The following is a guest post from Kevin at Just Start Investing.
Today we have a title fight between robo-advisors and online brokers.
In one corner, we have the fresh rookie looking to shake up the investing world. Their speciality is automation and giving you an end to end experience to save you time and stress. Put your hands together for… Robo-advisors!
In the other corner, we have a seasoned verteran. They’ve been around a few years and know how to deliver a customizable portfolio for cheap. That is, if you’re willing to put in the work. Give it up for… online brokers!
Stick with us to see who will win this evenly matched fight. But first, a quick backstory on each competitor is below.
What is an Online Broker?
In simple terms, a brokerage account acts as a middle-man between you and the investing market. Online brokerage accounts allow you to buy and sell investment vehicles easily and quickly online with the click of a button.
Traditional online brokerage accounts give you control over your investments – you can select exactly which investment vehicles to purchase. Plus, if you choose an online broker like Charles Schwab or Vanguard, fees will be very low – making it easy to set up a portfolio on your own.
What is a Robo-Advisor?
Robo-advisors are online investing platforms that do 99% of the work for you.
Most robo-advisors start by asking you to complete a series of questions to get a sense for your risk profile, goals, and to gather some basic information. Then, the robo-advisor will automatically open an account and select investment vehicles for you based on your answers.
Behind the scenes, robo-advisors are employing an algorithm that buys and manages investments for you – optimizing and reallocating your portfolio to match your goals.
The Pros of Online Brokers and Robo-Advisors
With backgrounds out of the way, it’s time to start round 1 of 2 of this title fight. Both of these investing options have different advantages that are unique to one another.
Online Broker Pros
Robo-Advisor Pros
The Cons of Online Brokers and Robo-Advisors
For round 2, we’ll look at things from another angle - what are the weaknesses of each of these options. Not surprisingly, in a lot of cases, the advantages of one are the disadvantages of the other.
Online Broker Cons
Robo-Advisor Cons
So, Who Wins? Robo-Advisors or Online Brokers?
Through two rounds, we have learned that both robo-advisors and online brokers have unique pros and cons. But I’m not sure that we have found a clear cut winner.
If you are someone seeking simplicity and want to take a hands off approach, then robo-advisors are likely right for you.
If you are ‘Type A’ and like to have control of your personal finances, setting up your own portfolio through an online broker will probably work better.
From a dollar and quantitative standpoint, it can be hard to tell who is the better choice. I ran a couple scenarios below, but as you will see, the “winner” varies depending on how the variables below shake out.
In both of the scenarios below, I looked at a few variables that I held constant:
I also looked at a few variables that I manipulated in the examples:
Example 1: Online Broker Winning
Overall Variables:
Online Broker Best Case Variables:
Robo-Advisor Worst Case Variables:
Outcomes:
In this scenario, the online broker drastically outperformed robo-advisors. With an ending 40 year balance that is over $100,000 higher than robo-advisors, which is 11.3% more.
The lower costs of online brokers kept the net annual gains higher, with the robo-advisor tax-harvest benefit not enough to offset it’s hefty fees.
Example 2: Robo-Advisor Winning
Overall Variables:
Online Broker Worst Case Variables:
Robo-Advisor Best Case Variables:
Outcomes:
In this scenario, the robo-advisor drastically outperformed online brokers. With an ending 40 year balance that is over $190,000 higher, which is 19.1% more.
The tax loss harvest benefit made all the difference in this scenario. It more than offset the robo-advisor fees, and the higher online brokerage expenses expanded the gap even further.
Summary: How to Make the Final Decision
So, who’s the true winner? Is there one?
As alluded to earlier, it really depends on your situation. For some people, robo-advisors will be the clear choice. For others, online brokers might work better.
As you can tell from the quantitative analysis - variables that are sometimes out of your control can affect who the winner is. So I’d recommend basing your decision more heavily on qualitative analysis and how badly you want to manage your investments versus let someone else take the reigns.
The following is a sponsored post from Masterworks.
Once you have the basics of investing covered (like index funds and real estate), you'll probably want to consider alternative investments in order to round out your portfolio.
And with good reason...because alternative investments produce strong returns.
Over the past 20 years alternative investments have outperformed more traditional asset classes like stocks and bonds. In fact, since 1999, an alternative portfolio has generated slightly higher long-term returns than equities, fixed income or a traditional 60%/40% split of the two, according to Invesco. At the same time, alternatives were much less risky than the other options.
For this reason, alternative investments are becoming increasingly important as tools for everyday investors to grow their investment returns while simultaneously protecting their portfolios.
And these assets can be quite powerful. Yale University famously committed a large portion of its endowment to alternative investments in the 1980s, and has to-date seen industry-beating results. In 2014, for instance, Yale’s endowment posted returns greater than 20%.
The problem is, there's generally a lot of time, effort, and unknowns involved in alternative investments which make them inaccessible for the average investor.
But things are changing -- at least with one form of alternative investment (artwork). A new platform from Masterworks allows everyone to invest in art both easily and cost-effectively.
Why Invest in Art? Strong Returns!
Many people overlook art as a viable investment option since the average investor doesn't have access to the kind of capital and connections it takes to buy art. But forgetting about art as an investment could be a mistake. Here's why:
Since 2000, blue-chip art (defined as those paintings by the top 100 artists in terms of sales volume) have exhibited strong risk-adjusted returns, and outperformed the S&P 500 by over 250% without dividend reinvestment (and 180% with reinvestment). At the same time, art is not all that correlated with financial markets – in a recession high end art is relatively stable. Not to mention that over time, the number of famous and expensive works available for purchase dwindles as masterpieces become absorbed into permanent museum collections (or sometimes destroyed), so the demand for the scarce works still in private hands becomes concentrated.
Bottom line: Art produces strong risk-adjusted returns.
Why Diversifying Your Portfolio is Essential
Today's highly priced markets seem to have many people worried, so where can you put money besides stocks? And when the markets are all over the place you want to keep your money in several investments that don’t move in the same exact way. Research by Citigroup suggests that art has one of the lowest correlations with the stock market, along with Cash and 10-Year US Treasury Notes. Meanwhile, Art appears to be the most correlated with Commodities – which reaffirms the view that it is a “hard” asset.
Art Was More Stable than the S&P During the Last Financial Crisis
The performance of the art market is determined by the number of sales and the prices paid for individual works. As it turns out, Art is pretty resilient during financial downturns, because its supply is self-regulating, so prices remain relatively stable. When times are tough, owners hold onto their artworks until the market becomes favorable again. The reduction in market supply means that prices see fewer fluctuations in the top tiers, because owners are relatively insulated from economic downturns.
Looking back to the 2008 Financial Crisis, auction records actually broke $2.2 billion that year. The contraction in the art markets began with a six-month lag, and between 2008 and 2009, the art market declined an estimated 26% (based on the Mei-Moses index), while the S&P 500 declined 57% from its peak on the worst day of trading. The art market bounced back swiftly by 2011, while equities didn’t reach pre-recession levels until 2013.
How Much of Your Investments Can or Should You Hold in Art?
Being aware of your investment time-horizon and expectations is incredibly important. For example, the British Pension Railway Fund allocated?40 million (roughly 2.5% of their total assets) to art and collectibles, in what turned out to be one of their best investments. The art holdings were liquidated between 15 and 25 years later, but not all investors want to keep their money locked up quite that long. Based on the Citigroup research allocating 1.4% to 4% of your portfolio to fine art is recommended, if you’re willing to hold between 10% and 15% in liquid assets.
How Masterworks is Changing the Industry
Now, you’re probably thinking that art is an interesting investment, but you just don’t have the capital to go and hire an art advisor and drop $2 million + on a Warhol. Thankfully a start-up called Masterworks is making this possible for you.
Masterworks purchases blue-chip paintings with strong appreciation histories from auction houses and then files them as Reg A+ Public Offerings with the Securities and Exchange Commission to take their paintings public. Masterworks attempts to purchase artwork at or below their appraisal values so that you can get the most out of your returns.
Masterworks also helpfully provides a resource center where you can learn more about the art market to help you make informed investment decisions. If you are interested in this kind of investment, Masterworks is certainly worth a look.
See disclaimer at www.masterworks.io/disclaimer.
The following is a guest post by Riley from Young and the Invested.
