Choosing Between a Traditional and a Roth IRA


I spent yesterday at Schwab’s IMPACT Conference. The annual conference is oriented toward independent financial advisers. Nearly 5,000 people attended this year’s conference. I’ll share some of my notes at the end of this week’s commentary, but first I want to focus on a specific session that addressed the topic of choosing between a traditional and a Roth IRA.

The subject is timely because of the Tax Cuts and Jobs Act (TCJA). Should the proposed tax reform legislation make it through Congress, the tax brackets will be condensed. The bill, which passed the House of Representatives today, would also end the ability to recharacterize (meaning undo) a Roth IRA conversion.

One of the points financial planner Michael Kitces made during the session was the tax equivalency of both types of IRAs. Assuming all things remain equal—the tax-adjusted dollars allocated for contributions, planned withdrawals and taxes—it should not matter which type of IRA is chosen. If anything changes, so does the decision. Lower future tax rates favor traditional IRAs; higher future tax rates favor Roth IRAs. Not wanting or needing required minimum distributions (RMDs) favors Roth IRAs. Desiring to put away more now in terms of absolute dollars favors traditional IRAs.
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 Highlights from this month’s AAII Journal

AAII Model Portfolio Update

As noted in this month’s AAII Journal, the Model Fund Portfolio is being discontinued. For those who have invested in funds that were in the Model Fund Portfolio, AAII chairman and founder James Cloonan believes there is no need to rush into making any changes and that you should pay attention to any long- or short-term tax consequences of selling. Jim also suggests gradually switching over to the Level3 Passive Portfolio if you are not interested in analyzing mutual funds.

This month’s AAII Journal also discussed the rule changes being made to the Model Shadow Stock portfolio. The rule that relative strength for the past 26 weeks must be in the top 50% is being eliminated. Momentum will be retained as a tie-breaker among qualifying stocks, however. A ranking on four-week relative strength will be used as the tie breaker. Stocks held over four years will be sold unless they currently qualify for purchase, they are up more than 40% from their purchase price, or there is no qualifying stock to replace them.

Updates to the Model Shadow Stock Portfolio will now be published six times per year in the AAII Journal, though changes will continue to only be made once every quarter. No stocks were added to or removed from the portfolio last month.

The Model Shadow Stock Portfolio, which is a real-money portfolio of micro-cap value stocks, gained 1.6% in October. By means of comparison, the DFA Micro Cap fund (DFSCX) posted a total return of 1.1% for October, while the Vanguard Small Cap Index fund (NAESX) gained 1.6% for the month.

Since its inception in 1993, the Model Shadow Stock Portfolio has a compound annual average return of 16.2% versus the Vanguard 500 Index fund’s (VFINX) gain of 9.4% per year on average over the same period.

AAII Sentiment Survey

Pessimism among individual investors jumped to a two-month high in the latest AAII Sentiment Survey. Neutral sentiment also rose, while optimism fell.

Bullish sentiment, expectations that stock prices will rise over the next six months, plunged 15.8 percentage points to 29.3%. Optimism was last at this level on September 6, 2017. This is the first time in four weeks that bullish sentiment is below its historical average of 38.5%.

Neutral sentiment, expectations that stock prices will stay essentially unchanged over the next six months, rose 3.6 percentage points to 35.4%. The historical average is 31.0%.

Bearish sentiment, expectations that stock prices will fall over the next six months, rebounded by 12.1 percentage points to 35.2%. Pessimism was last higher on September 6, 2017 (35.7%). The historical average is 30.5%.

At current levels, all three sentiment indicators are within their historical ranges. Bullish sentiment, however, is near the low end of its typical range.

The big rise in pessimism follows recent declines in the major large-cap and small-cap indexes. Many AAII members have previously expressed concerns about the possibility of a pullback or a more severe drop occurring. Tax reform could also be playing a role. While some of our members are optimistic about the prospects of tax reform being passed, about 40% of members polled in a different weekly AAII survey said the proposed legislation could hurt them.

Also having an effect on investor sentiment are earnings growth, economic growth and/or the market’s overall upward momentum (all cited as reasons for optimism). Other individual investors view stocks as being a bit too overpriced or are concerned about the lack of volatility. Political drama in Washington also continues to be at the forefront of many individual investors’ minds.

This week’s special question asked AAII members for their opinion of bitcoin and related digital currencies and blockchain technologies. More than half of all respondents (55%) have a negative view. Many say they avoid crypto-currencies, while others used the words tulips, mania, speculative, foolish and losses in their responses. Approximately 20% said they don’t have an opinion, with a lack of knowledge or understanding about bitcoin and blockchain as the primary reason why. Slightly more than 12% believe blockchain technologies have a future, but are either uncertain or downright skeptical about bitcoin itself.

Here is a sampling of the responses:

  • “Bitcoin is based on thin air. There is nothing backing it but euphoric sentiment.”
  • “Bitcoin is completely beyond my understanding. I would rather buy tulips.”
  • “A very speculative investment. I would not touch it.
  • “Bitcoin is a bubble, but the technology could be valuable.”
  • “No opinion. I still don’t understand it.”

This week’s Sentiment Survey results:

  • Bullish: 29.3%, down 15.8 points
  • Neutral: 35.4%, up 3.6 points
  • Bearish: 35.2%, up 12.1 points

Historical averages:

  • Bullish: 38.5%
  • Neutral: 31.0%
  • Bearish: 30.5%

Take the Sentiment Survey.

The Week Ahead

The U.S. financial markets will be closed on Thursday in observance of Thanksgiving. The U.S. equity markets will close early on Friday. On behalf of everyone at AAII, I wish you a happy Thanksgiving. Safe travels if you will be heading out of town.

As earnings season winds down, only 15 S&P 500 companies are scheduled to report. Included in this group will be Campbell Soup Co. (CPB), Hewlett Packard Enterprise Co. (HPE), Hormel Foods Corp. (HRL), HP Inc. (HPQ), Lowe’s Companies Inc. (LOW), Medtronic PLC (MDT) and Inc. (CRM) on Tuesday and Deere & Co. (DE) on Wednesday.

The week’s first economic report will be October existing home sales, released on Tuesday. Wednesday will feature October durable goods orders, the University of Michigan’s final November consumer sentiment survey and the minutes from the November Federal Open Market Committee (FOMC) meeting. The November Purchasing Managers’ Index (PMI) will be released on Friday.

The Treasury Department will auction $13 billion of two-year floating rate notes (FRN) on Tuesday.

Local Chapter Meetings

AAII Local Chapter Meetings offer you a variety of presentations from expert speakers who will give you their view on the world of investing. A bonus of attending a Chapter Meeting near you is the opportunity to meet other AAII members who share your interest and enthusiasm for investing. You can even share the Chapter experience with your family and friends by inviting them to attend Chapter Meetings with you!

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