Financially Get a Jump Start on 2017

office pictures may 2012 002The beginning of a new year is a good time to evaluate your finances and take steps to improve your financial situation.  Start by reviewing your living expenses and comparing them to your income.  Are you living within your means and spending money in areas that are important to you?  Look for opportunities to prioritize your spending where you will get the most benefit and joy.

This is also a good time to calculate your net worth to see if it has increased over the previous year and evaluate progress toward your goals.  To calculate your net worth, add up the value of all of your assets including real estate, bank accounts, vehicles and investment accounts and subtract all outstanding debts including mortgages, credit card balances, car loans and student loans.

With a better understanding of your net worth and cash flow you are ready to set some financial goals.  Start with the low hanging fruit including paying off outstanding credit card balances and establishing an emergency fund.  Maintain an emergency fund equal to at least three months of expenses.   Once your credit cards are paid off you may want to focus on paying off other high interest debt.

After paying off debt and creating an emergency fund, it’s advisable to get in the habit of saving at least 10% of your income.   Saving 20% may be a better goal if you are running behind on saving for retirement.

Take advantage of opportunities to defer taxes by contributing to your company’s 401k.  If you are self- employed create a retirement plan or contribute to an IRA.  Take advantage of any match that your employer may provide for contributing to your retirement plan.  If you are already making retirement contributions, evaluate your ability to increase your contributions.  If you have recently turned 50 you may want to increase your contribution to take advantage catch-up provisions that raise the contribution limits for individuals over 50.

As the new year begins you also may want to evaluate your career situation.  Saving and investing is just part of the equation, your financial security is largely dependent on career choices.  Look for opportunities to enhance your career that may result in a higher salary or improved job satisfaction.  It may be time to ask for a raise or a promotion or to explore opportunities in a new field.  Consider taking some classes to sharpen your skills for your current job or to prepare you for a new more exciting career.

You may have additional goals such as buying a new home, contributing to your children’s college fund, remodeling your house, or taking a big vacation.  Strategically think about your priorities and what will bring you satisfaction.  Start the year with intention, identify some impactful financial goals and create a plan.  Formulate an action plan with specific steps to help you meet your goals.

Risk and Your Investment Portfolio – Part 1

 

Jane Young, CFP, EA

Jane Young, CFP, EA

Deciding upon an asset allocation is one of the first and most significant decisions to be made when you start investing.  Your asset allocation is the percentage of different types of investments such as cash, bonds, stock or real estate that make up your investment portfolio.  Probably one of the most important allocations is that between investments in the stock market and investments in interest earning vehicles such as bank accounts, CDs and bonds.  An ideal asset allocation provides a balance between risk and return that helps you meet your goals but doesn’t keep you awake at night.

There is a trade-off between risk and return.  Generally, if you want a higher return you need to assume a higher level of risk.  Investment risk comes in many different forms with the most common being stock market risk.  Historically, over long periods of time, the stock market has out-performed most other investments.  However, in the short term it can be extremely volatile, including years with negative returns.  In the extreme case you could lose your entire investment in an individual stock.  To reduce risk in the stock portion of your portfolio, consider buying diversified stock mutual funds. You will still experience swings in the market but fluctuations in any one stock will have less impact.

On the other hand, interest earning investments such as bank accounts, CDs, bonds and bond funds are generally less risky and are not subject to stock market fluctuations.  Unfortunately, in exchange for this lower level of risk you may earn a much lower rate of return.

Additionally, bonds and bond funds are subject to interest rate risk and default risk.  If you purchase a bond or bond fund and interest rates increase, the value of your investment will decrease.  To make matters worse, when interest rates rise bond funds commonly experience a flood of redemptions forcing them to sell bonds within the fund at a loss.  Even if you hold on to your shares you can experience a drop in value. However, if you purchase an individual bond and hold it till maturity you will receive the full value upon redemption.   Use caution when buying low quality bonds or bond funds; you may get a higher return but you are subject to a much greater risk of default.

Many investors don’t consider inflation risk.  This results from taking too little risk with a conservative portfolio containing little or no stock.  Over time inflation has averaged about 3% annually, if you are only earning 2% on your portfolio your real return after inflation will be negative.  This is compounded if inflation rates rise significantly.  Consider increasing your allocation in the stock market to hedge against inflation risk.

In the current environment of low interest rates and high volatility it’s crucial to build a portfolio that balances risk and return to support your financial goals and provide you with peace of mind.

Variable Annuity Not Magic Solution

office pictures may 2012 002While driving home recently I was disconcerted by another commercial spouting false information and preying on investor fear.  This commercial was exaggerating the danger and volatility of the stock market by implying most investors lost millions in the 2008 and 2009 market crash.  In reality if you were invested in the stock market from 2006 to 2016 you would have seen a 65% increase in your stock portfolio.  If you didn’t sell when the market dropped, you would have experienced a reasonable return rather than a loss on your investment.   Commercials like this stir up fear and anxiety then promise the perfect solution to market volatility – the magic to provide great returns without taking risk.