Real estate investing often meets unexpected pitfalls, such as acquiring a money pit, handling overly needy tenants, or buying in an area which did not measure up to your expectations. These are all the nature of the business and should be accounted for before you enter the market.
In my case, I am a landlord who encountered two unexpected, yet informative experiences early in my real estate investing career. In a classic cause and effect scenario, one major instance of damage led to the discovery of a safety hazard in need of immediate action.
While both put my tenant at risk, the latter led to a replacement mandate for every owner in the building. This led to a complex-wide special assessment you come to loathe as a condo owner. But like all things in life, unexpected expenses crop up and hopefully you have been smart enough to budget accordingly.
The subject of this post will be the trying time I had the pleasure of experiencing early in my real estate investing career. It is fitting the story takes place at my condo, the investment property I felt most certain would present the fewest problems.
Clearly, there was an expectations gap and reality had other things in store.
My Real Estate Investment – A Condo in a 14-Story High Rise
When I started my real estate investing adventure, bright-eyed and bushy tailed, I knew being a property owner would present its challenges. This did not dissuade me from venturing out, but rather served as a caution I needed to observe for myself and fully recognize.
When I bought my condo in New Orleans, I lived there for almost 3 years. The unit presented a great location near my job, offered me my own space, and most importantly, represented a great value in a rapidly improving area of town.
During my stay, I was fortunate only to encounter one clogged drainage pipe from my air-conditioner compressor. Otherwise, the unit never gave me a problem and led me to believe the maintenance and upkeep would not be a hassle. Expectations can be a dangerous thing.
When I moved out, I decided to lease the unit and thereby enhance my return on the real estate investment. Initially, I thought I would use any free cash flow to pay off my mortgage faster, but first I decided to build up a reserve to guard against unexpected repairs or unit vacancy.
My experience of requiring little maintenance, when combined with a property manager on site, made leasing the unit a foolproof decision in my mind.
In many ways, the arrangement paid off and was ideal as an investment. However, despite budgeting for repairs, I hadn’t fully prepared myself mentally for them. In my building, those responsibilities fall solely on the unit owners' shoulders and will crop up whether you expect them or not.
And when stuff breaks or requires attention, I've come to learn some repairs can be managed with less urgency while some require immediate attention. This is the story of the latter.
The Emerald City
My trying real estate investing story starts not in New Orleans, where I live and own the condo, but 2,500 miles away in the Emerald City, Seattle, Washington.
In late 2017, my family decided to visit my brother in Seattle for Thanksgiving. He had recently moved there after a lifetime of pining for the Pacific Northwest and found his place amongst his friends who had moved there ahead of him.
We planned to stay for the 4-day weekend and see what the city had to offer. After visiting Gas Works park, the Space Needle, Chihuly’s Glass Museum, and Pike Place Market, our health took a turn.
Seattle, famous for its wonderful fall weather (sarcasm), got my wife and I sick. It’s unfortunate because our health in no way reflected our time spent in the city. I can’t wait to go back.
Little did we know our health was soon to be the least of our problems.
100 Hours of Exhaustion and Desperation
Having trouble sleeping with congestion and all the ailments associated with a cold, the last thing we needed was a 3 AM phone call from my tenant in New Orleans. She called to tell me the bathroom ceiling had collapsed, and the debris had fallen all over the bathroom and hallway floors.
Partly groggy from the cold medication and partly delirious from the time of night, it took me a few moments to assess the situation and what needed to be done remotely.
After talking through the situation with my tenant, I immediately offered to pay for her to stay in a hotel until I could get this repaired. Almost serendipitously, she had other accommodations available through her work, a nice hotel downtown.
She remarked how she had intended to use her free stay benefits but never found the time. When life closes a door, it opens a window. Or, in this case, when life collapses your bathroom ceiling, it books you a free room at a luxury hotel.
Fortunately, we didn’t need to change our plans to leave Seattle early because we were headed home later that day. We would be able to assess the damage that same day and decide how best to proceed.
When we arrived, my tenant had already cleaned most of the debris and managed to secure the suspended light fixture to a wall. My 400 square foot efficiency suddenly had 20% of its ceiling in trash bags.
As it turns out, the cause of the ceiling collapse was a leaking pipe from the unit above mine. Apparently, over the course of 10 years it had slowly dripped onto my bathroom ceiling.
Much like the straw which broke the camel’s back, the final drop tipped the weight of the ceiling and forced it to collapse. The strangest part was the lack of visible water damage prior to the event.
Knowing I could not repair this myself, I was able to hire a contractor through a recommendation of the building manager. Within 36 hours, he was on site and ready to begin his repairs.
He removed the metal grating left behind from the formerly-attached sheetrock ceiling, ran fresh wire to the new lighting fixture, and replaced the new ceiling and walls which had been damaged.
Compounding Problems
In the process, he discovered a major malfunction with my electrical box housed in the bathroom. When the company designed the box in the 1950s, it had a design flaw which could result in a short-circuit and starting a fire.
As you can imagine, this tendency to short-circuit would only increase when exposed to condensation (i.e., from water damage which had accumulated over the previous decade).
My contractor offered to refer me to an electrician, but we soon found out he wouldn’t be available for at least a week. He also quoted me a price I couldn’t believe was accurate.
After speaking with my father, an electrical engineer, he said this would be something we could handle ourselves. However, we would need to replace the circuit breaker box before the contractor could finish the wall replacement around the box.
Otherwise, we'd have to re-replace the wall. That would be more time, more money, and more inconvenience for my tenant. The contractor told us it needed to be replaced within the next 24 hours or he'd have to return to make the wall repairs in 2 weeks, which was unacceptable.
Facing a tight schedule, my dad and I had to size, buy, remove, replace, and rewire the box ourselves.
Working with urgency, we worked all night to install the new box in time for the contractor to replace the wall in the morning.
Exhausted, still sick, and working under the cover of darkness (no power and no daylight), we managed to remedy the entire situation in a little over 100 hours.
We also saw a way to save money by doing the circuit box replacement ourselves. As for the ceiling, the unit owner above me assumed full responsibility and paid the contractor in full.
Later that day, my tenant was able to move back into the unit. I never thought such a small condo could lead to such a big problem.
Lessons Learned from Real Estate Investing
From my story, I hope to convey the following lessons:
The following is a guest post by Alexander from daytradingz.com
It has been proven that long-term money investments offer the best returns concerning the time expenditure associated with such investments. However, even speculative investments with a very short time horizon can generate profits. Day trading is one of the most popular speculative investment strategies. In this article, you will learn more about the different types of day trading.
Scalping is an intra-day trading strategy, and it is applied by traders who attempt to complete round trip trades with the aim of making profits within very short periods, typically within seconds or minutes (a round trip is another word for buying and selling the whole position).
Scalp traders focus more on short time frame charts of between a few ticks and one minute. As a result, the profits also tend to be lesser as compared to other traders.
Consider an example of a scalper who purchases 1,000 shares of company XYZ at $10. Suppose the trader sells the same shares within a time duration of two minutes at a price of $10.05, he/she makes a profit of $0.50 per share which results into a total gain of $50.
Similarly, the value of the shares can drop by the same margin ($0.05) resulting in a loss of $50. It is essential to understand that scalpers and day traders may experience losses just as they may gain within the same period – as with any investment.
Day traders mostly focus on making profits with momentum trading. The primary goal for momentum traders is to make profits from more significant moves in the markets by taking advantage of intra-day trades mainly in the stock markets.
Momentum Traders aim to profit from the current momentum that a price move has. Especially during the earnings season, stocks tend to move sharply. It is not unusual for these dynamic movements to generate gains of between 20 and 30 cents per share.
The most crucial aspect for scalpers and momentum traders is the fee structure of the online broker.
If your brokerage account is held with an expensive broker, you will never make profits scalping or day trading. The reason is, that the absolute return in dollars is too small compared to expensive order fees.
Swing traders act both, short-term and mid-term. Let’s analyze both separately.
Swing traders are quite similar to day traders – however, swing traders tend to hold on their stocks for longer periods. It is common to keep a position for a few days or even some weeks.
Swing traders also have the great advantage that they can use one of the best investment apps to buy and sell their positions. They can also use trading apps like Webull, Stash, Stockpile or Robinhood to monitor their positions from anywhere.
