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Author: A2Ninja Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 75642  
Subject: Roth IRA diversification strategy Date: 5/18/2010 10:54 AM
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I'm a fairly young (28) professional who just opened a Roth IRA account with scottrade last year. I only have $10k invested in it and most of my other excess income is going towards debt reduction.

Contrary to everything I've ever heard about investing, I haven't focused on diversification in my Roth IRA, but rather I have selected a handful of stocks that I considered to be improperly valued, regardless of their business sector. The reasons why I haven't taken the standard diversification approach are:

1. I have enough time before retirement that I can afford to take some losses in my retirement portfolio and adjust my investment strategy as I move towards retirement.

2. Proceeds from Roth IRAs are non-taxable so if I were to hit a few homeruns, I could take the profits without paying taxes on them, but if I did it outside of a Roth structure, I would be hit with a tax.

3. I only have $10k (~5k invested), so my undiversified exposure isn't huge at this point. I will become more diversified as I invest more.

4. It seems to me that over the past 24 or so months market forces have been the main driving force in stock prices. In other words, there is a higher than normal correlation between which way any two stocks move because of market wide forces such as europe's debt crisis, panick, etc.

Given my situation, do you think it is reasonable to have an undiversified portfolio? Or should I set aside my greed for tax free gains and take my "free lunch"?
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Author: Fuskie Big funky green star, 20000 posts Top Favorite Fools Old School Fool Ticker Guide SC1 Red Winner of the 2010 Rule Breakers Challenge Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 67138 of 75642
Subject: Re: Roth IRA diversification strategy Date: 5/18/2010 11:51 AM
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Why do you think you cannot maintain a tax free diversified portfolio via your Roth IRA?

First, paying down your consumer debt is admirable and I wish you luck with that. There is a Consumer Credit/Consumer debt discussion board here at TMF that can help if you want some tough love advice.

I think it is too easy to scapegoat the economic turmoil as the driver for market direction. Companies are still responsible for performing, and how they perform during a recession can be as important if not more so than how they perform in good times. My suggestion is to not focus so much how the stock price has performed as how the company itself has performed. The two are usually but not always aligned and often that is where profits are to be found.

Finally, there is no such thing as a free lunch. You paid your dues (taxes) on your Roth IRA contributions so you are free to invest them in just about anything you want, whether it be individual companies, ETFs, mutual funds, bonds or the Fuskie Needs A Tesla Savings Program (FNATSP™).

Sure, the world seems to move together when there is a regional economic crisis. International economies are intertwined line never before. Never-the-less, having a diverse portfolio is still a good way to protect yourself against any one sector or investment strategy from running roughshod over your portfolio. There is always risk involved, but if you make smart investments in companies and management teams, then you can reduce that risk so that you will be better positioned when the markets rebound.

Fuskie
Who hopes you will continue to invest in your retirement and further your diversification strategy over time...

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Author: drippinfool Three stars, 500 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 67139 of 75642
Subject: Re: Roth IRA diversification strategy Date: 5/18/2010 12:26 PM
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"2. Proceeds from Roth IRAs are non-taxable so if I were to hit a few homeruns, I could take the profits without paying taxes on them, but if I did it outside of a Roth structure, I would be hit with a tax."

Careful. Only QUALIFIED distributions are tax free. Before age 59 1/2 only CONTRIBUTIONS are tax and penalty free. Before that age, absent other exceptions such as disability, qualified home purchase, etc., distributions of Roth EARNINGS are not only taxable, but subject to an additional 10% penalty.

See IRS Pub 590 for more information. Here's a link http://www.irs.gov/pub/irs-pdf/p590.pdf

-drip

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Author: A2Ninja Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 67140 of 75642
Subject: Re: Roth IRA diversification strategy Date: 5/18/2010 12:31 PM
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I am confidend that if I chose to, I could maintain a tax free diversified portfolio via my Roth IRA. What I was trying to say is that I feel like if you were going to own a stock that earned a large gain, it would be more beneficial for you to not have to pay taxes on that gain. I don't know of any way to avoid those taxes, other than through the structure of a Roth IRA. So I was saying that I'm willing to take on significantly more risk in my Roth IRA at my age in hopes of hitting it big on a couple stocks.

