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Author: ztreuhaft Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 74759  
Subject: Roth IRA + Individual Stocks Date: 4/5/2001 12:26 PM
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This is my first post ever, so please forgive me if this question has been asked before.

I have a Roth IRA with a small amount of money, a taxable account with a larger amount of money, and a long investment horizon (I'm 24, so it's about 40 years). I want to move into investing in individual stocks (i.e., Rule Makers), but can't figure out the best way to allocate the various assets while maximizing the tax benefits of the Roth.

Since I can only contribute $2K per year to the Roth, I'm nervous about buying individual stocks in that account. My thinking is that if I only hold a few stocks in the Roth, and they don't perform so well, I've wasted the tax advantage. Should I keep the Roth money in funds (e.g., VFINX) for the diversification? Should I keep it in individual stocks, and swallow the risk?

I guess the bottom line is this: What assets do I put in the Roth to best make use of the tax benefits of this account?
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Author: TheVlad Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 28923 of 74759
Subject: Re: Roth IRA + Individual Stocks Date: 4/5/2001 12:39 PM
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<<<I guess the bottom line is this: What assets do I put in the Roth to best make use of the tax benefits of this account?>>>

In terms of asset category, whether you invest in mutual funds or buy individual stocks, you are in the same category - equities. So, this doesn't diversify your asset allocation. Other asset categories are cash or equivalents, fixed-income instruments, real estate, precious metals... You get the picture.

From my point of view when all you have is $2000, it is much harder to invest in individual securities plus you have high transaction costs. So, I personally chose to put my Roth IRA money into a mutual fund.

Vlad

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Author: ztreuhaft Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 28924 of 74759
Subject: Re: Roth IRA + Individual Stocks Date: 4/5/2001 2:57 PM
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<<From my point of view when all you have is $2000, it is much harder to invest in individual securities plus you have high transaction costs. So, I personally chose to put my Roth IRA money into a mutual fund.>>



I actually read your post to someone else about your personal strategy of using the Roth to invest in aggressive growth mutual funds (BOGLX, i think it was). I think your rationale was that since the growth is tax-free, you might as well invest in something that has potential to be a tax-free blockbuster.

Would you mind expouding on your thinking here? It makes intuitive sense, and the upside is pretty strong, but I'm sort of skittish about the downside. I mean, if whatever aggressive fund I pick ends up in the tank for a while, don't I lose a lot of the benefit of compounding? I'd feel pretty silly if I ended up taking a writeoff in my TAX-FREE roth account (assuming i'm even allowed to do that)...



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Author: TheVlad Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 28932 of 74759
Subject: Re: Roth IRA + Individual Stocks Date: 4/5/2001 6:59 PM
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<<<Would you mind expouding on your thinking here? It makes intuitive sense, and the upside is pretty strong, but I'm sort of skittish about the downside. I mean, if whatever aggressive fund I pick ends up in the tank for a while, don't I lose a lot of the benefit of compounding? I'd feel pretty silly if I ended up taking a writeoff in my TAX-FREE roth account (assuming i'm even allowed to do that)...>>>

From the point of view of the classical asset allocation theory, I gravitate towards a higher-volatility portfolio. I have only two asset classes - equities and cash. No bonds, no real estate, no precious metals. I do actually want to branch out a bit into real estate but not at this point.

Having said that, I tend to consider myself more of a conservative skittish investor. That is, I want majority of my capital invested in equities with a low to moderate risk/average to above average reward profile. My 401(k) plan is invested only in Vanguard index funds, for instance.

However, I also like to have a smaller part of the capital invested in equities with a above average risk/high return profile.

Consequently, I decided to invest my ROTH-IRA into a fund that could potentially generate high returns for me due to its high turnover and more aggressive investing style. Yes, it does carry more risks but I am risking a small portion of my investments and I think those risks are moderated by the tax-free nature of this account.

It doesn't mean, however, that I am willing to jump into any super-aggressive fund. I want to be conservative as much as possible here, too.

When you look at funds' returns what you really want to see is the consistency of their high returns over a long period of time. At least, 10 years. Preferrably, more. When you flip a coin, say 20 times, there is actually a fairly high probability that you may end up with several heads or tails in a row. If you flip it for a real long time, the probability, of course, will be very close to 0.5 for either heads or tails. What that means for the funds is that a particular fund could beat a market index handsomely for 3 or even 5 years in a row. But it could be just the same case as when flipping a coin 20 times. What is much harder to do is to beat the index consistently over the long period of time. So, when we get to 10 years or longer, now we have a reasonable chance that the manager may be onto something here rather than just being lucky.

I did my research and I was very glad when I came across BOGLX (thanks, MorningStar). It did fit very well the parameters that were important to me. The fund was investing into small cap businesses. It is more risky than investing into large businesses but it also has potential for high returns. The manager had a good track record for 10 years (9 years with Numeric Investors but using the same investing methodology). The manager intends to keep fund small to allow it to continue to invest into small caps. The investment team appeared to be very good. At least, on the level of credentials. They employ quantitative models and, thus, are less likely to make emotionally-motivated decisions.

So I hope it does shed some light on my thinking. However, you should remember that this is my personal approach which may not be appropriate for you at all.

Good luck!

Vlad



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Author: skitime One star, 50 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 28933 of 74759
Subject: Re: Roth IRA + Individual Stocks Date: 4/5/2001 7:38 PM
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It is just my opinion, but if you are planning to invest in mutual funds and individual stocks diversification is not the issue. On the other hand, tax-advantage is the major issue here. IMHO, I suggest putting the mutual funds in the tax-advanted vehicle, because you have less control over captial gains, with individual stcoks you have a better grasp of the cap gains you are going to incure.

Good Day !

Michael A


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Author: kellykinney Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 29053 of 74759
Subject: Re: Roth IRA + Individual Stocks Date: 4/11/2001 1:38 PM
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I agree with both Vlad and Michael. I think Vlad makes some excellent points about diversification in one of his posts, and risk profiles, and Michael makes a great point about about control over taxes.

I have a pretty high risk tolerance for 401(k), and a moderately high risk tolerance for my IRA. For my other holdings, however, I am more convservative with Rule Maker equities and bonds.

My comment to your question is that I agree that an IRA is probably not the best place for stock holdings given the limited amount money which can be invested relative to the transaction and maintenance costs. I would say that if you are interested in equities, go to http://www.buyandhold.com and just make a $20 cash purchase of your favorite company, and then set up an EZVest purchase schedule, and start doing it on a regular (at least monthly) basis. That's just one option, but a great way to start on stocks.

Best of luck to you.

Kelly

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