In case that the stop loss is hit earlier, swing traders also exit their open position. That’s why swing traders are sometimes short-term traders as well.
Swing traders conduct mainly enter and exit the markets based on price movements on the bigger time frames like the 60 minutes chart or even the daily chart.
Swing traders may decide to go for a price target of $20 using the 60 minutes, daily or weekly chart. The position size is calculated depending on the relation between the target price and the stop loss price. While scalpers and day traders can not calculate the risk reward ration within a few seconds, the swing trader can plan his trades accordingly. A good risk-reward ratio is 1:2 or higher. That means that the potential reward should be double as high as the risk.
For example, a swing trader enters the market at $10 with a price target of $2 per share and a holding period of 4 weeks. Then a risk-reward ratio of 1:2 leads to a stop loss at $9. So only 1 dollar away from the entry, while the target is 2 dollars away from the entry point.
It is also common for speculators to apply a hybrid trading strategy.
Consider a swing trader who takes a position on 1,000 shares long and only takes gains from 700 shares leaving the rest (300 shares) as an intra-day swing position. Such a hybrid strategy allows a trader to spread risk over a more extended period.
Alternatively, it is also possible to open a position intraday with 1,000 shares, scalping for a substantial profit for 3/4th of the position, while holding the rest of 250 for a longer period.
However, I prefer not to mix up different time frames and trading styles due to the additional challenge to plan the risk and reward for the mixed hybrid trading style.
Speculative investing offers a lot of opportunities making profits within a short period. However, you should always be beware about the fact, that the risk is at least as high. Due to the brokerage fees the risk including fees is even higher than the potential.
So it is essential to plan the trading activities properly. Overtrading is one of the reasons many short-term traders fail. There can be days where you just do not any trade during a day. This is okay. There is no need to hurry. To trade where no good entry point exists is like buying consumer products you don’t need.
The following is a guest post from Barbara A. Friedberg from Robo-Advisor Pros.
When I mention to my friends that I’m passionate about fintech and robo-advisors, I’m typically met with a blank stare. Next come the follow up questions:
“A robot advisor, what’s that?”
“What the heck is a robo-advisor, I’ve never heard of that?”
So, I begin my story; robo-advisors are a new-ish way to invest your money, get professional money management and free up time to do the stuff you really enjoy.
Now, many folks tune out as the “money and investing” topic comes up. It’s typical to get a “What have you been up to recently?” comment at this point, in a not-so-subtle attempt at changing the subject.
But, not one to quit, I explain that you can grow your wealth – a lot – on autopilot with a robo-advisor. As soon as I mention hundreds of thousands of dollars, I have their attention.
And here are 5 reason that you need a robo-advisor:
1. You need a robo-advisor so that you can retire someday.
Retirement statistics are scary. Rebecca Lake writes in a recent RothIRA.com article that the average retirement savings of working families aged 32 to 61 is just north of $95,000, (Economic Policy Institute data). While 38% have less than $10,000 saved. Forty four percent of Americans aren’t saving for retirement.
You’ll likely live into your 80’s and could last even longer.
With the average Social Security benefit of $1,409.91 per month or roughly $17,000 per year, unless you live off the land, you’ll need to supplement your income.
With a robo-advisor you can open a retirement account, answer a few risk questions, transfer money in every month and have that money managed for free or a low fee by M1 Finance, WiseBanyan, Schwab and others.
Invest $500 per month, earn 7% annually and in roughly 30 years, you have over $610,000. If you earn $75,000 per year, you can certainly spare $6,000 to invest for your future! A robo-advisor can make the process seamless!
2. You need a robo-advisor because you want to have fun on the week-ends.
Most folks spend their week-ends playing with the kids, doing chores and squeezing in some fun. If you’re managing your investments on the week-ends – on top of everything else – then there’s not much time for fun.
After choosing a robo-advisor, setting up the account, selecting your risk level, you’re done! You can be confident that the robo-advisor will craft low fee, diversified investments, in line with your goals and risk level. As long as your bank transfer continues into the robo-advisor, your money is set up to grow for tomorrow.
The low-fee benefit of robo-advisors means that your money won’t be going to a high priced financial advisor, but into the investment markets to grow for your future.
3. You need a robo-advisor because you want to get the best returns for the least amount of work with your investing.
Who do you think earns the best returns in the investment markets over the long-term? Do you think it’s high priced active investment fund managers, who regularly buys and sells stocks and bonds, or the patient passive investor who selects low-fee index funds and sticks with the plan through the market ups and downs?
It’s the passive, index fund investor.
And, guess what, that exact strategy is followed by most robo-advisors. The investing studies are clear – passive investing in index funds leads to greater long term returns than the buying and selling of active fund managers.
In fact, Betterment, Personal Capital and others have some of the finest investment minds on their boards of directors, guiding their index fund investment selections.
4. You need a robo-advisor because your investment advisor charges too much.
The average financial advisor charges roughly 1.0% of assets under management. On top of that fee, there are trading commissions and the fees charged by the underlying investment funds. The Principal Blue Chip A (PBLAX), actively managed large cap mutual fund charges a 1.15% expense ratio. If your financial advisor includes that fund in your investment portfolio then you’re paying 2.15% in expenses as you total the fund and advisory fees.
Now, robo-advisors typically invest in low fee index funds. For instance, a popular S&P 500 exchange traded fund (ETF), the SPDR S&P 500 ETF (SPY) charges a 0.09% management expense ratio. Assume that you invest with WiseBanyan or M1 Finance, who don’t charge management fees, and your investments with the robo-advisor includes the SPY. Your total fee would be 0.09%. That leaves 99.91% of your money to grow for the future.
Of course, there will be other investment funds within your portfolio with varying expense ratios, but with a robo-advisor, those funds typically charge very low fees. And, some robo-advisors, such as Wealthfront and Personal Capital invest in individual stocks, without the underlying fees of ETFs, within their robo-advisor.
5. You need a robo-advisor because there are digital advisors with various styles and features.
Robo-advisors aren’t all alike. There are robo-advisors for every type of investor. If you want to try your hand at beating the market, but don’t want the responsibility of actually buying and selling stocks on a regular basis. There are actively managed robo-advisors.
For example, Personal Capital, Qplum, T.Rowe Price Active Plus Portfolios, Merrill Edge Guided Investing, Building Benjamins and Alpha Architect all combine a computerized robo-advisor with active investment management strategies. And you can expect to pay lower fees for these robo-advisors than you would for a human financial advisor.
If you can’t bear the idea of not having a financial advisor to speak with, there are many robo-advisors that also offer access to human financial advisors. Personal Capital, Betterment, Ellevest, Qplum, Wealthsimple and TD Ameritrade all include credentialed financial advisors to help you with your personalized investment questions.
So, if you want top-notch investments, low fees and a set-it and forget it investment approach, then you need a robo-advisor.
The following is a guest post from Millionaire Mob.
Allocating assets is very important. Actually, it’s likely the most important component for building sustained wealth over time. If you can master budgeting and saving, congrats! You are onto the next step of building wealth… Allocating your assets efficiently.
If you are seeking financial freedom, you must think about your asset allocation now. Not in the future. You must create a plan that works and most importantly, is realistic.
It’s okay to feel overwhelmed with where you should put your money, that’s natural. If you have a plan for success or an outline of how to invest your money, you will feel much less overwhelmed. Plus, you’ll feel a lot less guilty if you want to splurge on spending every once and awhile.
Why asset allocation is important?
Asset allocation is important. It’s as simple as that. But why? You need to mix you assets to allow your hard-earned savings to start working for you. Money is a tool that can help you create new opportunities and thus, more money. There are a few reasons why asset allocation is important:
How to Allocate Your Assets for Financial Freedom
Let’s dive into a few steps to help you start allocating your assets for financial freedom.
1. Determine Your Risk Tolerance
Where and how you invest is the most important part of allocating your assets. Before you invest, you should understand the capital stack. This is the biggest determinant of why lending can be less risky than being an equity owner. Also, the capital structure helps you understand that leverage (or low-cost debt) is not a bad thing with real asset ownership.