There is no miracle product that is going to provide you with high returns without risk.  If it sounds too good to be true, it is!  A basic concept of investing is the trade-off between risk and return.  If you want more return you will have to absorb greater risk.  If you want a risk free investment you will be limited to CD’s and US government bonds that pay very low interest rates.   If you want to earn higher returns you will need to take on some risk and invest part of your portfolio in the stock market.

The mystery product in commercials and ads that promise high returns with no risk is often a variable annuity.  While on occasion the use of an annuity may be appropriate for a portion of your portfolio, most variable annuities come with significant disadvantages.   A variable annuity is an insurance vehicle that invests your money into separate accounts similar to mutual funds.   Annuities are complex insurance contracts that are commonly sold on commission, with built-in fees and significant restrictions on when and how you can withdraw your money.    Earnings on money invested in a variable annuity grow tax deferred but are taxed at regular income tax rates when withdrawn.

Insurance salespeople influence you to buy annuities by promising protection from market volatility.  Basically, in addition to paying the typical fees and commissions, you can purchase an insurance rider to guard against a drop in the market.  However, this insurance usually only applies to a death benefit or the base amount used to calculate an annual income stream.   If you think a variable annuity is appropriate for your situation make sure you fully understand the product’s benefits and restrictions before investing.   Also consider an annuity with no or a low commission and without restrictions on when and how you can access your money.

A better option for managing market volatility may be to invest in a diversified portfolio that supports your time horizon.   Avoid the need or temptation to withdraw money from the stock market when it’s down.  Invest money needed in the short term in safe investments and limit your stock market investments to long term money.

Give the Gift of Financial Wisdom this Christmas

Jane Young, CFP, EA

Jane Young, CFP, EA

This year, the best Christmas gift for your adult children may be the gift of financial wisdom. Unfortunately, most young adults successfully graduate from school without a practical understanding of personal finance.  Starting out with a solid foundation and some smart financial habits can help your children live a happier, more fulfilling life.

Upon graduation from school, young adults are starting with a blank slate.  They are probably accustomed to a frugal lifestyle that is more about friends and experiences than expensive cars and fancy restaurants.  Before they take on a host of new financial commitments, encourage them to establish a lifetime habit of living below their means and saving for the future.  Work with them to develop a budget, establish an emergency fund and save for the future.  Help them to avoid the common tendency to increase their expenses in lock step with their income.  They can experience more freedom and opportunity by living below their means and gradually increasing their standard of living.

Another concept that is not taught in school, is the difference between good and bad debt.  Help your children understand the danger of high interest rate credit cards and consumer debt.  Encourage them to limit the number of credit cards they use and to get in the habit of paying credit card balances in full every month.  Also explain the importance of establishing a good credit rating by paying their bills on time.  Help them understand that low interest, tax deductible mortgage debt can be useful where high interest credit card debt can be very detrimental to their financial security.

It’s also important for them to understand some basic investment concepts including the power of compounding.  For example, if they invest $100 per month for 30 years for a total investment of $36,000, in 30 years with a return of 6%, their money can grow to over $100,000 due to compounding.   They have the benefit of time! By investing early, they have tremendous opportunity to grow their money into a sizable nest egg by retirement.

Understanding the importance of diversification and the relationship between risk and return is also essential.  Encourage your kids to avoid putting all of their eggs in one basket and help them understand that getting a higher return requires taking more risk.  It’s best to invest in a variety of investment options with different levels of risk and return.  Caution them that anything that sounds too good to be true probably is.  There is no free lunch!

To augment the personal wisdom that you can share, consider buying your kids a book on personal finance for Christmas.  Some books to consider include The Richest Man in Babylon by George S. Clason, Coin by Judy McNary, The Young Couples Guide to Growing Rich Together by Jill Gianola and the Wealthy Barber by David Chilton.

Don’t Let Emotions Derail Your Investment Portfolio

Jane Young, CFP, EA

Jane Young, CFP, EA

Emotions may be the single biggest detriment to your investment success.  We try to approach investments from a logical perspective but we are emotional creatures and money can stir-up intense feelings. The most common emotions are fear and greed which can lead us to overreact and sell low when the market is down and buy high when the market is at a peak.  Both actions are harmful to the performance of your investment portfolio. We can’t ignore emotions but we can better understand our emotional triggers and learn how to manage them.

You can minimize emotional reactions to fluctuations in the stock market by creating a plan.   With some planning you can establish a diversified asset allocation that incorporates your investment timeframe, financial goals and tolerance for risk.  A well designed asset allocation can ensure that money needed in the short term is placed in safer fixed income investments while long term money is invested in higher return, higher risk investments like stock mutual funds.   As a general rule, money needed in the next five years should not be invested in the stock market.  If you position your short term money in safer, less volatile investments such as money markets, CDs and bonds, you will be less likely to overreact   and act on emotion.

When you invest in the stock market prepare yourself for volatility including some years with negative returns.  Over long periods of time, the average return in the stock market has been around 9%, much higher than the average return for fixed income investments.  However, stock market returns are not level.  In some years, stock market returns will be higher than average and some years they will be lower than average. If you are prepared for this and maintain a long time horizon you will be more likely to stay on course.

