by Archie M. Richards, Jr., CFP^®
November 18, 2002

Sam writes several questions. Here's the first:

"I have a regular IRA in which the majority of investments are growth mutual funds. About a third are high-tech, which is a bummer. Some of the mutual funds have high front-end charges (Class A shares). The others charge sales expenses of an extra 1% per year (Class B or C shares). The average expense ratio is 1 percent, and the funds buy and sell their securities rapidly. Should I keep what I have, or should I switch to Vanguard index funds or exchange-traded funds?"

Make a switch, Sam. Both index funds and exchange-traded funds have low costs. They also have low rates of turnover, which reduces the capital gains taxes you must pay. Over the long pull, these factors make a big difference.

Sam continues: "With prices down, is this a good time to convert to a Roth IRA?"

Yes. Ordinary income tax, as you probably know, must be paid on funds converted from a traditional IRA to a Roth IRA. But the conversion is still worthwhile. The assets are not taxable while they remain in the Roth. They can stay there indefinitely, even after age 70½. And withdrawals from the Roth are not taxable.

"Would you recommend investing a portion of the assets of a retirement account into dividend-paying stocks such as Coca Cola and Rockwell Automation?"

A small portion of assets in individual stocks is okay. But index funds should make up the core.

"In a Roth IRA, should the dividends be reinvested?"

Yes. This avoids delay in putting the money back to work. It also avoids your having to decide what to do with the dividends. Generally, the fewer investment decisions a person makes, the better the results. Let the market do the work.

Jim writes, "Two-and-a-half years ago, my stocks and mutual funds stood at $475,000. Now they're worth $275,000. I had a stroke four years ago and am trying to get back on track. Should I wait and stay with the stocks and mutual funds in hopes they will move back up. Or should I switch to asset allocation now?"

Sorry about your stroke, Jim. Asset allocation with 13-month rebalancing is the right approach (see www.ArchieRichards.com). Given a moderate level of risk, it will result in the best possible growth of wealth over the long term.

I know it's hard to sell stocks that have big losses. But the market couldn't care less what your costs are. The only thing it cares about is the future.

The short term is always uncertain. Taking big losses in the funds you hold causes plenty of anxiety. The pain is doubled if the stocks you sell rise faster during the months that follow than the investments you acquire.

Here's the best way to deal with the uncertainty: Assume from the beginning that whatever you do, you'll be wrong in the short term. Assume that if you make the shift, the stocks you hold now will outperform and that if you don't make the shift, the asset allocation program will outperform. Take it for granted that you'll be wrong in the short term no matter what you do. This lessens the guilt and the sense of loss. It helps you to realize that what happens in the short term isn't your fault. It enables you to get past the short term and move to the most promising long-term investment approach. The right time to shift to asset allocation is always now.

Richard writes, "Vanguard has a Total International Index Fund as well as separate index funds for Europe, the Pacific, and Emerging Markets. Should I buy the Total International Index Fund or the three separate funds?"

The Total International doesn't buy investments of its own, Richard. Neither does it charge its own fees. Instead, the Total International puts its money into the other three international funds you mention. It's a fund of funds. The Total International Index Fund is the one you want.