If you are an ordinary investor and young, I’d consider the following approach to start investing for financial freedom:
When considering where to park your money, you need to think about these as part of the total pie collectively (both on a pre-tax and after-tax basis). You can gain significant exposure to indices and bonds through your retirement accounts including (401k, Roth IRA, IRA, etc.), but that’s not it.
You should think about your after-tax proceeds from work to allocate to index investments, direct real estate for income and alternative investments. You should have a sizeable nest egg of after-tax index contributions that you can start withdrawing once you achieve your optimal financial freedom target. Volatile stocks are a normal part of the market, so you need to stay invested over time. Make yourself aware that downcycles will happen.
I love real estate because it provides an opportunity to increase your income AND build wealth through the use of leverage. If you can find outstanding income properties, you can start building wealth immediately through compound interest.
2. Diversify
Diversification is paramount for any person aspiring for financial freedom. If you are an expert investor, you can make a case where diversification is a bad thing.
However, for personal finance, diversification needs to happen.
Diversification can happen on several levels, including:
Thus, you should hit on each of these levels of diversification when thinking about where to allocate your assets. Keep is high level when you think about diversification, no need to think about sub-industries, city specific, etc. If you think about diversification too much, you will run into overkill.
3. Keep It Simple Stupid (KISS)
If you want to allocate your assets for financial freedom, you should deploy the KISS method. Here’s how you can keep things simple:
Conclusion on Allocating You Assets
First, achieve the repetition of saving on a continually basis. Make your savings habitual. That should be the easy part due to many different automated tools tied with bank accounts. Set up automatic transfers from banking accounts to your investment accounts. From there, make a plan upfront of what number you need to achieve. Then, start deploying your capital into your various asset allocations. Don’t stray away from your plan. Stay focused and continue to invest.
Go out and enjoy life.
The following is a sponsored post from EquityMultiple.
Maybe you’ve heard of “real estate crowdfunding” and associate the term with Kickstarter and GoFundMe (and investments that don’t inspire much confidence). Perhaps you’re unclear on how the concept differs from REITs. Or, perhaps, you haven’t heard of real estate crowdfunding at all.
Real estate crowdfunding - an evolving set of online platforms for direct, private real estate investment - has emerged as a new alternative asset class, and viable means for individual investors to access private real estate on a level that was unavailable even 5 years ago.
Let’s take a step back and review why real estate is an appealing asset class, and worth taking a look at for all individual investors already exposed to the stock market and bonds:
Why Real Estate Crowdfunding
Unlike REITs, which have been around since the late ‘60s and are publicly traded, ‘real estate crowdfunding’ offers private-market investments in distinct properties. Because these investments are illiquid, with yield derived from the quality of the underlying asset and management, they tend to correlate far less with the stock market as compared with REITs. It’s been shown that portfolios substantially allocated to private-market alternatives (like real estate crowdfunding) tend to perform better over time.
Ownership of property - the other traditional means of investing in real estate - does offer de-correlation from public markets, and the opportunity to realize sizable yield through shrewd management. However, owning your own rental property is far from passive - indeed, managing real estate can quickly become a full-time job, especially as you consider multi-tenant commercial property.
Real estate crowdfunding, conversely, allows you to passively invest alongside established real estate firms, benefiting from the experience and scale of the firms you co-invest with. And, because investment-level minimums are typically as low as $5k, you can assume less risk and diversify across markets, property types and risk/return profiles.
Put it this way: if you have $100k to invest, you could put it entirely into a downpayment on a rental home, and deal with management of the property and tenants over time. With real estate crowdfunding, you could instead invest passively in 10 different commercial real estate projects across the country, and save yourself a ton of time and many headaches.
Keep in mind, however, that not all real estate crowdfunding platforms are created equal...
What EquityMultiple Offers
As the name implies, EquityMultiple does offer common equity investments, in the realm of ‘equity real estate crowdfunding platforms’. However, EquityMultiple provides a few unique features:
The following is a guest post from Alexander. He started his career in the financial business back in 1999. For many years, sharing investment ideas with his readers on his website daytradingz.com is an important part of his life.
High-frequency trading describes the practice to submit thousands of orders per second. The aim is to profitably benefit from even the smallest price changes within this short period. With fiber optic cables and increasingly sophisticated programs, the advantage of this practice lies in its incredible speed.
Since the emergence of high-frequency trading, it has kept the stock market afloat, causing millions upon millions of orders - per minute! Most of these orders are ultimately not executed because HFT-Traders are looking for short-term arbitrage only.
In the past, it was common practice for investors to make arbitrage trades by exploiting the price differences between individual stock exchanges. Nowadays, this trading practice and its potential profits must be left to the high-frequency traders with the best high-end trading computers.
Arbitrage profits can no longer be achieved with manual order entry. High-frequency trading now constitutes for a large part of the trading volume in some market segments.
Frequently, the terms algo-trading and high-frequency trading are used as synonyms. However, this is not correct.
While "algo-trading" describes the practice of computer-aided and partially computer-controlled orders in general, the term "high-frequency trading" explicitly refers to such computer-based trading practices where speed is at the forefront as well as strategic.
The fastest lines are installed, and the best possible proximity to the exchanges is sought (shorter line = faster transmission). Additionally, the programs are structured in such a way that they minimize the need for human intervention to an absolute minimum.
High-frequency trading is literally about milliseconds! This incredible speed, in which orders can be made in large numbers, allows the pursuit of very diverse market strategies, such as profits through arbitrage, where speed is everything.
However, high-frequency trading does not only show positive market developments. In fact, for the following reasons it is very controversial:
To master all of this has become more of a wish. One of the main reasons is because the stock market is so strongly internationalized that the various jurisdictions legally complicate effective supervision. Regulations are confronted with a global armada of supercomputers.
While the computers generate millions of transactions per day, the respective auditor has to look at the trading transactions individually or even fall back on computer-aided verification procedures. It is a game of cat and mouse.
High-frequency trading will not decline. On the contrary. It will continue to increase and become a natural part of life for investors. And private investors now also have the opportunity to benefit from algorithm-controlled trading strategy development and order execution.
Unlike institutional investors, private investors will never have the advantages of the server location, but they will catch up and benefit from technological progress.
The computer protected digitalization of stock exchange has created a foundation for further innovations. Good ones and bad ones. On the one hand, the potential for human error has been minimized, and liquidity has significantly increased.
On the other hand, a regulative hard-to-tame Hydra in the form of high-frequency trading has been created, turning an actual secondary market into an insatiable impulse generator with high potential, as the Flash Crash of 2010 has already shown.
In financial movies and financial documentaries such as the YouTube production "The Wall Street Code", you can see down to the last detail the power of high-frequency trading and the challenges it poses.
The following is a guest post from Alexander Voigt. He started his career in the financial business back in 1999. For many years, sharing investment ideas with his readers on his website DayTradingz is an important part of his life. You can almost call it his passion.
Equity Funds
Savings accounts or call money are currently not really suitable to increase one’s own capital by interest. There are other investment opportunities much more efficient, such as equity funds.
As the name suggests, this investment consists of shares, not in individual stocks, but in a portfolio of shares of different companies. The advantage here is that the risk of loss is significantly reduced if the investment strategy is correct.
At the same time, with a correspondingly intelligent selection, there are good chances to increase the various values in the equity fund. Without any need to scan the markets for individual stocks, this makes the investment profitable.
Certainly equity funds are a means of investment that demands more attention from the investor than the well-known savings account, but then an equity fund pays off while a savings account is actually losing money.
The risks involved in different funds can also be assessed with a little knowledge of the stock market. An investor need not be a securities specialist to be able to gauge how risk and opportunity behave in an equity fund.
Safe Investments – Equity Funds
Conventional savings are usually linked to the interest rate of the respective central banks. These are not growth-oriented, which of course is politically correct. Central banks must control the amount of money in circulation, using among other things the key interest rate, which is raised or lowered depending on the situation.
In contrast, public companies are obviously growth-oriented. A small example shows the differences. In the euro zone, the base rate was 3.25% in 2000. This meant that banks on savings deposits paid maybe 4 or 5% interest.
With slight fluctuations, the key rate remained in this area until 2009. After the global economic crisis in 2008, the key interest rate fell to currently zero percent. Even with generous calculation a savings balance of 100 euros would, including compound interest, result in 40 euros interest in the best possible case after 17 years.