Be wary of sensational news reports that claim the world is coming to an end and everything is different this time.  The stock market goes through cycles and there will always be scandals, bubbles and crises getting blown out of proportion by the media, financial pundits or financial companies trying to sell you something.  An example of this is commercials that use fear tactics to encourage you to buy gold and silver. They prey on the fear and uncertainty investors experience during a significant market drop.

Buying on emotion can also be detrimental to the long term performance of your portfolio.  We have a natural fear of missing an opportunity.  Avoid chasing the latest hot asset class or following the crowd because you don’t want to miss out.  Assets performing well this year may be next year’s losers and investments with abnormally high returns aren’t sustainable.  Don’t get swept up in the euphoria, keep your portfolio diversified where assets that perform well this year can buffer against those that aren’t performing well.

Slow and steady wins every time!

Avoiding the Stock Market Can be a Risky

Jane Young, CFP, EA

Jane Young, CFP, EA

You may be hesitant to invest in the stock market because it feels too risky.  However, consider the risk you are taking with your financial future by avoiding the stock market.  The primary reason to invest in the stock market is the potential for a much higher return, especially in low interest rate environments.  Most of us need the potential for long term growth provided by the stock market to meet our retirement needs.  If you invest all of your money in fixed income you may struggle just to keep up with inflation and you run the risk of outliving your money.

Historically, stock market returns have been almost double those earned by bonds.  According to the Ibbotson SBBI (stock, bonds, bills and inflation) report, between 1926 and 2014 the average annual return on Small Stock was 12.3%, Large Stock was 10.1%, Government Bonds was 5.5%, Treasury Bills was 3.5% and Inflation was 3%.  This illustrates that investing at least some of your portfolio in stock can provide a much greater opportunity than fixed income to meet your financial goals.

Investing in the stock market is not without risk.  As with all investments, we must take on greater risk to earn a greater return.  However, there are many ways to help manage the volatility of the stock market.  Before investing in stocks make sure your financial affairs are in order.  Pay off your credit cards, establish an emergency fund and put money that will be needed over the next five years into less volatile fixed income investments.  The stock market is for long term investing.  It can provide the opportunity to earn higher long term returns but you can count on some volatility along the way.  By creating a buffer to cover short term needs you will be less likely overreact to fluctuations in the market and sell when the market is down.

You can also buffer stock market risk by creating a well-diversified portfolio comprised of mutual funds invested in stocks or bonds from a variety of different size companies, different industries and a variety of different geographies.  Investing in a single company can be very risky but investment in mutual funds can reduce this risk.  When investing in mutual funds your money is combined with that of other investors and invested, by a professional manager, into a large number of stocks or bonds.  Investing in a large number of companies enables you to spread out your risk.

Dollar cost averaging, where you automatically invest a set amount on a regular basis – usually monthly or quarterly, can also reduce risk.  Rather than investing a large amount all at once, when the market may be high, you gradually invest over time.  With dollar cost averaging you buy more shares when the market is low and fewer shares when the market is high.

What is Financial Planning?

Jane Young, CFP, EA

Jane Young, CFP, EA

I’m sure you hear the term “Financial Planning” on a regular basis but you may not be sure what it really means.  Financial planning is an on-going, comprehensive process to manage your finances in order to meet your life goals.  The process includes evaluating where you are today, setting goals, developing an action plan to meet your goals and implementing the plan.  Once you have addressed all the areas of your financial plan you should go back and review them on a regular basis.

Financial planning should be comprehensive – covering all areas of your financial life.  The primary areas of your financial plan should include retirement planning, insurance planning, tax planning, estate planning and investment management.    Depending on your situation, your financial plan may also address areas such as budgeting and debt management, college funding, employee benefits, business planning and career planning.  Comprehensive Financial Planning is very thorough and can take a lot of time and energy to complete.  I recommend breaking it into bite size chucks that can be easily evaluated, understood and implemented over the course of time.  

You can work through the financial planning process with a comprehensive financial planner or you can tackle it on your own.  If you decide to hire a financial planner, I encourage you to work with Certified Financial Planner who has taken an oath to work on a fiduciary basis.  An advisor, who works as a fiduciary, takes an oath to put your interests first.

The first step of the financial planning process is to evaluate where you are today.  Tabulate how much money you are currently spending in comparison to your current income.  Calculate your current net worth (assets less liabilities).  Evaluate the state of your current financial situation.  What is keeps you up at night and what should be prioritized for immediate attention?

The next step is to devise a road map on where you would like to go.   Think about your values and set some long term strategic goals.  Using this information develop some financial goals that you would like to achieve.  Once you have identified some financial goals, a plan can be devised to help you achieve them.

Select the area you would like to address first.  Most of my clients start with retirement planning and investment management.  There is a lot of overlap between the different areas of financial planning but try to work through them in small manageable chunks.  Otherwise you may end up with a huge, overwhelming plan that never gets implemented.

