Mutual Funds May be Your Best Option

 

 

 

 

 

 

Jane M. Young

Generally the typical investor is better off investing in stock mutual funds than in individual stocks. A mutual fund is an investment vehicle where money from a large number of investors is pooled together and invested by a professional manager or management team.  Mutual fund managers invest this pool of money in accordance with a predefined set of goals and guidelines.

One of the primary benefits of investing in stock mutual funds is the ability to diversify across a large number of different stocks.  With mutual funds, you don’t need a fortune to invest in a broad spectrum of stocks issued by large and small companies from a variety of different industries and geographies.  Diversification with mutual funds reduces risk by providing a buffer against extreme swings in the prices of individual stocks.   You are less likely to lose a lot of money if an individual stock plummets. Unfortunately, you are also less likely to experience a huge gain if an individual stock skyrockets.

Another benefit of stock mutual funds over individual stocks is that less time and knowledge is required to create and monitor a portfolio.  Most individual investors do not have the time, expertise, or resources to select and monitor individual stocks.  Mutual funds hire hundreds of analysts to research and monitor companies, industries and market trends.   It is very difficult for an individual to achieve this level of knowledge and understanding across a broad spectrum of companies.  Mutual fund managers have the resources to easily move in and out of companies and industries as investment factors change.

Most individual investors appreciate the convenience of selecting and monitoring a diversified portfolio of mutual funds over the arduous task of selecting a large number of individual stocks.   Stock mutual funds are a good option for your serious money.  However, if you really want to play the market and invest in individual stocks, use money that you can afford to lose.

For diehard stock investors, there are some advantages to investing in individual stocks.  Many stock mutual funds charge an annual management fee of between .50% and 1% (.25% for index funds).  With individual stocks, there is a cost to buy and sell the stock but there is no annual management fee associated with holding stock.

Another advantage of individual stocks is greater control over when capital gains are recognized within a non- retirement account.  When you own an individual stock, capital gains are not recognized until the stock is sold.   In a high income year, you can delay selling your stock, and recognizing the gain, to a year when it would be more tax efficient.   On the other hand, when you invest in a stock mutual fund you have no control over capital gains on stock sold within the fund.  Capital gains must be paid on sales within the mutual fund, before you actually sell the fund.  Mutual funds are not taxable entities, therefore all gains flow through to the end investor.

Are Your Bonds Safe?

 

 

 

 

 

 

Jane M. Young

Let’s compare some differences between stocks and bonds.  When you buy a bond you are essentially lending money to a corporation or government entity for a set period of time in exchange for a specified rate of interest.  When you invest in the stock market you assume an ownership position in the company whose stock you are purchasing.  As a result, the value of your investment will fluctuate based on the profit or loss of the underlying company.  With the purchase of a bond the value of your investment hould not fluctuate based on the financial performance of the issuer, assuming it remains solvent.  You will continue to receive interest payments according to the original terms of the agreement until the bond matures.  Upon maturity the amount of your original investment (principal) will be returned to you along with any interest that is due.   As a general rule, stocks are inherently more risky than bonds, therefore investors expect to receive a higher return.

Bonds may appear to be safe but they are not without risk. Currently, there is some risk associated with low interest rates that may not keep up with inflation.  This is especially true with many government bonds. Two additional risks typically associated with bonds include default risk and interest rate risk.

Default risk is the risk that the issuer goes bankrupt and is unable to return your principal.  Most bond issuers are assigned a rating to help investors assess the potential default risk of a bond.   Generally, investors are compensated with higher interest rates when taking a risk on lower rated bonds and receive lower interest rates on higher rated bonds.

Interest rate risk is based on the inverse relationship between interest rates and the value of a bond.  When interest rates increase the value of a bond will decrease and when interest rates decrease the value of a bond will increase. If you hold an individual bond until maturity your entire principal should be returned to you.  You have the control to keep the bond until maturity and avoid a loss.  However, if you need to sell before maturity you may lose some principal. The loss of principal is greater for longer term bonds.  This needs to be weighed against the benefit of a higher interest rate paid on longer term bonds.

Bond mutual funds can provide diversification and reduced default risk because your money is pooled with hundreds of other investors and invested in bonds from a large number of different entities.  If one or two entities within the mutual fund go bankrupt there will be minimal impact on each individual investor.  However, with mutual funds you have less control over interest rate risk.  When interest rates increase, bond fund managers often experience a high rate of withdrawals forcing them to sell bonds at an inopportune time.  This usually results in a loss of principal, the severity of which is greater for longer term bond funds.

Pitfalls in Taking Early Social Security

Jane M. Young CFP, EA

 

You can begin taking Social Security at age 62 but there are some disadvantages to starting before your normal retirement age.   The decision on when to start taking Social Security is dependent on your unique set of circumstances.  Generally, if you plan to keep working, if you can cover your current expenses and if you are reasonably healthy you will be better off taking Social Security on or after your normal retirement age.  Your normal retirement age can be found on your annual statement or by going to www.socialsecurity.gov and searching for normal retirement age.

Taking Social Security early will result in a reduced benefit.  Your benefits will be reduced based on the number of months you receive Social Security before your normal retirement age.    For example if your normal retirement age is 66, the approximate reduction in benefits at age 62 is 25%, at 63 is 20%, at 64 is 13.3% and at 65 is 6.7%.  If you were born after 1960 and you start taking benefits at age 62 your maximum reduction in benefits will be around 30%.

On the other hand, if you decide to take Social Security after your normal retirement age, you may receive a larger benefit.  Do not wait to take your Social Security beyond age 70 because there is no additional increase in the benefit after 70.  Taking Social Security after your normal retirement age is generally most beneficial for those who expect to live beyond their average life expectancy.  If you plan to keep working, taking Social Security early may be especially tricky.  If you take benefits before your normal retirement age and earn over a certain level, the Social Security Administration withholds part of your benefit.   In 2012 Social Security will withhold $1 in benefits for every $2 of earnings above $14,640 and $1 in benefits for every $3 of earnings above $38,880.  However, all is not lost, after you reach full retirement age your benefit is recalculated to give you credit for the benefits that were withheld as a result of earning above the exempt amount. 

Another potential downfall to taking Social Security early, especially if you are working or have other forms of income, is paying federal income tax on your benefit.  If you wait to take Social Security at your normal retirement age, your income may be lower and a smaller portion of your benefit may be taxable.  If you file a joint return and you have combined income (adjusted gross income, plus ½ of Social Security and tax exempt interest) of between $32,000 and $44,000 you may have to pay income tax on up to 50% of your benefit.  If your combined income is over $44,000 you may have to pay taxes on up to 85% of your benefit. 

The decision on when to take Social Security can be very complicated and these are just a few of the many factors that should be taken into consideration.

 

 

 

Luncheon Workshop on Social Security – September 19th

Please join us for our next Fireside Chat Luncheon!  I will touch on several areas that may impact your Social Security benefits including pointers on when to start taking Social Security, taxation of your benefits and spousal and survival benefits.

We will have a light lunch available starting at 11:30 and the presentation will begin at 11:45.

When & Where:

7025 Tall Oak Drive, Suite 210

Colorado Springs, CO 80919

Wednesday, September 19th, 2012

This workshop is free of charge by you must register.  Please call Shelby at (719)260-9800 to reserve a slot for this session; seating is limited.

 

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