My Roth IRA: Beating the Market and a Look Under the Hood

I don’t do individual stock reviews and such these days since I’ve taken more of a passive/low-fee approach over the years compared to active stock-picking (hence my other site ETF Base which is focused solely on ETF investing and strategies). Anyway, what I set out to do years ago was to pick a basket of high yielding stocks for my self-directed Roth IRA account and keep reinvesting the dividends in the same account in a tax-free manner. As it turns out, the account has beaten the return of the S&P500 over the past 7 years and I have the detailed evidence to back it up. When someone beats an index over a prior month period or even a prior year period because they picked Apple stock or whatever, that’s not much of an achievement and can often be attributed purely to luck (random variability actually; I don’t believe in good or bad luck). But with the approach I took with high yielders in various sectors, it appears to have won out over a slow moving US market this decade.

 

Roth IRA Benefits

The beauty of the Roth IRA or any other IRA (details about it can be found here) is that dividends and capital gains aren’t taxed. See, any funds you invest in a Roth are from post-tax dollars you’ve already earned, so dividends and capital gains go untaxed for the life of the account, as long as you wait until 59 1/2 before withdrawing funds. Granted, there are income limits to contribute which are the following:

The Roth IRA MAGI (modified adjusted gross income) phase out ranges for 2012 are:

• Single filers: Up to $110,000 (to qualify for a full contribution); $110,000–$125,000 (to be eligible for a partial contribution)
• Joint filers: Up to $173,000 (to qualify for a full contribution); $173,000–$183,000 (to be eligible for a partial contribution)

So, anyone under those limits can contribute up to $5,000 each or $10,000 per couple. It’s not as much as you can sock away in a 401(k), but I like funds in this account over a 401(K) anyway since 401(k) plans tend to have higher expense ratios, are likely to see a higher tax rate in retirement and many other reasons I outlined in this article on Roth IRAs over 401(k)s.

 

Under the Hood of My Roth IRA

As I mentioned, over the years, I’ve chosen stocks from various sectors, often yielding about 6-9%, with the assumption that even if they don’t have much capital appreciation, the dividends alone will roughly match the market and the few that have capital appreciation will push it the total return over the edge. That appears to be what happened. In order to keep fees in check, I only buy into a new position when I have over $1000 in cash, so the trading fee is always less than 1% of the amount purchased.  And I don’t sell (or trade).  I’ve only sold 1 position in the 7 years as I recall. Anyway, in order of % gain (to the right), here are the positions which don’t include dividend returns:

(click to enlarge)

 

• MO (Altria) is my strongest performer (I also own VG Vector group below). While I’m not a fan of tobacco products in general, as an investment, it’s well-known that they are often a great investment. High cash flow, high dividends, and many settlements have already been reached, which makes catastrophic litigation unlikely.
• ACC is the college real estate ETF. I love this one since I got into college real estate investing myself. What a concept! Immune to the housing crisis at large, students are always going to need housing. It’s been a stellar performer.
• HYG – I bought this high yield bond fund during the financial crisis and it’s given my 8-10% yields annually not to mention some capital gains.
• T, VZ – both AT&T and Verizon have nice yields and since the launch of the iPhone, they’ve been doing well with a new source of income for the data plans nobody can live without.
• AGNC is throwing off a fat 15% yield which would usually raise a red flag as a diving stock with an artificially high yield, but this one’s only been moving up, not down, indicating the market is not pricing in a cut.

The rest of done so-so when you consider the 6-8% dividends over the years – roughly a wash even on the ones in the red.

Returns Calculated

The thing is, it’s tough to do an apples to apples comparison when you’re making annual investments and trying to compare to a fixed equity index. So, what I did was used the Internal Rate of Return (simple Excel function fully explained in that post) to show what my annualized return was given the periodic investments I made.

The calculation showed that I returned 5.4% annually net of trading expenses.
When I go back to the inception of the account, the S&P500 (SPY ETF) returned 16% over the same period which breaks down to 2% annualized. If you consider that SPY pays a dividend hovering around 2% over the years, then let’s just call it a 4% annualized return.

 

So, over a 7+ year period, I beat the market by about 1.4% net of all fees.

 

Not too shabby. Virtually no professional money managers to that – ever. They tend to lose money to the market and collect 7 figure salaries doing so. Over this time period, hedge funds have done very poorly as well while collecting 2 and 20. So, I thought it was worth sharing.

While a 1.4% beat may not seem like much, since we’re all long-term investors here, let’s take a 20 years time horizon for say, a pension rollover.  If I had rolled over $100,000 and earned 4% vs. 5.4% a year, at the end of 20 years, it would be worth $219K vs. $286K, a difference of $67,000!  That’s a pretty big difference for such a small increase in returns, but that’s the difference between meeting the market and beating the market.  Of course, those are future dollars and in present value, let’s say it’s only say, $35,000.  It’s still significant and depending on how much you invest over a lifetime, or how much you exceed market returns by, the difference could be huge.

If you’re interested in high yield investing, there are numerous options out there besides dividend stocks, including Preferred Stocks and High Yield Master Limited Partnerships.

 

$600 to Open a Roth IRA!

As it turns out, if you don’t have your own Roth IRA now and want some additional funds to start it up, you can get up to $600 depending on how much you roll over or fund the account with via this promo from OptionsHouse.  If you are just starting out with a $5,000 new account or smaller, the best deal is 100 Free Trades.  You won’t even need them, but it’s worth it!  No other online brokerage is offering anything like it and their $3.95 stock trades are as low as it gets in the industry.  For the purposes of a trade or two a year using the method I outlined, it’s a great deal.  Check out the signing bonus deal here or the 100 Free Trades here.