Once you have worked through all of the areas in your financial plan you need to go back and revisit them on a regular basis.  Some areas like investments, taxes and retirement planning need to be reviewed annually where other areas like insurance and estate planning can be reviewed less frequently.  Keep in mind that financial planning is an on-going, life long process.

Financial Advice after Losing a Spouse

Jane Young, CFP, EA

Jane Young, CFP, EA

After the funeral is over and everyone has returned home you are faced with the overwhelming task of getting your financial affairs in order.  It’s natural to feel disinterested, distracted and confused with all the decisions that need to be made.  Over the next few years you may feel like you are in a fog and you may have trouble concentrating. During the first couple years be easy on yourself and avoid making any major decisions.  You may be approached by a lot of people trying to give you advice and sell you products, avoid any major changes or decision for at least a year.  Don’t buy or sell a house or make major decisions on where you want to live, avoid any major changes to your investments and avoid making any significant gifts to charity or family members at this time.  Be aware of salespeople who use scare tactics to coax you into making decisions before you are ready.  Take it slow, give yourself time to grieve.   In a few years you may have a completely different perspective on how you want to proceed. 

There are some things that need to be done right away.  Initially it is important to be sure you have enough liquidity to cover your living expenses.  Start by getting organized – if you have always handled the household finances you know what bills need to be paid and where all of your assets are.  If not review all of your current bills and go through the credit card statement and check register to get handle on bills that will need to be paid.  Pull together all of your financial statements to understand your current situation.  Evaluate you current income situation to be sure you have enough money to cover your expenses.

Relatively soon you will want to apply for any benefits for which you may be entitled.  This may include Social Security, Veterans Benefits, Life Insurance or a Pension.   If you spouse was working, be sure to contact their employer to apply for any unpaid wages or survivor benefits.  This is also a good time to make sure you have adequate health insurance.  You should also contact your home and auto insurance company to make sure your coverage is intact.

At this point you may want to assemble a financial support team to help you through this difficult time.  Depending on the complexity of your situation, it may be helpful to hire an Estate Planning Attorney, a Certified Public Account and a fee-only Certified Financial Planner to help you settle the estate, file tax returns, retitle assets and eventually develop of financial plan.  Ask friends and colleagues to recommend and help you select trusted professionals.

More to Rental Property Than Meets the Eye

 

Jane Young, CFP, EA

Jane Young, CFP, EA

With low interest rates and the fear of another drop in the stock market, many people are looking for alternative ways to earn investment income.  Many investors find the tangible nature of real estate appealing.  Although real estate may seem like the logical alternative to stocks and bonds, investment in real estate can be very complex, time consuming, and wrought with risk. 

Before buying, perform a realistic cash flow analysis on the income and expenses associated with the property you are considering.  Begin with start-up expenses associated with acquiring the property, including the down payment and any necessary improvements. Next tabulate the routine expenses that you will incur with a rental.  These may include mortgage payments, insurance, property taxes, home owner’s association dues, routine maintenance, and legal and accounting fees.  As a rule of thumb, maintenance and repairs run about 1-2% of the market value of your home, depending on the home’s condition.  Also consider an emergency fund to cover large unexpected repairs. 

Managing rental real estate can be very time consuming.  Seriously think about whether you want to manage the rental yourself or you want to hire a property manager.  Do you have the time and the desire to manage the property? If you do it yourself, you will need to market the property, evaluate potential renters, maintain the property, respond to tenant issues, collect rent payments and potentially evict tenants.   You also may want to learn about fair housing laws, code requirements, lease agreements, escrow requirements, and eviction procedures.  If you don’t have the time or the temperament to manage the property, consider hiring a property manager.  Property management fees usually run about 10-12% of rental income.

Some additional risks to consider when renting property include the possibility of major damage inflicted by a tenant, drawn out eviction processes, and law suits for negligence and safety issues.

After evaluating your expenses, do some income projections.  Research rents paid for similar properties in your target neighborhood.   Be sure to incorporate a reasonable vacancy rate.  According to the Colorado Division of Housing, the average vacancy rate in Colorado Springs has been about 6%, for the last 4 quarters.

Include the tax benefit of deducting depreciation into your analysis.  To calculate annual depreciation, divide the initial value of your rental home, not including land, by 27.5.  Unfortunately, you will probably have to recapture (repay to the IRS) this deduction upon sale of the property at a maximum rate of 25%.

Subtract your projected expenses from your projected income to determine your net profit.  Will the net profit you expect to gain from the property compensate you for your capital, time and risk?  In addition to the profit from rental income, be sure to factor appreciation of your property into your analysis.  Additionally, if you have a mortgage, your equity will increase every year as you pay off your mortgage.

Don’t Let Financial Scare Tactics Steer You Off Course

 

Jane Young, CFP, EA

Jane Young, CFP, EA

It’s a formidable task to sort through the barrage of financial information from all the various media sources.  It can be difficult to separate fact from fiction.  Information is often slanted when a reporter or writer has a subtle personal or political bias.  Even heavily biased information can appear objective if the messenger has a strong belief that their story is factual.   While it’s always necessary to filter information for personal bias, financial messages designed to intentionally mislead can be especially harmful.  We are constantly bombarded by advertisements and headlines that deliberately twist the facts to scare us and encourage us to buy products or services.