With relative ease, I could probably diversify my Roth IRA, but in doing so, I would limit both the upside and downside potential. Given that the updside potential is tax free, I think it makes more sense for me to take on more risk in my Roth, and to pursue a diversified investment strategy with any investments that I choose to hold outside of my Roth.

There very well may be a flaw in that logic, but since I'm relatively new to investing I figured I would run it by some people who are much more wise than myself.

Thanks for the advice on paying down my consumer debt, however I probably should have clarified that I'm paying down my mortgage to get my home above water so that when my ARM starts adjusting (this fall), I am in a position where I can refinance. However I'm sure there's an excellent discussion board for that as well.

Thanks again for all of your advice!

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Author: PSUEngineer Big funky green star, 20000 posts Top Favorite Fools Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 67141 of 75642
Subject: Re: Roth IRA diversification strategy Date: 5/18/2010 12:52 PM
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Given my situation, do you think it is reasonable to have an undiversified portfolio? Or should I set aside my greed for tax free gains and take my "free lunch"?

What you are suggesting is that you will use your Roth IRA as a gambling account. You will search for companies where you will either hit home runs or strike out trying. You are not satisfied with hitting singles and scoring slowly. Your home runs will be rewarded more since Uncle Sam in the dugout doesn't get a cut.

That strategy is really dependent on your whole financial situation. Should you be swinging for the fences if you have credit card debt? Should you be swinging for the fences if you have few other assets? IMO, you shouldn't be gambling unless you can afford to lose the money. If you need it for retirement, then don't risk it.

Now that I said that, my own Roth IRA is my gambling account. It is a small percentage of my assets. It isn't a factor in my retirement. I keep a large majority of my retirement assets in diversified mutual funds.

PSU

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Author: aj485 Big gold star, 5000 posts Feste Award Nominee! Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 67142 of 75642
Subject: Re: Roth IRA diversification strategy Date: 5/18/2010 1:03 PM
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I'm a fairly young (28) professional who just opened a Roth IRA account with scottrade last year. I only have $10k invested in it and most of my other excess income is going towards debt reduction.

Do you have an emergency fund? Do you have other retirement savings?

If this account is your only savings/investments, you might want to think about what will happen if you have an emergency that you need money for, assuming you don't want to add to the credit card debt you are trying to pay down.

1. I have enough time before retirement that I can afford to take some losses in my retirement portfolio and adjust my investment strategy as I move towards retirement.

You also have enough time before retirement that you don't need to use this account as a gambling account right now, if you don't have other savings.

AJ

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Author: aj485 Big gold star, 5000 posts Feste Award Nominee! Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 67143 of 75642
Subject: Re: Roth IRA diversification strategy Date: 5/18/2010 1:06 PM
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Thanks for the advice on paying down my consumer debt, however I probably should have clarified that I'm paying down my mortgage to get my home above water so that when my ARM starts adjusting (this fall), I am in a position where I can refinance.

Have you looked at if you are eligible for HARP (Home Affordable Refinance Program)? It allows people with first mortgages up to 125% LTV to refinance. http://makinghomeaffordable.gov/refinance_eligibility.html

AJ

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Author: A2Ninja Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 67144 of 75642
Subject: Re: Roth IRA diversification strategy Date: 5/18/2010 1:16 PM
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That's exactly it, I would essentially be using the Roth as a gambling account. However I should clarify a couple things. I don't have any credit card debt. I have paid off my HELOC, but my house is still slightly underwater and I would probably need to bring about $15 k to closing in order to refinance. I have $15.8k set aside in a Capital One Direct Money Market account to use for refinancing. I also have $9k in my company's 401k account and I'm using a moderately aggressive diversified investment strategy there. Finally, I also have 6 months worth of expenses set aside as an emergency fund.

"You also have enough time before retirement that you don't need to use this account as a gambling account right now, if you don't have other savings."

That's a great point.

Thanks for all of your advice!

