How Equity Investors Can Use IRA Umbrella

RUSS WILES <i> is editor of Personal Investor, a national consumer-finance magazine based in Irvine. </i>

When it comes to investing, Caswell Neal isn’t your typical retiree. The former electrical engineer has filled his nest egg with stocks and stock mutual funds rather than more conservative selections.

He doesn’t even own any bonds, bond funds, money market portfolios or certificates of deposit. “With equities, I feel I can make well beyond what I could with fixed-income products,” says Neal, a Westchester resident.

But his risk-tolerant approach isn’t widely shared. Despite convincing evidence that equities outperform bonds and money market products over the long haul, mutual fund owners generally prefer to play it safe with their retirement investments.

Of the $127.3 billion in mutual fund assets parked in individual retirement accounts at the end of 1990, only 41.7% was in stock funds, according to the Investment Company Institute in Washington. Another 6.7% was in combination equity-bond funds, but the remainder--more than half the total--was in bond or money market portfolios.


“The public perceives that bond funds offer safety with greater yields (than stock funds),” says Erick Kanter, an ICI vice president. “But there’s no real growth potential, other than the compounding of interest.” Historically, bond returns have exceeded inflation by only about 2% a year, compared to nearly 7% for equities.

Certainly, nobody wants to suffer a setback in a tax-deferred account in which losses can’t be deducted. But if you keep your money invested in the stock market long enough--and IRAs are multi-year vehicles, after all--your chances of reaping a profit are substantially increased. Unlike certain individual stocks, a good equity mutual fund can be counted on to mirror the market and bounce back after any slump.

Rather than buy and hold, you can try to time your mutual fund trades. One advantage of doing so within an IRA is that you don’t have any taxable transactions to report each year.

When Congress fiddled with the tax laws in 1986, making IRAs non-deductible for certain people (primarily higher-income folks already covered by a pension plan at work), it discouraged a lot of investors from making IRA contributions. Only 14% of the respondents in one survey said they put money into an IRA for tax year 1990, down from 22% in ’86.

But many financial advisers argue that the ability to defer taxes on capital gains over time outweighs the one-time benefit of a $2,000 writeoff. Neal agrees. “So what if you can’t get the deduction,” he says. “It’s more important that your money will be growing (unaffected) by taxes.” He has nearly two-thirds of his IRA holdings in two volatile funds: Fidelity Emerging Growth, a small-stock portfolio, and Fidelity Select Biotechnology, a sector fund.

In addition to the common assumption that equity investments don’t make sense for retirement accounts, some mutual fund buyers harbor other misconceptions about IRAs. They include:

* You can’t put IRA money into a fund that requires more than a $2,000 minimum investment.

Actually, most fund companies will bend over backward to get your retirement account. The accompanying chart lists some top-rated funds that welcome IRA investors for $2,000 a year or less, even though they impose much higher minimums for regular, taxable accounts.


* You have to make your IRA contribution in one lump sum.

Many companies don’t require the full $2,000 investment. And most will let you add money in increments. In fact, many offer automatic share-purchase plans. Under them, you authorize the fund group to tap your checking account in regular increments and invest that money in a portfolio of your choice.

Methodical purchasing can help remove emotional impediments, since you don’t have to worry about buying at a market peak, notes Paul Robertson, chief operations officer of United Services Funds in San Antonio. “Plus, if you have to wait to get a pile of cash to invest, you might miss a rally.” His firm offers a share-purchase plan under which it debits as little as $20 a month from a contributor’s bank account.

* You can’t hold certain types of funds in an IRA.


Generally, you can invest in any category, including real estate and precious metals funds. (By contrast, you would face problems holding individual properties and most coins in a tax-sheltered account.) A few firms will even let you place a municipal bond fund inside an IRA, should you be crazy enough to want it. The ICI reports $45 million of IRA assets invested in this manner, despite the fact that there’s a wasteful duplication of tax shelters.

* You should spread your mutual fund holdings among several IRAs to get maximum diversification.

The problem here is that fund companies typically charge at least $10 to $15 per account to act as trustee for your IRA. If you have more than a half dozen or so accounts, you could face annual fees in excess of $100, which can really add up over time. (A few groups don’t charge an IRA trustee fee, including Benham Capital Management of Mountain View, Calif., and the American Assn. of Retired Persons in Washington).

* You can’t access your IRA funds before age 59 1/2.


Actually, you can withdraw and spend the money at any time, but there are some drawbacks. First, you remove assets from a tax-sheltered umbrella. Second, you generally pay a 10% penalty to the IRS, and you may face ordinary income taxes on part of the amount withdrawn. However, you can avoid the 10% penalty if you agree to take the money in yearly installments that reflect your remaining life expectancy, as determined by IRS tables. This usually means relatively small annual withdrawals.

Regardless of when you decide to take out your money, many mutual funds offer automatic withdrawal plans--a convenient means of receiving a monthly check drawn against either an IRA or a taxable account.

So while IRAs carry some restrictions, they generally make sense for mutual fund buyers. Equity investors in particular should take advantage of the opportunity to compile tax-sheltered gains over many years. “This is something you shouldn’t pass up,” says Neal. “For goodness sake, get under the IRA umbrella.”

IRA-FRIENDLY FUNDS Mutual funds appeal to smaller investors since most require just $2,000 or less for regular, taxable accounts. Even those with higher minimums will often lower the amount to $2,000 for investors opening an individual retirement account. The following equity funds all require at least $5,000 for taxable accounts but no more than $2,000 for IRAs. All enjoy top, five-star performance ratings from Morningstar Inc. of Chicago.


5-year 1991 Fund Regular return return (objective) minimum ('86-90) (3 months) Load Phone Gabelli Asset (G) $5,000 +106%* +11% None 800-422-3554 IAI Regional (G) $5,000 +104% +18% None 800-927-3863 Mutual Beacon (G&I;) $50,000 +81% +11% None 800-553-3014 Vanguard Trustees’ International (Intl.) $10,000 +145% +4% None 800-662-7447 U.S. Boston Growth & Income (G&I;) $5,000 +91% +15% 1%* 617-259-1144

Objective abbreviations: (G) growth; (G&I;) growth & income; (Intl.) international.

Notes: Gabelli Asset’s five-year return covers the period from 3/86 through 12/90; U.S. Boston Growth & Income charges a maximum 1% back-end load.