All of this may sound obvious; we should be smart enough to recognize when someone is trying to sell us something or trying to pull something over on us.  However, we have to be diligent to differentiate between legitimate news and sensationalism.  Producers and editors of financial magazines, television shows, and newsletters use exciting headlines to increase circulation and keep people tuned in.   It is common for the media to exaggerate negative information to generate an emotional reaction.  As an investor, you need to keep dramatic headlines in perspective and avoid changing course based on media hype.

A more sinister scare tactic is the threat of impending doom used by some unscrupulous people to sell products such as gold, variable annuities, and financial newsletters. Recently several gold dealers have been running compelling marketing campaigns to convince you that the financial world is on the brink of disaster.  They use well known actors with an authoritative flare to scare you into believing your only salvation is gold. Depending on your situation, it may be logical for you to have some amount of gold in your portfolio.  However, you don’t need to convert your entire portfolio to gold just because a few gold dealers imply they have exclusive access to top secret information predicting imminent financial demise.

You should also be on the alert for unethical firms who use scare tactics to sell variable annuities and financial newsletters.  Some unscrupulous salespeople try to scare people into making inappropriate purchases in variable annuities by preying on their need for security.  A variable annuity may be a good option, but don’t be tricked into buying something you don’t want or need due to exaggerated threats about a pending financial disaster.  Additionally, I have recently observed a newsletter editor greatly exaggerate the impact of recent legislation to encourage people to buy his newsletter.

Appealing to our sense of fear is an age old sales gimmick.  Be on your guard, marketing campaigns have become very sophisticated.  Before making any changes, fully understand what you are buying and make sure it fits into your overall financial plan.  Avoid emotional reactions to media hype and salespeople claiming to predict the future in order to sell their products.

Investing in a Volatile Market

 

Jane Young, CFP, EA

Jane Young, CFP, EA

Here are some things you should keep in mind when investing in the stock market; the market will fluctuate, there will be years with negative returns, the stock market is for long term investing, and the media and prognosticators will greatly exaggerate negative information to create news and get attention.  If you keep this in mind, you can dramatically improve your long term investment returns and sleep better at night.  Based on numerous studies conducted by DALBAR, the average investor earns several percentage points below the market average due to market timing and emotional reactions to market fluctuations.  It’s how we are wired.  When the market goes up, we feel good and we want don’t want to miss out on the opportunity to make money.  As a result, we buy stock when the market is at its peak.  On the flip side, when the market drops we worry about losing money, and sell when the market is at the bottom.  It’s hard to make money in this cycle of buying high and selling low.  When investing in the stock market, try to avoid overreacting to the inevitable short term fluctuations in the market.

Other factors that can help you ride out dramatic fluctuations in the market include establishing a solid financial foundation and maintaining an asset allocation that meets your investment timeframe.  Establish a solid financial foundation by living within your means, minimizing the use of credit, and maintaining an emergency fund of 3 to 6 months of expenses.  A strong foundation helps you avoid pulling money out of the stock market at inopportune times should an emergency arise. 

Once you have established a strong financial foundation you can start investing in the stock market.  One key to success with stock market investing is establishing an asset allocation that’s in line with the timeframe in which you will need money.  Money that is needed in the short term should not be invested it the stock market.  As a general rule, do not invest any money needed within the next five years in the stock market.  Over long periods of time the stock market has trended upward, but in the short term there have been periods with substantial drops.  Give yourself time to ride out the natural fluctuations in the market.  

Additionally, it is important to diversify your money across a wide variety of investments.  You can reduce the amount of risk you take by diversifying across different companies, municipalities, industries, and countries.  When one type of investment is doing poorly, another may be doing well.  This helps to buffer the losses you may experience in your portfolio.  An excellent way to diversify is through the use of a variety of different types of mutual funds.  Mutual funds pool your money with money from others to invest in a large number of companies or government entities based on a predefined investment objective.

