IRA Breakdown

A lot of you probably have an IRA. You might even have two -- for example, a traditional and a Roth. You probably know that in general, IRAs, or individual retirement accounts, are investment vehicles geared for your golden years. But do you know the different types? And are you sure the one you have is best suited for your needs?

There are actually four different types of IRAS: traditional, Roth, SEP and SIMPLE. The traditional IRA allows the investor to contribute pre-tax income (this is good -- it lowers your taxable income) to an account that will grow over time. For example, Mary, who makes $80k, will first contribute $5k to her IRA, and then pay her taxes based on an income of $75k.

The current contribution limit is $5000 for those 49 years of age and younger, and $6000 for those 50 and over. In addition to the tax benefit, the contributions and their earnings grow tax-deferred over time. (This means you won't pay any capital gains nor dividend income tax.) When you do reach retirement and decide to start withdrawing, the money will be treated as income and you'll be taxed. The hope/plan is that you'll be in a lower tax bracket and therefore pay less taxes in those golden years than you would have while working. The other benefit is that of compounding -- there's more to grow over time since taxes aren't being removed from the pool of money.

A Roth IRA is similar in that if offers a haven for retirement earnings, but different in that
it may not be funded with pre-tax income. So if the same Mary from the previous example makes $55k after taxes, her ROTH contribution will come from the $55k. The benefit is that she'll receive the distributions free of tax since she already paid taxes on her earned income before contributing. However, there are income limits for a Roth. If Mary takes a better job and her adjusted gross income rises to $111k, the amount she can contribute is reduced. If her AGI rises to $116k, she is no longer eligible. (Don't get me started on this one -- there is of course no adjustment by the good ole USG for cost of living -- the "rich" woman in New York making $116k is not eligible, but her friend with a $90k salary in Topeka, KS, can contribute.)

SEPS and SIMPLE IRAs are established by employers, usually small businesses. A SEP is a simplified employee pension where the even a sole proprietor can contribute 25% of her net earnings (or $45,000 -- whichever is less). They feature low administrative costs and flexibility -- if a new business has uneven cash flow and doesn't contribute one year, that's okay (although not advised). The earnings grow tax deferred until you start making withdrawals, similar to the traditional IRA.

SIMPLE stands for savings incentive match plan for employees. The employer gets a tax deduction for contributions made and can either elect a flat rate or match a percentage of the employee's contribution. Like with SEPs, the earnings grow tax deferred.

A few final nuggets:
1. The IRS is always changing the contribution limits -- they like to keep everyone on her toes!

2. If you have a 401(k) plan, this doesn't mean you can't contribute to an IRA! In a perfect world, you'd max out both.

3. Malbec is a fabulous wine with which to learn about IRAs. I just tried (and bought a case of) Dona Paula, a delicious chocolaty, raspberry and full flavored wine perfect for crisp fall nights.

Want to loose money? Sell now and go to cash!

There could be no truer, simpler investment strategy than "Buy high; sell low". Yes, I did say that: "Buy high; sell low". If you're investing to get tax write-offs and lose money, that is!

Here's a great example: you read about some fabulous, gang-buster company and decide to buy some stock because hey, "everyone knows it's only gonna go up". A few weeks/months/years later, the performance isn't there, so you sell at a loss and either go to cash or buy some of the next hot item as "it couldn't happen again". You figure you'll make it up next time.

Sound stupid? Yeah, because it is! No one in her right mind would plan to operate in this fashion, but it's amazing how many folks out there do. They're the ones right now who are listening to negative media, walking around morose, "feeling the pain" of those people out there who've lost their etc., etc., etc. and taking on a sympathy depression to cope. These folks are fueling the negative sentiment. (I actually had someone Monday ask me if I'd heard about "the stock market crash"! She wanted to know if I "had had any stocks" and "if so, what was I going to do?" Let's just say that my response of "nothing" received a puzzled look.

I have a healthy emotional balance -- some highs, some lows with mostly positive, even keel, pretty bubbly days. (Health outlook, eating and physical activity deserve the credit.) I don't mind the variety -- especially when I'm downright hyper and loving the energy! But when it comes to investing and matters money, I become the steely-eyed, emotionless accountant type. I am content and rendered stronger by this chosen position. In fact, the worse the news gets, the more content I become. Because I know that the answer is, in fact, to stay the course. Meditate on the peace of doing nothing. Or just do nothing.

Why? Because I developed an investment strategy a few years back. And part of that strategy was sticking to the strategy. We don't know when the market will "recover" (I don't view it as a "recovery" because cycles are normal.), but we do have this set of foundational facts upon which to build a strong strategy:

1. For every rolling 20 year period since the Civil War, stocks have beaten bonds and cash. (Except for one time.) A diversified basket of stocks is still the best investment given a 20 year horizon.

2. Cycles are normal in markets. As the total number gets bigger, the perceived volatility grows. (Ever notice how the media doesn't like to talk about relative percentages, preferring instead to use bigger numbers of points? And how they whiz past the NASDAQ and S&P to report the Dow?) No one ever promised a smooth ride! The smoothest ride of hiding in cash is a downhill grade.

3. No one can really accurately predict the market volatility or cycles. If it were possible, there would be a lot more rich folks walking around. The problem with getting out is that you won't know when to get back in. When is the bottom, the bottom? When is the top the top? These questions are largely irrelevant because the measures are backward looking -- we'll only really know after the fact. (I didn't like philosophy.)

4. Reactive selling is stupid. Really stupid. And not to mention, it's expensive. No one likes to talk about transaction costs, but they'll eat right into a trading portfolio. Every time you buy or sell, there's a fee attached (not so with a 401k unless you're talking about your precious time). So buy and hold. Sell when you plan to sell, not when "the market!!!" tells you to.

5. It's amazing how much sentiment drives the market. Think about that. There are fundamental assets -- the expected growth in dividends backed by actual companies. And their values fluctuate constantly. Let the market and the media be schizophrenic.

6. Investing sooner is better than later. Compounding over time is the best asset you can "buy".

For the roller coaster ride ahead, I recommend a smooth, comforting Willamette Valley Pinot Noir. A to Z Wineworks makes a delicious one for about $20. No corkscrew necessary since it's bottled with a screw cap!