Assuming that the 100 euros were invested in the DAX, which with its industrial heavyweights is by no means a very dynamic equity fund, but extremely conservative in the area of equity investment. Nevertheless, the DAX achieved an average performance of just over 5% per annum over the same 17-year period.
Invested in the DAX the 100 euros would have made almost 130 euros with compound interest. Other, more dynamic equity funds are still far above that. It should be noted that the past 17 years produced particularly mixed results for the stock market.
For whom are equity funds suitable?
While day trading belongs to the most speculative approaches to make money in these days, investments in equity funds give the investors more safety. So, they are also connected with less emotional stress.
Especially people looking for an alternative investment to the usual bank products are well advised to turn to equity funds, especially when it comes to long-term investment objectives with an overall low risk.
The management of an equity fund usually follows a specific investment concept with considerable diversity, such as investment in certain industries. In this case the companies of one or more industries are rated in terms of their growth, but also in terms of their stability.
If a company meets the specified criteria, its shares are integrated into the fund. Another concept is tied to dividend stocks or specific regions, which may be a whole continent like Europe or a single state such as Japan.
Another distinguishing feature may be a focus on small or large companies. The advantage of investing in small caps, in smaller stock companies, lies in the faster performance of their stocks. Especially in recent years, funds have achieved excellent value growth with this investment concept.
For example, the best small-cap funds made gains of between 13.8% and 15.76% between 2014 and 2016. The risk can be cushioned by a wide spread. But the success of such a fund may also turn out to be a handicap.
If the fund reaches a certain size thanks to multiple investors, it may be difficult for the managers to invest the amount of money according to their own criteria. In this case what’s lacking are simply suitable public companies.
Are there high risks in equity funds?
In fact, the risks are minimal if the investor or investor avoids certain types of funds, like sector funds with a very high degree of specialization. Of course just these equity funds offer the same promise of return, but the risk is very high that the forecasts for development will not materialize. With investments in a single industry even a company getting off the rails can pull down others.
Although the stock market and in particular equity funds have shown a positive performance over decades and are thus actually ideally suited for asset accumulation, skepticism remains high. This is clearly shown by the shareholder rate, the proportion of people in a country who invest their money in shares or equity funds.
Focusing on the goal instead of the way
Of course the daily price performance is a problem when investing in equity funds. With long-term investment periods of perhaps 10, 15 or 20 years, it may well happen that the price of the fund slips below zero on some days.
But this is by no means significant for the overall development. This is demonstrated very well by the world's oldest stock index, the Dow Jones. This index of the 30 largest industrial companies in the United States records their price development since 1928.
In these almost 90 years including a world war, several stock market crashes and other economic and political difficulties, the Dow Jones index climbed from about 30% to 10,170%. If somebody had theoretically invested only 100 euros in the Dow Jones equity fund in 1928, they would have achieved a whopping 10,270 euros in 2017, mind you, without compound interest.
With compound interest, it would be an amount with 29 digits. At 10 digits one reaches a billion, at 13 digits a trillion. Of course this is just as abstract as the assumption of an investment over the course of 90 years.
But it shows a very clearly that buying stocks beat every other investment working with fixed or floating rates. Because behind stocks there are people with ideas, with experience and with knowledge, working every day to move ahead, thus advancing the stock corporation.
An equity fund is in this sense not just a mix of shares of different companies, but a representation of the employees of these companies.
Investors who are searching for a more self-managed approach may profit from reading the article Best Stock Screener. The article explains the difference between stock screeners, stock scanners and charting tools. It also presents 40+ different investment tools that are available and it tells you how to use them effectively.
The following post is from FMF contributor Veselina Dzhingarova.
When you have spare cash, it is understandable that you want to make it work harder. Some people put their savings into a high-interest account. Others buy property. But, what if you could use that money to make extra money – and have some fun at the same time?
For anyone with an appetite for risk and a desire to make money, investing is a great hobby. You may not end up as rich as Warren Buffet, but if you play your cards right and learn the essential tools of the trade, you could make a tidy profit on your investment account. The good news is that investment is really easy these days. You don’t need a hotline to an investment broker and you certainly don’t need to work on the trading floor of the London Stock Exchange.
Anyone can have a go at investing in stocks, shares, ETFs or foreign currencies. All you need is an internet connection and some time to learn the ropes.
Create an Online Trading Account
Online trading is so easy, anyone can try it. There are several reputable online trading platforms where anyone can set up a trading account. You don’t need any prior experience. You don’t even need to trade using real money. Decide what you want to trade, whether its forex, stocks, commodities, binary options, or CFDs, and look for a trading platform that offers this.
Start by creating a demo account. Practice, test your skill, try out a few theories, and see if you have what it takes to make money. Once you feel confident enough to risk using real money, start trading for real.
Watch Buzz Index
Buzz Index uses Artificial Intelligence to identify trends and patterns in the financial markets. All savvy investors watch the markets and use news bulletins and other pertinent information to figure out which way the markets are going to turn, but AI makes life a lot easier.
Market insights are derived from superior artificial intelligence and the data is filtered through complex algorithms to produce useful information for smart investors. These insights can help you make the right trading decisions and boost your investment portfolio. AI is the future, especially in the world’s financial markets.
Try Social Trading
Social trading is an exciting new development in the world of investment. Wouldn’t it be wonderful to have an experienced mentor guiding your decisions as you play the markets? Thanks to social trading networks like eToro, you can do exactly that.
Social trading allows less experienced investors to connect with more experienced traders. You can copy their trading portfolio, discuss trading strategies, and ask for advice. It doesn’t guarantee you instant success, but the odds you will make money are far higher than if you struck out alone. Experienced traders are happy to share their insights. After all, they were newbies too, once upon a time.
Only trade on regulated platforms and don’t risk money you can’t afford to lose.
The following is a guest post from a lawyer writing about personal finance and investing at The Biglaw Investor.
One of the greatest achievements in the investing world over the past decade has been the dominance of index funds and the retreat of high-fee mutual funds and financial advisors. Investors, as a class, are starting to understand that attempting to beat the public market is a fool’s errand where the only guaranteed return is delivered to the brokers and advisors that take a cut out of each transaction.
At the same time, fast-growing technology has pushed private markets - previously unavailable to most investors - to the public.
Are there opportunities to get returns that aren’t correlated with the broader public stock market? I think there are.
One example of this “private-to-public” shift is the rise of real estate crowdfunding platforms. They open up investment classes previously unavailable to most investors by connecting investors with deals you typically wouldn’t see unless you were actively involved in the business, often outside of the investor’s home area.
For example, if you’ve ever wanted to own an apartment complex in a college town but didn’t leave near a college town and didn’t want the hassle of dealing with college kids, there’s now several options that allow you to get a piece of the equity.
However, I’m most interested in a quiet part of the real estate crowdfunding market known as “hard money lending”. As we’ll see in a second, hard money lending is a bit different than participating in the equity side of a real estate investment. Hard money lending has lower returns, ties up your cash for shorter periods but has the benefit of being backed by a hard asset. You’ll also get repaid before the equity investors see a dime.
Hard money lending is a private loan to an individual or company, secured by a first-priority lien against a hard asset (like real estate), typically for the purpose of fixing and flipping a property.
Let’s walk through a hypothetical example.
Imagine a local real estate fix-and-flip specialist in Texas spotting a house in his neighborhood for sale at a huge discount. The property might be a foreclosure, damaged by a storm or otherwise in a state of disrepair. As someone experienced in the local market, the specialist decides to buy the property, deploy a renovation team and then put the house back onto the market a higher value. To execute this plan, the specialist needs access to a bridge lender that can provide the cash for the purchase and renovations.
When the specialists approaches the bridge lender, it’s important to understand that the bridge lender is familiar with this market as well. This provides a further check on the specialist’s plans to purchase and renovate the property. If the bridge lender is convinced of the plan, they’ll typically provide loans for terms in the 6-18 month range to allow the specialist to execute the fix-and-flip.
Since the specialist intends to sell the property at a higher value, these aren’t your typical mortgages and because things could go wrong, the bridge money lender will typically charge between 7-12% interest on the project and perhaps a small origination fee as well. To smooth the cash flow for the specialist, the bridge lender will also typically only require interest payments during the term of the loan with one balloon payment at the end once the house is sold.
