Q&A Time: Rule of 72 and Withdrawing Roth Conversions

Question:

For years I have been taught that the stock market, over the long run, grows at a rate of 11%. Recently, I heard a commentator challenge this statement. He said in 1929, the Dow was around 300. Today, it is around 12,000. This means that it has doubled about five and a half times in 82 years. Using the rule of 72, this comes out to only 4.8% per year. Am I missing something? What’s the real story?

Answer:

The rule of 72 states to find the number of years required to double your money at a given interest rate, you divide the compound return into 72. The result is the approximate number of years that it will take for your investment to double.

Your math above is correct. For the past several months, we have seen more pundits talk about price appreciation. However, there is another aspect to a stock’s total return: Dividends. If you look at Large Cap stocks as a whole, the total return from 1926 through 2010 is 9.9%, using the geometric mean and 11.9%, using the arithmetic mean. Capital appreciation was 5.5% or 7.5%, using the geometric and arithmetic mean, respectively. Dividend income was 4.1%. If you add 4.1% in dividends to the 4.8% the commentator quoted, you are closer to the 9% total return you are used to seeing for the Dow. Additionally, if you are dollar cost averaging into the market by investing a set amount into the market at regular intervals, and you reinvest your dividends, generally, your performance should be better than the market’s performance.

Question:

I opened an IRA in 1990, transferred that IRA to Fidelity in 1993. Then I converted it to a Roth IRA in 1998. I made annual contributions of $2,000 from tax years 1990 to 1997 for a total of $18,000, before the conversion to a Roth in 1998. I know Roth contribution dollars can be withdrawn without penalty if they are not from the last five years, but what about Roth conversion dollars? I am 44 years old. Can any conversion dollars be withdrawn without penalty?

Answer:

You must wait five years to withdraw any money that was converted from a traditional IRA to a Roth IRA. Remember, in a Roth, you can only withdraw contributions before age 59½ without penalty.

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