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Author: Fuskie Big funky green star, 20000 posts Top Favorite Fools Old School Fool Ticker Guide SC1 Red Winner of the 2010 Rule Breakers Challenge Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 67145 of 75642
Subject: Re: Roth IRA diversification strategy Date: 5/18/2010 1:36 PM
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What I was trying to say is that I feel like if you were going to own a stock that earned a large gain, it would be more beneficial for you to not have to pay taxes on that gain. I don't know of any way to avoid those taxes, other than through the structure of a Roth IRA. So I was saying that I'm willing to take on significantly more risk in my Roth IRA at my age in hopes of hitting it big on a couple stocks.

You can realize the same kinds of gains in a diversified portfolio as you can if you only bought one company. The difference is if your one company fails, you lose everything. If you want to roll the dice and are prepared to get snake eyes, then have at it. But it would not be smart investing in my book. Losing your shirt in a Roth IRA is no better than losing it in a standard retail account. In fact, it would be worse. At least in a retail account you could write off the investment loss.

Just because you are diversified does not mean you achieve a lower rate of return on your investment. Similarly, being undiversified does not improve your chances for greater gains. Diversification is a question of risk. If you owned 2 companies and one of them was GM, then you would have lost 50% of your cost basis. Now maybe the other company is Apple and you more than made up for the loss. But chances are you just lost half your assets. On the other hand, lets day you owned GM along with Apple, Netflix, Dolby, Activision, and Coca-Cola (not to be confused as recommendations). You have a broad mix of screamers, streamers, steamers and sleepers. GM's impact is lessened on your overall portfolio in comparison to the performance of your other investments.

The bottom line is the chances of your being able to pick just one company that will stand the test of time are not great. The chances of you being able to pick a family of companies that on average will outperform are much better. You have a greater chance of success when one family member is able to pick up the other when its down. Many is the person who has insisted on going it alone only to realize eventually that lonliness sucks. Just saying. And all the other advice too.

Fuskie
Who has no problem with using a Roth IRA to generate annual gains tax free through income investing or to realize growth gains with no tax liability (with the proviso that you wait until retirement to take any distributions), but does not see the relationship to diversification or the lack thereof...

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Author: Watty56 Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 67146 of 75642
Subject: Re: Roth IRA diversification strategy Date: 5/18/2010 1:58 PM
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.... I only have $10k (~5k invested), so my undiversified exposure isn't huge at this point....

It may be larger than you think; you need also look at the $10K as;

1) A percentage of your net worth including the house that is underwater.

2) How long it will take you to save up another after tax $10K if you lose it.

3) What that $10K will be worth if it is just left it in an index for the next 50 years until you are 78. If it doubles in real (after inflation) dollars every 10 years 9about a 7.2% return) then it could double five times and be worth $320K by then.

You also need to factor in the high probability that your investments will underperform an index fund over the next few decades. A professional money manager would be in the investing hall of fame if they could beat a comparable index fund over that time frame and they typically have an advanced education for one of the best universities, work 60+ hours per week on investing, and have the best staff and computer systems that money can buy. Even with the few advantages that a small investor has, very few will actually beat the indexes.

A more reasonable and probably less risky approach to increasing you returns over the long run would be to select a more focused index fund with a higher expected return to invest your money in.

I don't have the numbers handy but just by looking at a grid of nine funds that cover the permutations of large, mid, small cap companies, that are broken into Growth, value, and blend categories will identify the ones with historically higher returns. I've seen several write ups that cover the various index funds relative historic performance so you should be able to find lots of this information if you look for it. There are dozens of possible types of index funds to choose from without even getting into the real obscure ones.

Greg

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Author: ptheland Big gold star, 5000 posts Feste Award Nominee! Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 67147 of 75642
Subject: Re: Roth IRA diversification strategy Date: 5/18/2010 2:21 PM
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After reading a couple more of your posts, I'm going to go against the flow and say your fine with a somewhat undiversified portfolio in your Roth.

First, I think diversification should be looked at across all of your investments, not just looking at a single account. So you have cash, you have some money - your 401k - probably in mutual funds, and you have this Roth account. You are more diversified than your initial post suggests.