8 Timeless Tips to Keep Your Investments on Track

  1. Keep It Simple – Don’t invest in anything that you don’t understand.   Most investments aren’t that complicated. Be very cautious if you are considering an investment with pages and pages of difficult to understand legal verbiage.  You can bet the small print wasn’t added for your benefit.
  2. Pigs Get Fat, Hogs Get Slaughtered – The biggest risk to sensible investing is fear and greed.  If it sounds too good to be true, it probably is.  Don’t fall for offers with exceptionally high returns. If someone promises you a return significantly higher than the market rate, there’s a catch.  It’s either a scam or there are huge risks involved. Perform some due diligence to understand why the returns are higher than normal.
  3. Keep Your Emotions in Check – Establish and stick to an allocation that meets your timeframe and risk tolerance. The stock market will rise and fall.  Don’t fall into the trap of panic selling when the market falls, only to turn around and buy when the market’s back on top.  You don’t make much money selling low and buying high.
  4. Diversify, Diversify, Diversify – At a minimum, your net worth should reflect a combination of stock mutual funds, fixed income investments, and real estate.  You should hold a large number of different investments within each category.  For example, your stock portfolio should be comprised of small, medium, and large companies in a variety of different industries in the U.S. and abroad.  A diversified portfolio provides a buffer against volatility.  Each category responds differently to changing economic and political conditions.
  5. Invest Based on When Money is Needed – Maximize your risk/return ratio by designing a portfolio that supports your investment time horizon.  Generally, money needed in the short term should be invested in safe, less volatile investments.  Your return may be limited, but your principal will be safe.  With long term money, you can take more risk and potentially earn a higher return.  With a longer time horizon you can ride out the fluctuations in the stock market.
  6. Be Tax Smart – Consider tax consequences when buying and selling investments, and maximize your contributions to tax advantaged retirement plans. Within taxable accounts, municipal bonds and mutual funds with a low turnover ratio are good options.  Also, watch for opportunities to harvest tax losses.
  7. Avoid High Fees, Commissions and Surrender Charges – High fees, commissions, and surrender charges can eat into your return and limit your flexibility.  Review prospectuses and investment reports to fully understand the fees and penalties associated with the funds or products you are considering.
  8. Stocks Don’t Have Memories – Don’t keep a poor performing security with hopes it will return to its original purchase price. Stock and stock mutual funds should be evaluated based their future potential.  There is no correlation between the current value of a stock and what you paid for it.

How ETFs Differ from Mutual Funds

 

Jane Young, CFP, EA

Jane Young, CFP, EA

ETFs (Exchange-Traded Funds) and mutual funds are investment vehicles that enable investors to pool their money to buy a collection of stocks or bonds.   This makes it practical for the average investor to diversify their holdings across a large number of companies or entities.   Mutual funds can be actively or passively managed.   Generally, ETFs are passively managed and are designed to represent a specific index or category of securities, similar to an index mutual fund.   ETFs are especially useful in focusing on narrow sectors of the market that frequently aren’t offered by mutual funds.   ETFs can be especially useful to invest in a specific country or industry sector.

Mutual funds and ETFs differ in how they are traded.  Mutual funds are bought and sold through a mutual fund company.   ETFs are bought and sold on the market, between investors. Shares in a mutual fund are traded based on the price at the close of the day.   ETFs can be traded throughout the day, anytime the market is open.  This is similar to the manner in which individual stocks are traded.  

Generally, ETFs have lower fees than mutual funds because of lower overhead costs.  This is especially true when comparing ETFs to actively managed mutual funds.  However, when you purchase an ETF you must pay a brokerage fee every time a transaction is made.  Mutual funds may be more efficient if you are planning to dollar cost average, or buy shares over a period of time.

Due to structural differences, ETFs can provide greater tax efficiencies than mutual funds.  ETFs are traded on the market between investors, much like individual stocks.   When investors buy and sell shares of ETFs, shares are exchanged between one another; there is no taxable sale of stocks or bonds within the ETF.  On the other hand, mutual funds are traded within a mutual fund company.  If several investors decide to sell, the manager may be forced to sell stock or bonds within the fund to cover the redemption.  This is a taxable event that may result in capital gains that must be passed on to the shareholders.

Additionally, the structure of an ETF allows for the creation and redemption of shares with in-kind transactions.   Capital gains taxes are avoided because there is no taxable sale of stocks or bonds within the ETF when an in-kind redemption is done.

Finally, ETFs are generally tax efficient because they are passively managed, similar to an index fund.  Passively managed investments track to an index and don’t do a lot of trading.  With less trading, the investor should incur less capital gains while holding the ETF.   Mutual fund investors can also minimize their exposure to capital gains by purchasing index funds and tax efficient funds that do minimal trading.  Both Mutual Funds and ETFs that invest in bonds or dividend paying stocks must pass interest and dividend income on to shareholders.

The Pitfalls of Market Timing

Jane Young, CFP, EA

Jane Young, CFP, EA

Market timing is one of the most detrimental ways an investor can negatively impact his stock market returns. History shows that investors do not effectively time the market. For the last nine years, DALBAR, Inc., a market research firm, has conducted an annual study on market returns called the Quantitative Analysis of Investor Behavior (QAIB). This study has consistently found that returns earned by the individual investor are significantly below that of the stock market indices. The 2013 QAIB report found that during the 20 year period between 1998 and 2012, the average mutual fund investor lagged the stock market indices by 3.96%. This is a significant improvement over the period between 1991 and 2010, in which the average investor lagged the mutual fund indices by 5.1%. According to Dalbar, “No matter what the state of the mutual fund industry, boom or bust: Investment results are more dependent on investor behavior than on fund performance. Mutual fund investors who hold on to their investments are more successful than those who time the market.”
The stock market is counterintuitive in that the best time to sell is usually when the market seems to be doing well, and the best time to buy is usually when the market is doing poorly. As investors, our decisions are frequently driven by emotion rather than cognitive reasoning. We frequently overreact to emotions of fear and greed which throws numberswiki.com