The bridge lender gets a decent return backed by a hard asset for a 6-18 month term. The specialist gets the cash he needs to complete the project with the cash flow flexibility to pay off the loan upon the sale.
If the bridge lenders are doing all of the lending, how can the average Joe investor participate (or the first-year associate at a law firm)?
The bridge lender is eager to move onto the next deal but can’t since its money is tied up in the current project. Since it makes money on each loan via the loan origination fee, the bridge lender is incentivized to do as many deals as prudently possible without taking on too much risk.
That means the bridge lender is happy to sell the loan to the broader market and move on to the next deal, much in the same way mortgages work where your local bank will ultimately sell the mortgage to the bond market.
Previously these bridge lenders had no such option. Instead, they carried the loan on their books until repayment and passed on other available deals until the cash was available for redeployment.
The maturing hard money lending space is now providing the bridge lender with access to a broader private market where it can sell the loan to a bunch of investors.
Once the loan is sold, effectively the private investors such as you and me are now acting as the lenders in the deal, happily collecting our 6-12% return while the fix and flip specialist and renovation crew continue to execute the plan.
The risk profile of hard money lending is easy to understand once you grasp the concept of LTV or loan-to-value ratio. This is because as a lender of debt, you have a higher position in the capital stack than an owner of equity.
In other words, holders of debt are always paid before holders of equity. Further, holders of debt with a security interest in an asset are paid before unsecured creditors. Therefore, debt holders with a first-priority security interest are at the top of the capital stack.
Here’s an example:
As you can see, the more equity in the capital stack, the more secure the creditor’s position in the capital stack. Because hard money lenders want to see specialists put skin in the game, they rarely lend 100% of the purchase and renovation price to the specialist. Instead, they may only lend 75% of the property’s valuation which requires the specialist to come up with the rest of the money himself.
In the 75/25% example, if the project cratered and the house had to be sold, the hard money lender would have to see a reduction of more than 25% in the property’s valuation before the hard money lender lost his first $1. When the LTV is even lower, the credit is in a better position.
It makes sense that the hard money lender is in the most secure position because the hard money lender is also capped on his upside potential. The most money he’ll receive in the deal is the interest rate on the hard money loan. Meanwhile, the person furnishing the equity portion of the deal has a higher risk/reward profile since he could easily lose everything if the property runs into problems or he could double his money if he’s able to sell the property for 125% of the original purchase price, including the renovation costs.
As you’ve probably noticed, a critical component of hard-money lending is ensuring that the valuation of the property is accurate. An inaccurate valuation makes the loan-to-value calculation worthless. The platform I’ve been using over the past five and a half months provides you with the specialist’s appraisal and also engages a third-party appraisal firm to provide a report on the property, to ensure that the valuation is correct.
Another major risk is that we encounter a situation similar to the predatory mortgage lending that led to the 2008 financial crises. If a bridge lender makes money on each origination and if it’s easy to sell each loan into the market, what’s stopping the bridge lender from doing as many deals as possible without concern as to repayment credit risk since that will be transferred to the investors?
To mitigate this risk we must rely on the platforms themselves and their incentive to only work with bridge lenders that have a proven track record of success. If Platform A works with unscrupulous bridge lenders and starts to have problems with its loans, you’d expect investors to flee to Platform B. Several failed deals could easily be a death knell for Platform A. Therefore, Platform A’s main job is making sure it only allows loans onto the system where it has a high degree of confidence that they’ll be repaid.
Many platforms reportedly turn away bridge lenders and various deals for this very reason. At least right now, they only want to work with the best of the best. However, the concept that underwriting standards will decay over time given the easy ability to resell loans to investors is something that a prudent investor should be considering at all times. I’m comfortable accepting lower returns in exchange for confidence in the valuation report and security of the credit stack.
Before writing about hard money lending, I wanted to put capital to work on a platform so I could learn about the process. I choose PeerStreet after walking away impressed with the two co-founders, one which is an ex-Google employee responsible for creating Google Analytics and the other which is a former real estate lawyer. PeerStreet appears to be the perfect combination of technology and real estate, with a complex technological backend and a heavily vetted process of finding deals (as of the date of this article, investors on the PeerStreet platform have yet to suffer a loss).
To be clear, there are several ways to get involved in hard money lending. It’s beyond the scope of this article to talk about them all. I’m only focusing on PeerStreet because it’s the platform that I’ve used and the way I’m becoming familiar with the market.
PeerStreet offers two ways to invest. Either I pick the investments available on its platform or I allow the automated investment system to make investments for me based on preset criteria. I’ve done a mixture of both. The great thing about the automatic investment is that after an investment is made I get an email where I can look over the investment and decide whether everything’s okay. If I don’t like it, I have 24 hours to cancel the investment. If everything looks good, I simply do nothing and allow the investment to proceed.
Here’s a look at my PeerStreet portfolio, where I’ve deployed about $10,000.
As you can see, I’m lending money in California, Colorado, Illinois, Florida, New York and Virginia. By only putting $1,000 in each deal, the platform allows you to diversify geographically and across different specialists, thus reducing the risk that you’ll be involved in a particularly painful deal.
You may also notice that on one of my loans no interest has been paid despite originating nearly 45 days ago. Rather than crediting your account with interest when and as it’s paid by the specialists, PeerStreet aggregates the interest payments and pays on the 1st and 15th of the month to provide a more predictable cash flow for the investors. If you’re interested in seeing updates, I’ve posted more detail about my PeerStreet investment here.
It could be. If you’re looking to tie up your money for a duration between six to 18 months, hard money lending offers attractive returns in the 6-12% range secured by an actual asset and buffered by the equity portion of the capital stack furnished by the specialist.
As for the downsides, to participate on the PeerStreet platform you need to be an accredited investor ($1 million in net worth; $200K in annual income), which means that many investors won’t be allowed to participate. Additionally, the interest you receive from hard money lending will be taxed at ordinary income rates, which can make the real return significantly less for high earners already subject to high marginal tax rates. PeerStreet does offer the option of investing via a self-directed IRA if you’d like to include this asset class as part of your retirement savings, something which I’ve considered but haven’t implemented.
While I’m comfortable deploying $10,000, I suspect that I won’t be increasing this position until I move it into a tax-sheltered retirement account. Given my marginal tax rate of 41%, too much of the returns are eaten up by ordinary income taxes to make this a lucrative investment during this stage of my legal career. However, I would be comfortable increasing the amount of capital devoted to this investment class if I was retired and wanted to generate some additional income.
The final benefit of hard money lending is that it should be uncorrelated to the broader stock market. Sure, we saw a huge housing crises during the 2007-2008 financial meltdown but when you’re investing in hard money lending you’re involved in very specific fix-and-flip deals. While housing prices might decline, so long as you maintain a solid LTV ratio it’s the equity investor that will see his position wiped out. Even in 2007-2008, housing prices didn’t fall to zero. Acting as a secured lender that has the ability to liquidate the house to seek repayment is always the strongest position.
A bazillion years after the rest of us knew that index funds were awesome, the popular podcast Freakonomics discovered the same thing.
I want to share a few highlights from their show. Let's begin with the active management versus index funds argument:
Many investors pay firms to manage their money — sometimes a percentage of assets, sometimes a flat fee. In return, you may get a variety of services — including advice about insurance or taxes. And, of course, investment advice: how best to save for a house, or your kids’ tuition, or retirement, whatever. Why pay someone for that advice? Because, let’s face it, investing can be confusing, and intimidating. All that terminology; all those options.
So you hire someone to navigate that for you — and they, in turn, use their expertise to pick the very best investments for your needs. This is called active management. They actively select, let’s say, the best mutual funds for your needs. And you pay them for their expertise. You also pay those mutual funds, by the way — sometimes there’s what called a sales load when you buy it; and an expense ratio, a recurring fee the fund deducts from your account. So, between the mutual fund fees and the investment fees, that’s usually at least a couple percent off the top — and that’s whether your funds go up or down, by the way. So hopefully they go up. Hopefully the active management you’re paying for is at least covering the costs?
What we actually found was the top 2 to 3 percent had enough skill to cover their costs. And the other 97 or 98 percent didn’t even have that.