Second, and more importantly, diversification is not the be-all and end-all of investing. If you do not have the time or ability to research individual companies and make your own investment decisions, diversification is probably a good idea. Pick a couple of index funds, put money into them regularly, and let time do it's thing. Odds are you'd end up OK - not poor, not rich, but able to fund a retirement.

What you are describing might be what some would call value investing. Value investing is a viable way to go. But it takes time to do the necessary research, and it takes time to see the results of that research. A company can stay undervalued for an awfully long time - time measured in years. And it can be hard to tell the difference between an undervalued company that just needs time for the market to appreciate it's value, and a company that really isn't worth much. Mistakes in value investing can be very expensive lessons indeed.

Many posters on this board have some conservative tendencies in their investment strategies. And that is a good thing. I'm probably one of them. But in this case, I'm going to stick my neck out and suggest that it can be OK to have less diversification than many people would suggest.

You might want to look at the writings of people like Ben Graham and how investors such as Warren Buffet put his investing ideas into practice.

--Peter

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Author: JAFO31 Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 67148 of 75642
Subject: Re: Roth IRA diversification strategy Date: 5/18/2010 2:41 PM
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A2Ninja: "What I was trying to say is that I feel like if you were going to own a stock that earned a large gain, it would be more beneficial for you to not have to pay taxes on that gain. I don't know of any way to avoid those taxes, other than through the structure of a Roth IRA. So I was saying that I'm willing to take on significantly more risk in my Roth IRA at my age in hopes of hitting it big on a couple stocks.

. . .

There very well may be a flaw in that logic, but since I'm relatively new to investing I figured I would run it by some people who are much more wise than myself."


In general, home run hitters tend to strike out more and not hit for as high an average as single's hitters.

Like Peter, I am not entirely uncomfortable with your choice, as long as you fully understand it.

One "flaw" in your logic is that while your home runs will not be taxed, you will also not get to share (write-off) your losses. And as noted in the second preceding paragraph, you will likely have more losses with your approach than a more conservative approach.

Regards, JAFO

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Author: aj485 Big gold star, 5000 posts Feste Award Nominee! Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 67149 of 75642
Subject: Re: Roth IRA diversification strategy Date: 5/18/2010 3:45 PM
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I have paid off my HELOC, but my house is still slightly underwater and I would probably need to bring about $15 k to closing in order to refinance. I have $15.8k set aside in a Capital One Direct Money Market account to use for refinancing. I also have $9k in my company's 401k account and I'm using a moderately aggressive diversified investment strategy there. Finally, I also have 6 months worth of expenses set aside as an emergency fund.

It appears to me that, especially at your age, you probably have enough resources to use the Roth as a 'gambling' account if that's what you want to do with it. I would recommend continuing to save/invest in other accounts, like your e-fund and your 401(k).

AJ

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Author: PSUEngineer Big funky green star, 20000 posts Top Favorite Fools Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 67150 of 75642
Subject: Re: Roth IRA diversification strategy Date: 5/18/2010 4:16 PM
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It appears to me that, especially at your age, you probably have enough resources to use the Roth as a 'gambling' account if that's what you want to do with it. I would recommend continuing to save/invest in other accounts, like your e-fund and your 401(k).

I would tend to favor your first suggestion to wait. Right now, slightly more than 50% of the retirement account assets are in a gambling account. {$10k in Roth IRA, $9k in 401k} I don't think there is a problem with gambling a small portion that you are willing to lose but right now the OP is gambling with a large percentage of retirement assets.

PSU

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Author: Fuskie Big funky green star, 20000 posts Top Favorite Fools Old School Fool Ticker Guide SC1 Red Winner of the 2010 Rule Breakers Challenge Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 67151 of 75642
Subject: Re: Roth IRA diversification strategy Date: 5/18/2010 4:39 PM
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In other words, diversify first, then take a piece of that and use it for gambling.

Fuskie
Who was told once that the best way to not lose in Vegas was to budget the amount you are willing to gamble as an entertainment expense...

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