Even without tax deduction, contributions to an IRA pay off in long run

MUTUAL FUNDS

March 08, 1992|By WERNER RENBERG

In the next few weeks, you'll probably note an increasing number of advertisements by mutual fund companies urging you to make your 1991 contribution to an individual retirement account (IRA) before the April 15 deadline for your 1991 federal income tax return.

Whether or not an IRA contribution to a fund is deductible from income, such annual investments can pay off in the long run.

To help you in planning your retirement strategy, you can get useful brochures for free from some companies, such as Fidelity (800-544-8888), T. Rowe Price (800-541-0295) and Scudder (800-225-2470).

Price even offers its Retirement Planning Kit on a diskette that you can use in a personal computer ($15; 800-541-4041).

But what if you're close to retirement or already retired? What if you're more concerned about whether you'll be able to take the money you need out of your IRAs as long as you need it than about whether you should put money in?

Clearly, it's important to accumulate a retirement nest egg using IRAs -- via annual contributions and rollovers of lump-sum distributions from employers' plans -- and other assets. But, once you're retired, preserving your capital might be even more urgent.

This calls for a different investment strategy: one that'll help you avoid the risk of outliving your money or reducing your living standard by providing for sufficient growth of capital to generate the cash you require while exposing you only to moderate fluctuation.

The table illustrates the kinds of challenges and possibilities you face when you start to plan such a strategy.

It shows what would have happened if you had retired Jan. 1, 1977, with $150,000 in a retirement account, sheltered from current taxes, that was invested in stocks (Standard & Poor's 500 Index), long-term corporate bonds (Salomon Brothers High-Grade Bond Index) or a balanced mutual fund (Lipper Balanced Fund Index.)

Even if past performance doesn't guarantee future results, studying such data can help you understand how different investments behaved under various circumstances in the past and, thus, help you in your planning.

The table assumes you would have withdrawn $10,000 in 1977 and raised your withdrawal in each subsequent year by the inflation rate. (Let's suppose Internal Revenue Service rules for minimum IRA withdrawals wouldn't have been a problem.)

By last year, you would have taken out $22,986 -- equivalent to $10,000 in 1977 purchasing power -- bringing the total withdrawn in these 15 years to $251,644.

While the average annual total returns for stocks (14.3 percent), a balanced fund (11.9 percent) and bonds (10.1 percent) weren't far apart -- and all widely exceeded the 5.9 percent inflation rate -- the portfolios' results differed a lot. A major reason: differences in the extent and timing of stocks' and bonds' ups and downs.

If you had invested the $150,000 in the S&P 500, you would have ended 1991 with a portfolio still worth $230,674. While stocks had three negative years -- down 7.4 percent in 1977, 5.0 percent in 1981 and 3.1 percent in 1990 -- their returns exceeded 30 percent in four of the years.

If you had invested in high-grade bonds to match the index, your account would have been depleted in 1990. Flat and negative returns in the first five years, when inflation peaked at 13 percent and bond prices tumbled, had retarded this portfolio's growth.

If you had invested in a balanced fund (60 percent stocks, 40 percent bonds), you also would have been down in years the stock market dropped, but you still would have had $121,363 left.

While hypothetical, these are not unrealistic numbers. You could have invested in equity, bond or balanced funds that have

outperformed the indexes over this 15-year period.

What inferences can you draw in planning for your future -- other than the importance of starting with the largest possible nest egg?

* You may assume, say, an average 4 percent inflation rate in projecting withdrawals -- meaning you'd require $14,802 in 10 years and $18,009 in 15 years for every $10,000 you need this year -- but don't rule out the possibility that inflation can accelerate from time to time.

* Because stocks are clearly the superior long-run performer, good stock funds belong in your portfolio, even if returns in future years are closer to the long-run average of 10 percent.

Because of their volatility, however, you'll want to hold their share of your assets to a level you can be comfortable with.

* If long-term bond yields of around 8 per cent are indicated, bonds would have less potential for appreciation from declining interest rates than investors enjoyed not too long ago. But a meaningful allocation to bond funds -- for diversification against stock market risk and for income -- seems appropriate nonetheless.

* As long as inflation and money market yields remain about where they are, excessive reliance on money market funds can hold down your portfolio's performance.

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