Roth IRA Horse Race

This goes hand in hand with the Roth 5 year ladder conversion.

Credit goes to MadFIentist

Not gonna copy his whole post and examples, but
When you convert from a Traditional IRA to a Roth IRA, you have the option of undoing the conversion before you file your tax return (this is called a Roth recharacterization). That means, you could execute the conversion in January and then rewind the conversion by April 15th of the following year (or October 15th, if you file an amended return) and the IRS treats it as though the conversion never happened.

To build a Roth IRA Horse Race, you’d instead do two different conversions into two separate (and empty) Roth accounts. So in this example, you’d convert $10,000 worth of Total Stock Market index fund into it’s own Roth account and $10,000 worth of Total Bond Market index fund into a separate Roth account (segregating the funds like this will make the recharacterization process much easier). This will result in converting twice as much as you would actually like to convert for the year."

Then you recharachterize the loser back to a Traditional.


Good tip, although I think you mean “recharacterize the loser back to a Traditional.”

totally did. OP fixed.

The basic idea here is that you have a 1.75 year option on the performance of your converted account (optimally from Jan 1st to Oct 15th next year, the extension deadline on the prior year’s taxes, which is the latest you can recharacterize a conversion). If the account does well, you keep all the profits tax free since it’s a Roth now. If the account loses money, you recharacterize and essentially share the loss with the government (or will eventually when you pay less tax on that Traditional withdrawal down the road).

There are lots of different approaches to Roth conversions, but if you understand options, the main point is that the value of an option is bigger the longer the timeframe and the higher the volatility of the investments. Thinking that way can help you approach these things the right way.


I’ve got to read up on conversion rules for partial conversions. For some reason, I thought a partial ended up being much more complicated that this.

Anyone have a recommendation for a good place to get the ground rules?


xerty, any suggestions for funds that are still boglehead-ish that can be held long-term? Seems like that might be in contradiction though. I guess it would not be advisable to change AA to try to max the horse race, and perhaps domestic vs international might be enough.

You could try a straight index fund vs. inverse of the fund (important NOT to select a leveraged inverse). An example may be SPY and SH for the SP&500.

This would be for a scenario where you believe the markets will move in a very clear direction over the time period, but open to either direction. There will be some tracking error risk however (see fact sheet for ProShares SH later).

Technically you could look for a portfolio that will also perform well in a sideaways (and not volatile) market so you have all three directions covered. An ETF which sells covered calls comes to mind. PowerShares’ S&P500 Buy-Write ETF (PBP) may be the largest by AUM, but it’s still fairly low volume and likely wider bid/ask spreads.

SPY vs. SH Chart example

ProShares SH Fact Sheet

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For normal indexes, you’d want high and preferably uncorrelated volatile investments. Maybe EEM/VWO for emerging market stocks and TLT for long term treasuries? Gold maybe, or a gold miners fund like GDX.

But honestly, the option value is worth so much if you have something really risky that you should be willing to consider off the wall stuff like GBTC, the otc bitcoin trust, despite it trading at a 50-75% premium to their holdings. If bitcoins double, you keep all that tax free; if they become completely worthless (unlikely), you will share that loss with the government, say only losing 2/3 of “your” money net of the tax effect. Heads you make $1, tails you lose $0.66, average after tax return is 17%, pretax equivalent 26%. Where are you going to get returns like that?


I am keeping an eye on this space since CFTC is approving BTC options which could lead to long and short ETFs that could work for this type of strategy.

[quote=“therivler1, post:1, topic:688”]
Credit goes to MadFIentist [/quote]

Actually I suggested a more detailed approach to this strategy 12+ years ago, sans the “Horse Race” name:

There is no reason this can’t be pushed beyond portfolios down to individual investments.

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Nice, didn’t realize. A man before his time! Or, you need a blog and some slick article naming :wink:

Does this strategy make sense for individuals that are not yet retired or starting a Roth Conversion Ladder but meet the income eligibility for Roth contributions? Obviously, it doesn’t make much sense to contribute to an IRA then perform a backdoor Roth if you are eligible to just contribute to the Roth in the first place. However, with a little extra effort, I could see this strategy giving a slight edge by contributing to an IRA and starting a Roth IRA Horse Race via conversion ladder.

It has the benefit of not paying taxes on the converted gains, but also being able to harvest any re-characterized losses. You can win both ways if one investment gains and the other loses.

Actually it can. Many states exempt a limited amount of pension/taxable IRA income as a concession to poor retirees (sometimes with an age requirement, but sometimes not), and that often applies to taxable IRA conversions. So if

  1. Your state has an income tax,
  2. Your state allows a state tax deduction for traditional IRA contributions, and
  3. Your state exempts small amounts of taxable IRA income

Then it absolutely makes sense to backdoor your Roth contribution rather than making them directly since you’ll pick up a a free state tax deduction on the full amount. For a 5% state tax and a $5500 IRA contribution, this saves about $250/year in state taxes. Not a huge windfall, but it’s not much work submitting a conversion form, and many brokers will just let you tell them to do a conversion over the phone. SC and IL are good examples, lots of details here:

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I’m planning to do my first Roth horse race next year, starting with three horses. My Trad IRA is currently with Schwab. I have some questions, especially for those who had entered the race at Schwab.

a) Is there a fee to enter the race (Trad to Roth IRA conversion)? I guess not, because there is no fee to open a Roth IRA account. And I assume that Schwab does not charge for internal asset transfer?

b) Do I need to mail in the application to enter the race? Or can everything be submitted online?

c) When the winner is known, are there any fees to withdraw the loser horses (re-characterization) ? Again, can this be done online?

Thank you!

a- No fees as far as I know. At least at TDA and I assume Schwab is the same.

b- You can typically fax it or attach a pdf to a secure message to them.

c- Never done it, but likely no fees and can be done online.

In any event, it’s no worse than sending a one page form via USPS and sig guarantee isn’t required.

Article on various 2018+ conversion strategies, limited primarily by the lack of conversion recharacterizations by the new tax law.