up on the wrong side of the bed this morning. How about giving me a break instead? I think thou doth protest too much. Where in the world did you gather such an impression? Let's do a quick review of this thread.

PSUEngineerFool said:

"TMFPixy says

<<For a 401k to be better beyond the maximum match, the plan must offer some halfway decent options. Too many don't, thus making it fairly easy to outperform them in a taxable investment.>>

I have concerns with this statement. From my observations, most companies offer an index mutual fund. The taxable account needed to try to outperform the index would probably be several stocks (in essence creating your own mutual fund).

You make the assumption that most people will have the time and ability to be able to pick their own stocks and beat the S&P 500 when most professionals of managed mutual funds can't.

I think alot of people are blinded by the high flying tech stocks of this bull market. Today's darlings are Compaq and Dell. If you remember from the 1980's, Zeos and Wang were top computer companies. Zeos was bought out at a low price by Micron and Wang struggled until converting to a computer services company. Of course you can say the computer market is more mature today.

How about investing in established companies instead. You would lose to the S&P 500 with Sears and McDonalds. Everybody bought a Zenith TV when I grew up in the 70's. But I wouldn't want their stock.

Maybe everyone thought Borland would be like Microsoft since they dominated database software in the beginning. Poor choice there."

TMF Pixy responded:

"Greetings, PSUEngineerFool, and welcome.

<< From my observations, most companies offer an index mutual fund. The taxable account needed to try to outperform the index would probably be several stocks (in essence creating your own mutual fund).>>

Not really. I'm willing to wager at least 40% of 401k plans do NOT offer an S&P 500 index fund as an option. If you doubt that, just look at the numerous posts in this folder where folks complain about not having that option. In my own firm it wasn't until two years ago we were finally able to browbeat our investment committee into adding one. As I said, far too many have a poor selection. Over the long term, most managed funds come out woefully behind the vanilla index fund.

<<You make the assumption that most people will have the time and ability to be able to pick their own stocks and beat the S&P 500 when most professionals of managed mutual funds can't.>>

No, I don't. Only those who are interested in how their portfolios will do will venture beyond the 401k options or mutual fund environment. Sad ,that, but true. Fortunately, that doesn't pertain to the majority of the readers of this or other folders within Fooldom. It is NOT rocket science, and with but a modicum of knowledge virtually anyone can outperform the vast majority of stock funds out there. We aren't pressured to churn our portfolios chasing the "hot" idea of the moment. In stead, we use a buy and hold strategy that produces much better results. Ever look at the turnover ratio of stock funds? Of the roughly 3540 stock funds started in 1995 or earlier, the median turnover rate is 67%. The highest is 1,378.1%!! It's no wonder they have a hard time performing.

<<To beat an S&P 500 index fund in a 401(k), you must
1) do thorough research on each stock
2) constantly keep track of stock and company performance
3) always buy low and sell high
4) hope something unforeseen in the market doesn't screw up the first 3 steps.>>

Or you could probably just use one the various Dow strategies discussed elsewhere and still fare better than with a fund. Regardless, it's a personal issue. Each of us have to examine what we are willing and able to do. If we are Fools, we'll make the comparisons and go with the one we think will give us the biggest bang for our buck."

From that exchange you got the message I said, "…you all are just so stupid, why can't you be smart like me and make all kinds of money by choosing individual stocks." Personally, I think you have read far more into my remarks than is either there or than what was intended. Indeed, I'm quite distressed you think that's what I was trying to impart.

I have and will continue to maintain that investing is an intensely personal issue. Everyone must resolve it individually. If investing in index funds is your bag, great! In fact, double great because chances are you will do far better doing that than trying to pick any managed stock fund that will exceed the market over the long term. Can you do better than the market? Sure, by buying individual stocks. Do you have to take scads of time and do reams of analysis to do so? Not unless you want to do so. Just try using one of the Dow strategies. If history is any guide, over the long term you will better the S&P 500 index by doing so. Rocket science? Hardly. Time consuming? Ya gotta be kidding! Are you stupid if you don't do that? Nope. If you're content with lower returns, that's fine by me.

