Reader Questions Answered

VectorVest and Trading Forex in IRAs

Back in action after nearly a week off leading up to my 40th birthday!

It’s nice to see that the markets didn’t really do very much while I was away, which actually makes what I wrote about in my last post, Watching for a Market Explosion or Implosion, even more so. Now I’m stressing about getting my holiday shopping taken care of ASAP (don’t for get the The Trader’s Wish List). ­čÖü

I got a couple of quick questions while I was on break (along with several happy birthdays). The first was this:

Are you familiar with the market timing and analysis “system” used in/by VectorVest? If so, what are your thoughts about it as a research source?

I personally haven’t ever looked at VectorVest (coincidentally, one of the commercials was just running on CNBC). I encourage any reader of this post to share their views if they are or have used the service, however.

The other quick question was this:

Can you trade currency with a Roth IRA acct?

While you can certainly trade currency ETFs in an Individual Retirement Account (Roth or otherwise), actually trading spot forex, or even futures, is a harder thing because of their highly speculative nature. If you have your IRA account set up with a traditional broker or other financial institution then the answer is very likely to be negative. There are ways, however, to open IRA accounts which are less constrained (can invest in real estate, etc.). I forget the exact term for those accounts (self-directed IRA, or something like that).

Trading Tips

Borrowing to Fund Your Trading or Investing

I’ve recently been thinking about some things├é┬árelated to my own personal finances in regards to taxes, investing, and debt pay-down. Over the next couple months I have quite a few important decision to make. All of this thought got me to thinking about the idea of borrowing to trade or invest. It’s a subject that comes up from time to time among market participants.

Borrowing for Trading
For the record, I’m not generally a proponent of borrowing to fund one’s trading. This is├é┬áespecially true├é┬áif you don’t have sufficient non-trading income or resources├é┬áto pay the loan back if the trading doesn’t produce the anticipate performance. The risk of disaster is too great.

You do not want to be in a position where you take some trading losses and cannot make the requisite loan payments. That’s a quick way to destroy your credit and/or personal relationships. It’s really easy to get caught up in positive thinking and be sure you’ll do well enough with your trading to repay the loan. We don’t need to look too far to see what that sort of mindset did to people in the housing market.

Borrowing to Invest in Your Retirement
Now, having said that, there can be instances where borrowing (or not paying down debt, which is effectively the same thing) to fund investing or trading├é┬ámakes sense. That’s when you can lock in a spread. The easiest example of this would be borrowing at 5% and being able to put that into a 7% bond, or something of that sort. There are other situations where things are a bit more complex.

Consider an IRA (or another equivalent tax-deferred retirement investment account). Depending on your marginal tax rate and the rate you’d pay on the debt in question, it could make a lot of sense to borrow to fund a contribution to that account. Let me walk through an example to demonstrate.

The maximum current annual tax deferred contribution to an IRA account for an individual is $5000. Let’s say that we can borrow at 10% and that our marginal tax rate is 28%. The length of the loan impacts how much of a benefit we see in doing so. With that in mind I’ll present two different scenarios. The first is a 1-year loan. The second is a 5-year loan.

1-year Loan
Tax Benefit: $1400 (28% marginal tax rate x $5000)
Loan Interest: $275 ($439.58├é┬ámonthly payment├é┬áx 12 – $5000 initial amount)
Net Benefit: $1125

5-year Loan
Tax Benefit on the IRA investment: $1400 (28% marginal tax rate x $5000)
Loan Interest :├é┬á$1374 ($106.24├é┬ámonthly payment├é┬áx 12 – $5000 initial amount)
Net Benefit: $26

That’s just a first cut look at things. If that $1400 tax benefit is actually a tax refund, it could be used to paydown 28% of the loan, reducing the total interest cost of the loan, especially for the longer-term one.

I’m not even including the actual return on the IRA investment in the equations here. At a 5% rate of return (compounded), that $5000 grows to over $8000 in 10 years and over $13,000 in 20 years.

This does, of course, assume that you can make the requisite payments from your normal pay since you certainly won’t be pulling money out of your IRA to do so – unless you want to get hit with├é┬áa penalty and tax bill. Run the numbers, though. See if it makes sense in your circumstance.