us onto an investment roller coaster. When the stock market goes up we start to feel more and more optimistic, and as the market rises higher we get caught up in a state of euphoria. Our sense of greed kicks in and we don’t want to miss the opportunity to make money, so we buy when the market is high. The market may stay up for a while but eventually the economic cycle changes and stock prices start to drop. Initially we rationalize that this is temporary, or just a minor correction. As the market continues to drop we become more and more concerned. Soon our sense of fear kicks in, we start to panic and we sell at the wrong time. If we don’t recognize the dangers of this emotion driven cycle we are deemed to repeat it.
In addition to our intrinsic emotional response, we are bombarded by sensationalized news and advertising campaigns to influence us to change the course of our investment strategy. Don’t get caught up in the hype about the next big investment craze. Your best course of action is to develop and follow an investment strategy that supports your tolerance for risk and investment timeframe. The stock market is volatile and is best suited for long term investing. Time is needed to absorb fluctuations in the market. Keep short term money in fixed income investments. You will be less tempted to time the market in a well-diversified portfolio specifically designed for your investment time horizon.

Variable Annuities May Not Be Your Best Option

Jane Young, CFP, EA

Jane Young, CFP, EA


A variable annuity is an investment contract with an insurance company where you invest money into your choice of a variety of sub-accounts. Sub-accounts are similar to mutual funds, where money from a large number of investors is pooled and invested in accordance with specific investment objectives. Like mutual funds, sub-accounts may invest in different categories of stock or interest earning investments.
One characteristic of a variable annuity is the tax deferral of gains until the funds are withdrawn. However, upon distribution the gains are taxable at regular income tax rates, as opposed to capital gains rates that may be available for mutual funds. Additionally, there is no step-up in basis upon death for assets held in variable annuities.
Variable annuities are generally more appropriate for non-retirement accounts because gains within a retirement account are already tax deferred. Traditional retirement accounts and Roth IRAs meet the tax deferral needs for most investors. However, in some cases a variable annuity may be attractive to a high income investor who has maximized his traditional retirement options and needs additional opportunities for tax deferral. This is especially true for an investor who is currently in a high tax bracket and expects to be in a lower tax bracket in retirement.
When investing in variable annuities, with non-retirement money, there is no requirement to take a Required Minimum Distribution at 70 ½. However, there is generally a 10% penalty on withdrawals made before 59 1/2. Trades can be made within a variable annuity account without immediate tax consequences. The entire gain will be taxable upon withdrawal. There is no annual contribution limit for variable annuities, and you can make non-taxable transfers between annuity companies using a 1035 exchange. However, you may have to pay a surrender charge if you have held the annuity for less than seven to ten years, and you purchased it from a commissioned adviser. Before buying an annuity, read the fine print to fully understand all of the fees and penalties associated with the product. Most variable annuities have early withdrawal penalties and a higher expense structure than mutual funds.
A variable annuity may be an option for someone who wants to purchase an insurance policy to buffer the risk of losing money in the market. For many investors, due to the long term growth in the stock market, this guarantee may be come at too high a price. Some investors are willing to pay additional fees in exchange for the peace of mind that a guaranteed withdrawal benefit can provide. Guaranteed minimum withdrawal benefits (GMWB) can be very complex and have some significant restrictions. Additionally, some products offer a guaranteed death benefit for an extra fee. Read the contract carefully and make sure you understand the product before you buy.
Due to the high costs, lack of flexibility, complexity and unfavorable tax treatment variable annuities are not beneficial for many investors.

Tips to Acheive Financial Fitness

Jane Young, CFP, EA

Jane Young, CFP, EA


The first step toward financial fitness is to understand your current situation and live within your means. Review your actual expenses on an annual basis and categorize your expenses as necessary or discretionary. Compare your expenses to your income and develop a budget to ensure you are living within your means and saving for the future. The next step is to pay off high interest credit cards and personal debts. Once you have paid off your credit cards, create and maintain an emergency fund equal to about four months of expenses, including expenses for the current month. Your emergency funds should be readily accessible in a checking, savings or money market account.
Now it’s time to look toward the future. Get in the habit of always saving at least 10% to 15% of your gross income. Think about your goals and what you want to accomplish. If you don’t own a home, you may want to save for a down payment. When you purchase a home make sure you can easily make the payments while contributing toward retirement. Generally, your mortgage expense should be at or below 25% of your take home pay.
Contribute money into retirement plans, for which you qualify. Make contributions to your 401k plan, at least up to the employer match and maximize your Roth IRA. If you are self-employed, consider a SEP or a Simple plan. If you have children and want to contribute to their college expenses, consider a 529 college savings plan. Do not contribute so much toward your children’s college fund that you sacrifice your own retirement.
As you save for retirement, be an investor not a trader. Investing in the stock market is a long term endeavor, forecasting the short-term movement of the stock market is fruitless. Avoid emotional reactions to headlines and short term events. Don’t overreact to sensationalistic stories or chase the latest investment trends. Establish a defensive position by maintaining a well-diversified portfolio, custom designed for your unique situation. Slow and steady wins the race!
Don’t invest in anything that you don’t understand or that sounds too good to be true. If you really want to invest in complicated products, read the fine print. Be especially aware of high commissions, fees, and surrender charges. There is no free lunch; if you are being offered above market returns, there is probably a catch. Keep in mind that contracts are written to protect the insurance or investment company, not the investor.
It is impossible to predict fluctuations in the market or to select the next great stock. However, you can hedge your bets with a well-diversified portfolio. Establish an asset allocation that is aligned with your goals, investment timeframe, and risk tolerance. Your portfolio should contain a mix of fixed income and stock based investments across a wide variety of companies and industries. Rebalance your portfolio on an annual basis to stay diversified.