And BTW, just so no one forgets: 40% of 401k plans do NOT have an index fund as an option. They then become quite easy to beat for money beyond an employer's match. For instance, try an index fund in a Roth. Or try a self-directed account. But don't do the latter unless you can tear yourself away from other aspects of your life for at least 30 minutes a year every 12 to 18 months. Stick with the index fund instead. Both should do better than the 401k.

Regards….Pixy




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Author: TMFPixy Big gold star, 5000 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 2904 of 75379
Subject: Re: IRA capital gains convert to ordinary income Date: 4/17/1998 3:03 PM
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Nonqual,

<<But I digress, my question is whether any studies/analyses are planned a la the Roth vs IRA work that would provide a framework for evaluating trade-offs in making decisions about the capital gains vs ordinary income issues i.e. while it seems intuitively obvious that paying lower capital gains taxes as you go may be more economical than paying taxes at the full marginal rate later (presuming no post retirement reduction in marginal rates), how do the various assumptions (i.e. investment horizon, dividend yield, price appreciation, turnover frequency, etc. say for the FF and for an index fund) affect how large an advantage one approach has over the other?>>

Gathering the data to try 18-month trading models would be a horrendous undertaking. Timing and taxation of dividends, price data on specific dates, assumptions, etc., make it a project that I haven't the time to undertake. However, nothing says no one else willing to devote the time certainly can post the results here with no objection from me. <g>

Regards….Pixy



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Author: PSUEngineerFool Big funky green star, 20000 posts Top Favorite Fools Top Recommended Fools Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 2906 of 75379
Subject: Re: IRA capital gains convert to ordinary income Date: 4/17/1998 4:08 PM
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Pixy

I am sorry I am lousy at putting in typewritten words what I am thinking. Hey, I am an engineer. I write terribly and over analyze everything.

One last stab to make my point and I will shut up.

My real concern is some people out there think the stock market is "easy" and ignore risk. I am worried there are some who have stumbled on this site and started investing in the Foolish 4. They haven't read the Motley Fool Investment Guide (or some other guide) and understand how the stock market really works.

How many Fools are new at this and were not invested during 1987? Yes, I know, you read how investing is long term and events like that should not concern you. But reading and experiencing is 2 different things. I am much better off today going through that experience and not panicing. But if some are investing without spending some time studying, they may panic in the end.

Past performance does not guarantee future returns. I am afraid some only have experience with the recent bull market. (OK, I am an alarmist)

I agree with you that investing is intensely personal. So lets get back to investing and have some fun.

Fool on!




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Author: nonqual One star, 50 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 2907 of 75379
Subject: Re: IRA capital gains convert to ordinary income Date: 4/17/1998 4:30 PM
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Pixy,
<<Gathering the data to try 18-month trading models would be a horrendous undertaking...>>

I concur, but trying to do it with historical data would be like trying to sprint before crawling. What about conceptually and prospectively using the following assumptions (or whatever you think may be more representative):

Time period: 10 years
Annual Contributions: $4,000 at first of year
Annual Dividend Yield: 1.5%
Capital Appreciation: 16%/yr or 24%/ 18 months
Marginal Tax Rate: 28%
Capital Gains Rate: 20%

I'd try it myself, but I can barely use a word processor let alone a spreadsheet. Just curious

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Author: TMFPixy Big gold star, 5000 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 2909 of 75379
Subject: Re: IRA capital gains convert to ordinary income Date: 4/17/1998 4:54 PM
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PSUEngineerFool,

<<My real concern is some people out there think the stock market is "easy" and ignore risk. I am worried there are some who have stumbled on this site and started investing in the Foolish 4. They haven't read the Motley Fool Investment Guide (or some other guide) and understand how the stock market really works.

How many Fools are new at this and were not invested during 1987? Yes, I know, you read how investing is long term and events like that should not concern you. But reading and experiencing is 2 different things. I am much better off today going through that experience and not panicing. But if some are investing without spending some time studying, they may panic in the end. >>

I thoroughly agree. If I believe a person is a novice, I certainly suggest caution and education first along with a suggested series of readings. Ya gotta walk before you run.