This is why I like index funds -- they all but guarantee you're going to beat actively managed options. No one can consistently (if at all) pick the top 2-3% of actively managed funds. So the chances of doing better than simply investing index funds are almost zero.
Now let's compare the costs -- and how an average actively managed fund can cost you a ton of money:
We’ll start with the typical mutual fund.
They charge a lot for this service. We estimate the average expense ratio is almost 1 percent for an actively managed fund. Then these active funds, all of them have sales loads. The index funds do not. The active funds further turn over their portfolios at a very high rate and that’s costly. You add that all up and the cost of owning a mutual fund on average is 2 percent.
And how does that compare to an index fund?
You can buy an index fund of, an S&P 500 Index Fund, let’s say, for as little as 4 basis points, four one-hundredths of 1 percent. In a 7 percent market, you’re going to get 6.96 percent.
That difference — 2 percent versus four one-hundredths of 1 percent — may not sound like a lot. But over time, those numbers are compounded by what Bogle calls the “relentless rules of arithmetic.”
If the market return is 7 percent and the active manager gives you 5 after that 2 percent cost, and the index fund gives you 6.96 after that four basis point cost — you don’t appreciate it much in a year — but over 50 years, believe it or not, a dollar invested at 7 percent grows to around $32 and a dollar invested at five percent grows to about $10. Think what an investor thinks about when he looks at that number. He says, “Wait a minute! I put up 100 percent of the capital. I took 100 percent of the risk and I got 33 percent of the return.” Well, anybody that thinks that’s a good deal, I’ve got a bridge I want to sell them.
Here’s the reality: this is the business, the mutual fund, actively-managed business, where you not only don’t get what you pay for, you get precisely what you do not pay for. Therefore, if you pay nothing, you get everything.
Add a few zeros to 32 and 10 and you can see what a huge difference this would make to a large amount of money like that found in a 401k. It's hundreds of thousands of dollars, if not millions, over the course of a working career.
This is the paradox of index fund investing -- that you can beat most others by being "average."
This is because index funds give you the average while actively managed funds give you their results LESS their high fees. The fees are the killer that usually takes the return rate below the average.
Finally, they talk about the difference between one index fund and another:
The Vanguard S&P 500 index fund is about 5 or 6 basis points. Schwab recently cut 1 to 2 or 3 basis points. There are S&P 500 funds with 50 and 75 and 100 basis points. It’s an insane — that is a tax on [the] dumb.
In other words, all index funds are not created equal. Why would you pay many times what you need to for the same thing?
You must be sure you invest in a LOW COST index fund, not just any index fund. Otherwise, you are just throwing money away.
Personally, I've used the same three index funds for the majority of my investing over the past 20 years.
Investing this way is simple, easy, and gets me very good returns.
I appreciate Freakonomics agreeing with me! ;)
Here's a piece from MarketWatch saying savings rate is more important than investment return. A summary of their thoughts:
The secret to building wealth has less to do with returns and more to do with your savings rate, according to analysts at Pension Partners.
In other words, the amount of money you contribute to your retirement fund is far more important than what investment vehicles the money is parked in, as you can control the former but not the latter.
It makes sense intuitively. Saving $20,000 a year will grow your wealth a lot faster than saving $10,000 a year. But even incremental savings-rate increases play a far bigger role than corresponding increases in the rate of return.
To illustrate the importance of savings vis-à-vis investing, Charlie Bilello, director of research at Pension Partners LLC, ran some numbers on what would happen to your wealth if you increased your savings rate by 1% and correspondingly what would happen if the rate of return on a portfolio increased by 1%.
Bilello assumed a median U.S. household income of $58,000, which after taxes leaves $49,300 to spend. Saving only 1% of this income every year for 30 years at a 10% return will lead to an accumulation of $81,096. That number is less than your wealth after saving 5.5% of income at a meager 1%, which would grow to $94.319.
Ok, let's review a bit:
My best advice is to save as much as you can for as long as you can, putting what you save in index funds.
That's it.
Years ago I wrote Costs Matter If You Want to Maximize Investment Returns. It was a summary from the great book The Bogleheads' Guide to Investing, one of the only five money books anyone ever needs to read.
The bottom line: costs are one of the main determiners in how well an investment will do. The lower they are, the better.
Money magazine covered this same issue in an old issue I found recently. They listed the results of investing $1,000 a month for 30 years with a 6% return rate. The only thing that was different were the costs for the fund they invested in.
Here are the results after 30 years of investing:
Some thoughts:
That's my take on costs and investing. Anything to add?
The following is a guest post by Chris Cagle from Retirement Stewardship.
If you read the financial press or investing blogs these days, you are sure to see an article about how the stock market has risen to record highs. Many are sounding the alarm that the market has reached such rarified heights that a major correction or crash is imminent.
A few are expressing concern that we are in a stock market “bubble,” which is a subject of some disagreement among those who closely track such things. There are analysts who say that although the market has hit record highs, it is far from “bubble” territory. Others who look at various price-to-earnings ratios as predictors of things to come are more concerned.
So the big question is, "Where will it go from here? Are we headed for a major correction or even a crash? Or perhaps we are heading toward heights we have never even dreamed of?"
The certainty of uncertainty
Most people get spooked about big market declines. About a year ago, I wrote about stock market volatility and what to do about it. At one point, the markets were down almost 10 percent from the start of 2016. I expressed my usual sentiment of “don’t just do something, sit there” as I generally hold to the premise that if you have a diversified portfolio that accurately reflects your risk tolerance, you will be well positioned to weather most any storm that comes along.
But the current situation is different. Although it seems counterintuitive, some people are getting a little nervous about the dramatic rise in the markets. And they’re certainly wondering how long it can continue.
Well, there's only one thing we know for sure: We can’t know for sure. But we do know that markets are cyclical; they never go in the same direction forever. So, it's with a high degree of confidence that we can assume that they will, eventually, go down. When and by how much is anybody's guess.
In fact, some historical declines, if not unforeseen, have been unprecedented. The 2008 crash was one of them – it was more than any other decline since 1929. But things were very different in 2008 than they are in 2017. Plunging real estate prices and collapsing credit markets were the main causes of the 2008 market crash.
But does that mean that a major correction or even a crash is any less possible? Not necessarily as it would be fantasy (and therefore pretty foolish) to assume that the stock market trends of the last nine years will go on without end. Does that mean that you should sell all the stocks in your retirement portfolio? Probably not, but taking some profits off the table to "keep some powder dry" for the next big buying opportunity might not be a bad idea.
Straying from the herd
I recently went against my usual “buy and hold” philosophy and sold about 15 percent of my shares in my large value domestic stock dividend fund to add to my cash reserves. Although it is a somewhat conservative fund, it is up over 60 percent in the last five years. In doing so, I raised my cash position to almost 30% of my portfolio, which is higher than its been in a long time.
Of course, I could just sit still and do nothing, which is what I do most of the time. And I suppose that some would say that this is really just trying to time the market. There may be some truth to that, but I am very aware of the many risks that folks like me who are getting close to retirement face, especially “sequence of returns risk.” Therefore, I am scaling back my stock allocation just a bit. I am also giving myself a little flexibility to buy more shares of a fund I really like when the right time comes.
I will admit that I am diverging somewhat from my own investing principles. As I wrote in an article about saving and investing,
Some people’s strategy for investing is to “play the markets.” They buy and sell and try to time market ups and downs in order to make a profit. Although there is the occasional success story, this has been proven to be a losing strategy in the vast majority of cases.
The fact is I do not “play the markets,” and I have only “sold high in order to buy low” a few times. I don’t think I can time the markets, so I am content to sit patiently and wait to put some of my cash back to work.
Straying can be scary
I will confess that I found selling some shares when things seem to be going so well felt a little uncomfortable, especially as I watched the fund that I had sold go even higher in the days since.
But reassuringly, Carl Richards, in a recent article titled, Sticking with the Herd: A Risky Proposition, reminds us that it could actually be the most dangerous just when it feels the safest to keep running with the heard. He wrote,
“…maybe we should think very carefully about doing the same thing as everyone else. Does it really keep us safer to stick with the herd, or are we risking everything by continuing to look at the world through an outdated lens?
