<FOOLISH FOUR PORTFOLIO>

Foolish Four IRAs
...and we reveal "How Much?

by Ann Coleman
([email protected])

Alexandria, VA (December 4, 1998) -- Well, folks certainly are excited about our Pinocchio Portfolio. I've gotten a lot of mail with many questions, mostly "when," "which" and "how much" -- patience, please! All will be revealed in due time (meaning when I get it all figured out).

One easy-to-answer question is "how much?" We will be starting with $4,000 -- a nice even grand per stock. Of course, it won't be even by the time we figure out how many shares goes into $1000 and we take a bit out for commissions, but this is a good start-up figure. What if you don't have that much? We'll have a $2,000+ plan, too. Still a bit light? No more McTaco Hut for you! Start taking your lunch and maybe next year you, too, can own the Foolish Four!

It's just coincidence, but $4000 is equal to a married couple's IRA contribution or the amount a single person can contribute for this year and next. (You can deposit $2000 anytime this year through April 15 of next year for 1998, and another $2000 for 1999 anytime after January 4.)

I mention IRAs because the Foolish Four is particularly well suited for IRA investments. Since the strategy has you trading an average of two stocks per year, and since those trades will hopefully be generating a lot of capital gains, keeping your Foolish Four stocks in an IRA is a great way to avoid taxes on those gains.

As suggested in the 13 Steps to Investing Foolishly (has everyone read the first 6 Steps?), you should max out contributions to your employer's sponsored 401(k) plan first, then max out an IRA, then consider a regular brokerage account. There may be exceptions, such as when an employer plan doesn't offer matching funds and is limited to really underperforming mutual funds, but in general, that's the best strategy.

This year, the Roth IRA offers a better deal than the traditional IRA. If you don't have a Roth IRA, and you qualify for one, I strongly urge you to check out this option. The rollover issue aside, for most people of moderate income, the Roth is a wonderful, wonderful way to save for retirement. If you are still contributing to your old traditional IRA, check out the possibility of switching this year's contributions to a Roth.

For those of you who spent the last year in a coma, the Roth IRA makes you give up your current tax deduction on IRA contributions (which not everyone qualifies for, by the way). In return, the distributions when you retire are entirely tax free.

If you still have money to invest after you've taken advantage of every tax-advantaged kind of account that you qualify for, there's always the traditional brokerage account. Tax-advantaged retirement accounts are great and can make you a millionaire in time, but if your ambitions are larger, you might need a regular brokerage account, too. Is the Foolish Four a good choice for regular brokerage accounts?

Well, of course -- with a few caveats. The Foolish Four's mechanical approach to picking stocks may be best for many people no matter what kind of account they have. Ever think you were the perfect short indicator? Buy a stock and watch it drop? This Four's for you! Not everyone has the knack or skill or confidence or time to pick stocks.

But you should know that long-term buy-and-hold strategies such as the Cash-King (soon to be Rule Makers) portfolio strategy, which is buying stocks that it hopes to hold for the next 20 years, and the Fool Portfolio (soon to be Rule Breakers), which buys companies that it expects to dominate the dominant industries well into the next century, have a built in tax advantage -- in some cases, they can be better than the traditional IRA. Yep, that's right.

Capital gains taxes are not paid until you sell an asset. That's a deceptively simple statement. Here's how it works, situation exaggerated a bit to illustrate the point.

Put $4,000 in a traditional IRA and $4,000 in a regular brokerage account. In both accounts you invest that $4,000 in Net Domination (NTD on the NMSE -- the New Millennium Stock Exchange). You buy the stock and do a Rip Van Winkle. Fast forward 20 years. You are 59 1/2 and ready to retire. Whattaya got?

Well, Net Domination has done very well. After an initial growth spurt that made Amazon.com <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: AMZN)") else Response.Write("(Nasdaq: AMZN)") end if %> look like a utility company, it settled down and dominated the Internet business as a mature company. Its average growth rate while you napped was a blistering 25% a year. Each of your accounts is now worth $381,584.87.

Since you have never sold a single share, you've never paid taxes, and so your brokerage account has grown at the same rate as your IRA.

Now, you retire to a small island off the coast of Florida with several gallons of mosquito repellent and arrange for a helicopter to airlift in a case of rum every month. Which of your accounts will pay for most of the rum?

Withdrawals from your IRA account will be taxed at regular income rates. Since you are not going to be in any shape to actually earn income, and your needs are modest, your withdrawals are your only income. The IRA money is taxed at 15% (roughly). Withdrawals from your brokerage account, however, are taxed at the lower capital gains rate of 10%. In effect, your buy-and-hold strategy has functioned something like a tax-advantaged retirement account. The advantage came from simply not selling the stock and from the lower capital gains rates.

I hope this isn't too confusing. Here's the Cliffs Notes version:

If you have both a tax-advantaged retirement account and a brokerage account, use the retirement account for strategies that call for selling stock on a regular basis. Put the stocks you intend to keep for many years (if you have any) in the brokerage account.

I hope everyone who needs to set up a brokerage account is now in paperwork hell, just like me. There IS a light at the end of the tunnel.

Next week: Stock Strategies.

Fool on and prosper!

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Current Dow Order | 1998 Dow Returns

12/04/98 Close

Stock Change Last -------------------- UK - 3/16 43.19 IP + 1/16 43.50 MO + 3/16 55.56 EK + 1/2 73.56

Day Month Year FOOL-4 +0.21% -0.61% 13.44% DJIA +1.54% -1.10% 14.01% S&P 500 +2.30% 1.11% 21.24% NASDAQ +2.50% 2.75% 27.56% Rec'd # Security In At Now Change 12/31/97 276 Philip Mor 45.25 55.56 22.79% 12/31/97 206 Eastman Ko 60.56 73.56 21.47% 12/31/97 289 Int'l Pape 43.13 43.50 0.87% 12/31/97 291 Union Carb 42.94 43.19 0.58% Rec'd # Security In At Value Change 12/31/97 276 Philip Mor 12489.00 15335.25 $2846.25 12/31/97 206 Eastman Ko 12475.88 15153.88 $2678.00 12/31/97 289 Int'l Pape 12463.13 12571.50 $108.38 12/31/97 291 Union Carb 12494.81 12567.56 $72.75 Dividends Paid YTD $1092.81 TOTAL $56721.00 </FOOLISH FOUR PORTFOLIO>