by Archie M. Richards, Jr., CFP^®
November 22, 2004

Ralph writes that he has $100,000 in an IRA and $400,000 in a non-IRA account. He wants to invest as this column has suggested: 30 percent U.S. stocks, 30 percent foreign stocks, 20 percent real estate investment trusts (REITs), and 20 percent long-term bonds. He wonders whether the IRA and the non-IRA segments should each be given complete allocations separately, or should the high-income investments be placed in the IRA while the others go into the regular account. In addition, Ralph, who recently retired, wants to withdraw 5 percent a year - currently $25,000. Should this be paid from the IRA or the non-IRA investments?

I would acquire two of everything, Ralph, and make complete allocations in both the IRA and non-IRA accounts.

The alternative, as you say, is to place just the income-producers into the IRA. Long-term bonds currently yield more than REITs. You have $500,000 total, and bonds take a 20-percent share. 20 percent of $500,000 is $100,000. You would therefore concentrate $100,000 of bonds in the IRA and place the other investments outside.

Let's say we then experience the same trends as occurred during the recession of 2001. The stocks perform poorly while the REITs and the bonds do well. In the following year, you'd need to rebalance.

Rebalancing is a key part of successfully investing. Every year (make it at least a year and a day to avoid short-term gains) you would identify the investment segments that have strayed significantly in value from their original percentages and bring them back to the original.

Okay, after the stocks fall and the bonds rise, you'd want to reduce your holdings of bonds back to 20 percent of the then-current value of all your holdings. But you couldn't transfer the bond proceeds over to the non-IRA account, because this would constitute an IRA distribution and trigger high-taxed ordinary income.

To achieve the desired overall percentages, you'd have to acquire within the IRA portions of all of the investment segments you have outside. Since you'd be working with the proceeds of only a portion of the bond account, the amounts of the other investment segments purchased in the IRA would probably be too small.

To avoid this problem, set up two discrete portfolios from the beginning - one in the IRA and the other outside. Do everything twice and rebalance the two sides separately.

Minimize the number of qualified plans you have, to avoid having to create fully diversified portfolios in each plan.

All this awkwardness is caused by Congress, whose members are prone to talk out of both sides of their mouths. When the poor complain about taxes, the legislators can say, "Yes, but we're taxing the rich at higher rates." When the rich complain about taxes, the legislators can say, "Yes, but we provide plenty of loopholes, like IRAs."

As a result, investors can't readily construct the best and safest kind of portfolio, namely, diversification within each investment sector and diversification among various investment sectors.

As to your $25,000 income, Ralph, pay it from your non-IRA accounts. This delays your IRA distributions for as long as possible and postpones the payment of taxes.