Understanding Mutual Fund Fees

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Jane M. Young, CFP, EA

When investing in mutual funds it is important to be aware of the associated fees.  High fees can significantly impact your total investment return.   All mutual funds have operating expenses and some have sales fees, commonly known as a load. When you invest in mutual funds you have a choice between load and no-load funds.   A mutual fund load is basically a commission charged to the investor to compensate the broker or sales person.   As the name implies, no-load funds do not charge a sales fee.

The first type of load fund is an A share fund, where you pay a front end sales charge plus a small annual 12b-1 fee.   A 12b-1 fee is a distribution fee that covers marketing, advertising and distribution costs.  The typical front-end load is around 5%, but can go as high as 8.5%.  Class A shares offer breakpoints that provide you with a discount on the sales load when you purchase larger quantities or commit to making regular purchases.  The 12b-1 fee associated with most A shares is generally about .25% annually.

The second type of load fund is a B share, where you pay an annual fee of around 1% plus a contingent deferred sales charge (CDSC), if you sell before a specified date. The CDSC usually begins with a fee of 5% that gradually decreases over five years.  After five years or so the fund converts to an A share fund.  The actual percentages and timeframes may vary between fund families.  Most mutual fund companies have stopped offering B share funds because they are usually the most expensive option for the investor and the least profitable option for the mutual fund company.

The third type of load fund is a C share that charges a level annual load, usually around 1%.  This is on-going fee that is deducted from the mutual fund assets on an annual basis.

Generally, any given mutual fund can offer more than one share class to investors.  There is no difference in the underlying fund.  The only difference is in the fees and expenses that the investor pays.

All load and no-load mutual funds charge fees associated with the operation of the fund.  The most significant of these expenses is usually the management fee which pays for the actual management of the portfolio.  Other operations related fees may include administrative expenses, transaction fees, custody expenses, legal expenses, transfer agent fees, and 12b-1 fees.

These annual fees are combined and calculated as a percentage of fund assets to arrive at the fund’s expense ratio.  The expense ratio is an annualized fee charged to all shareholders.  The expense ratio includes the fund’s operating expenses, management fees, on-going asset based loads(C shares) and 12b-1 fees.  The expense ratio does not include front-end loads and CDSCs.   According to Morningstar the average mutual fund expense ratio is .75%.

 

 

Stock Can Be a Good Option in Retirement

 

 

 

 

 

 

Jane M. Young

As we approach retirement, there is a common misconception that we need to abruptly transition our portfolios completely out of the stock market to be fully invested in fixed income investments.   One reason to avoid a sudden shift to fixed income is that retirement is fluid; it is not a permanent decision. Most people will and should gradually transition into retirement.  Traditional retirement is becoming less common because life expectancies are increasing and fewer people are receiving pensions. Most people will go in and out of retirement several times.  After many years we may leave a traditional career field for some well-deserved rest and relaxation.  However, after a few years of leisure we may miss the sense of purpose, accomplishment, and identity gained from working.  As a result, we may return to work in a new career field, do some consulting in an area where we had past experience or work part-time in a coffee shop.

Another problem with a drastic shift to fixed income is that we don’t need our entire retirement nest egg on the day we reach retirement.   The typical retirement age is around 65, based on current Social Security data, the average retiree will live for another twenty years. A small portion of our portfolio may be needed upon reaching retirement but a large percentage won’t be needed for many years.   It is important to keep long term money in a diversified portfolio, including stock mutual funds, to provide growth and inflation protection.   A reasonable rate of growth in our portfolio is usually needed to meet our goals. Inflation can take a huge bite out of the purchasing power of our portfolios over twenty years or more.   Historically, fixed income investments have just barely kept up with inflation while stock market investments have provided a nice hedge against inflation.

We need to think in terms of segregating our portfolios into imaginary buckets based on the timeframes in which money will be needed.  Money that is needed in the next few years should be safe and readily available.  Money that isn’t needed for many years can stay in a diversified portfolio based on personal risk tolerance.  Portfolios should be rebalanced on an annual basis to be sure there is easy access to money needed in the short term.

A final myth with regard to investing in retirement is that money needed to cover your retirement expenses must come from interest earning investments.  Sure, money needed in the short term needs to be kept in safe, fixed income investments to avoid selling stock when the market is down.  However, this doesn’t mean that we have to cover all of our retirement income needs with interest earning investments.  There may be several good reasons to cover retirement expenses by selling stock.   When the stock market is up it may be wise to harvest some gains or do some rebalancing.  At other times there may be tax benefits to selling stock.

 

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.

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