<<Past performance does not guarantee future returns. I am afraid some only have experience with the recent bull market. (OK, I am an alarmist)

I agree with you that investing is intensely personal. So lets get back to investing and have some fun.>>

And that gets another agreement from me. See? We're not that far apart. <g>

Regards....Pixy

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Author: TMFPixy Big gold star, 5000 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 2910 of 75379
Subject: Re: IRA capital gains convert to ordinary income Date: 4/17/1998 4:56 PM
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Nonqual,

<<What about conceptually and prospectively using the following assumptions (or whatever you think may be more representative):

Time period: 10 years
Annual Contributions: $4,000 at first of year
Annual Dividend Yield: 1.5%
Capital Appreciation: 16%/yr or 24%/ 18 months
Marginal Tax Rate: 28%
Capital Gains Rate: 20%

I'd try it myself, but I can barely use a word processor let alone a spreadsheet. Just curious>>

I'll mull it over and come up with something in the next couple of weeks just for fun and comment.

Regards....Pixy

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Author: vtaeger Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 2911 of 75379
Subject: Re: IRA capital gains convert to ordinary income Date: 4/17/1998 5:16 PM
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JeanDavid wrote:
<<However, I had around 19 other stocks that did better,
so that my present IRR for the last 12 months is just
slightly under 45% according to Quicken.>>

Vanguard S&P Index fund was up 47.44% for the year ending 4/16/98. It's a crazy world when a 45% return does not get bragging rights.

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Author: JeanDavid Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 2914 of 75379
Subject: Re: IRA capital gains convert to ordinary income Date: 4/17/1998 5:49 PM
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<Thank you for sharing your story about your dud. I am
truely happy for you for your success in attaining a
45% return.

 But your financial situation is more the exception
than the rule.>

Well, that unlikely rate of return sure is. It was
hanging around much closer to 20%, underperforming the
S&P 500 until fairly recently. The IRR for the last 12
months has been so high because of, among others, the
following (these are annualized rates of return over
the times I have held them (some of these times are
quite short)):

RTN.A   +323%*
PMTC    +297%*
DD      +289%
PFE     +265%
CATP    +241%
DELL    +238%
__
* No longer held

These are ATYPICAL, but I have held some of them for a
while and they sure help. Even BRK.A is doing +59.06% for me, which may not be as impressive, but is so substantial that it is now occupying the largest single position of my portfolio (now only 18 stocks).

It is true that I have been investing, Wisely most of the time, but Foolishly since August 1996, since about 1967 and not all those investments worked out badly.
According to Quicken, my annualized rate of return for
all my investments has been only 14.71% which may help
to give some perspective to all this.


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Author: JeanDavid Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 2916 of 75379
Subject: Re: IRA capital gains convert to ordinary income Date: 4/17/1998 6:06 PM
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<JeanDavid wrote:
<<However, I had around 19 other stocks that did better, so that my present IRR for the last 12 months is just slightly under 45% according to Quicken.>>

Vanguard S&P Index fund was up 47.44% for the year ending 4/16/98. It's a crazy world when a 45% return does not get bragging rights.>

You are right there. Even Mr. Buffett had problems this year. As he said in his letter to the shareholders,

" Given our gain of 34.1%, it is tempting to declare victory and move on. But last year's performance was no great triumph: Any investor can chalk up large returns when stocks soar, as they did in 1997. In a bull market, one must avoid the error of the preening duck that quacks boastfully after a torrential rainstorm, thinking that its paddling skills have caused it to rise in the world. A right-thinking duck would instead compare its position after the downpour to that of the other ducks on the pond.

So what's our duck rating for 1997? The table on the facing page shows that though we paddled furiously last year, passive ducks that simply invested in the S&P Index rose almost as fast as we did. Our appraisal of 1997's performance, then: Quack. "

(The "Quack" was in about 6-point type.) Berkshire beat the S&P by about 0.7% last year (as measured by increase in book value).

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