He goes on to remind us of Warren Buffet’s advice to be greedy when others are fearful and fearful when others are greedy. Interestingly, the Fear and Greed Index is currently at 83, which is in the “extreme greed” territory -- the highest category. For me, it just seemed like a good time to apply Mr. Buffet’s advice.
Richards himself acknowledged that it can make you feel “wildly uncomfortable” when you separate yourself from the herd. That’s because we lose the perceived safety what we feel when we run with the pack. It did feel “funny” to sell even a few shares when everything seems to be on a steady march upward. But, as he also wrote,
“…then the market adjusts, and suddenly all the people who chase each other into it are chasing each other back out. Suddenly, sticking out doesn't seem like such a bad idea.
Straying, but not too far
It is important to note that I am not talking about gloom and doom here. I only sold some shares of two of my favorite funds to raise some additional cash; I didn't liquidate my entire portfolio and plow it into my gold ETF (GLD), which I maintain only a small allocation to (although I did add a little to it).
Simply based on current valuations, and the duration of the current market bull run, I don't think this was a bad idea. In fact, some would say that this is a good time to have 15, 20, or even 30 percent in cash for the next buying opportunity. When it may come is anybody's guess - I'm certainly not going to try. It may be a week, a month, a year, or longer. But it will come.
How do I know? Well, they always do.
Fidelity lists six habits of successful investors as follows:
This is a pretty good list and it's hard to argue with Fidelity. Here's what I'll add about investing success:
1. Go with low-cost index funds. They will give you the best overall return (once expenses are factored in) for the least amount of time and hassle.
2. Save as much as you can for as long as you can. Time is your greatest investment asset.
3. Stick with it! Even when the market goes down (or especially when it goes down), stay with your strategy.
It's really that simple IMO. Anyone want to add anything else?
Here's an interesting article that says the investment choice of the poor is alarming.
It reviews a Gallup survey that asks Americans to choose the best investment from a list of choices. Sounds harmless, right?
Well, here's what causes the author to be concerned:
The most interesting thing is that there are some serious differences between the investment styles of the poor and the rich. First, the rich love real estate and stocks:
Upper-income Americans are much more likely to say real estate and stocks are the best investment, possibly because of their experience with these types of investments. Upper-income Americans are most likely to say they own their home, at 87 percent, followed by middle (66 percent) and lower-income Americans (36 percent). Gallup found that homeowners (33 percent) are slightly more likely than renters (24 percent) to say real estate is the best choice for long-term investments.
But lower-income Americans tend to favor gold:
Lower-income Americans, those living in households with less than $30,000 in annual income, are the most likely of all income groups to say gold is the best long-term investment choice, at 31 percent. Upper-income Americans are the least likely to name gold, at 18 percent.
Here's why they are concerned:
But there's another strong possibility as well: Lower income individuals tend to be less financially literate. Many of the poor surveyed by Gallup might simply not be as well-educated about stocks, bonds, and real estate investment trusts as the rich. After all, only 11 percent of those who make less than $25,000 a year have a non-retirement investment, compared with 60 percent of those who make more than $75,000. Gold, on the other hand, might seem like an attractive investment option if only because it is fairly synonymous with wealth.
Tied to financial literacy is familiarity. Because the poor have little money to spend, productive investments like stocks, bonds, etc. are out of reach. Gold, however, is the one of the few investments that are not.
Some thoughts here:
So what do we do about it? Or do we even need to do anything about it? Does anyone care? After all, this is what people SAY, not what they DO. After 25 years working with surveys I know there's a big difference between the two.
Thoughts?
I remember back in the day when index funds were the second-choice of almost every investor.
But based on what I've seen lately, the tide has certainly reversed.
Let's begin with some great thoughts from 20 Something Finance who quotes the following:
“84% of large-cap funds generated lower returns than the S&P 500 in the latest five-year period and 82% fell shy in the past 10 years.”
And yet 67% of all invested U.S. assets were in actively managed funds. Ugh.
The key findings:
“The expense ratio is the most proven predictor of future fund returns.” The takeaway is this: high expense ratios eat in to fund performance, outweighing any other perceived performance benefits. And actively managed funds have higher expense ratios than passively managed funds, and subsequently lower performance.
Yes, costs matter. That's one of the main points in the great book The Bogleheads' Guide to Investing (here's a review of the book that gives details).
Moving on, Barbara Friedberg lists 5 Reasons to Choose Index Funds for Your Investment Portfolio as:
1. Index Funds Are Proven Winners
2. Index Funds Streamline Investment Decisions
3. Index Funds Lower Costs
4. Nobel Prize Winners and Financial Luminaries Support Index Fund Investing
5. With Index Funds – All Your Money is Working For You
Some thoughts on these:
I've been investing in index funds for at least a couple decades now, thanks to Vanguard. In fact, almost 60% of my assets are now in index funds.
How about you? Where do you invest your money?
Vanguard lists five myths and misconceptions about indexing as follows:
The myths I want to highlight are #2 and #3.
I've had many people say to me that they don't want to "settle" for average returns which are what they believe index investing provides. However, this is not the case. Indexing provides average gross (before expenses) returns, but once costs are deducted, indexing provides superior net returns (which are what you actually take to the bank). Here's how Vanguard puts it:
The reality is that index funds, in their attempts to deliver the average returns of all investors in a particular market, have delivered far-from-average performance.
An important reason for this is cost. Indexing has proven to be a low-cost way to implement an investment strategy, lending a significant tailwind in producing above-average returns over the long term relative to higher-cost active strategies. For example, 84% of active small-cap blend funds and 71% of active emerging-market funds underperformed low-cost index funds for the ten years through 2013.
Can some investors beat index investing? Yes. Can a very few do it again and again for decades? Yes, but only a handful. Does doing so require a good amount of skill, time, nerves of steel, and even luck? Yes. In other words, most people (even professional fund managers) can't beat indexing -- the odds are stacked against them. So why try? Instead, spend your time and effort working on growing your career -- something you can impact and which will yield much bigger dividends in the long term.
Closely tied to the net return is costs, which Vanguard addresses in myth #3. Their thoughts:
The "higher the price, the better the product" myth is another intuitive, everyday maxim. In investing, it would seem to be translated as: "We can expect to enjoy higher returns from expensive or highly rated managers."
However, the reality in investing is that this seemingly commonsense relationship is reversed—you often get what you don't pay for (that is, higher performance is frequently equated with lower cost). Perhaps even more unintuitive is that highly rated funds have actually underperformed their lower-rated peers.
They then show a couple of charts that illustrate these points of view.
I know Vanguard has a vested interest in promoting index investing so the arguments are far from biased. But that doesn't mean they aren't valid or true. The reasons above (plus others) are the reasons I have invested in index funds for over two decades now. And I don't plan on changing anytime soon.
How about you? What's your key financial investment these days?
The following is a guest post from Marotta Wealth Management. I've stripped out the political commentary (or at least I think I have -- hope I didn't miss anything) because it didn't really add anything, but am running the piece anyway because I think it lists some good ideas on how to avoid capital gains taxes if you really want to.
The capital gains tax traps wealth in an investment vehicle requiring special techniques to free the capital without penalty.
Multiple ways are available to avoid the tax. Here are 14 of the loopholes the government's gain tax unintentionally incentivizes.
1. Match losses. Investors can realize losses to offset and cancel their gains for a particular year. Savvy investors harvest capital losses as they occur and then use them on current and future taxes. Up to $3,000 of excess losses not used to cancel gains can offset ordinary income. The remainder of the loss can be stored and carried forward indefinitely.
This encourages investors to sell great investment vehicles during a temporary dip only to buy them back again 30 days later for a new cost basis.
2. Primary residence exclusion. Individuals can exclude up to $250,000 of capital gains from the sale of their primary residence (or $500,000 for a married couple).
Families who stay in the same home for decades suffer a tax that more mobile families avoid.
Smart homeowners who might move or need the capital move more frequently to avoid the tax. Needlessly selling and buying a home is the arduous cost to the economy.
3. Home renovation. Sharp real estate agents and home renovators make their under-market investment purchases their primary residence while they are fixing them up. They then flip the houses, selling for a better sales price but avoiding any tax on their gains via the primary residence exclusion.
4. 1031 exchange. If you sell rental or investment property, you can avoid capital gains and depreciation recapture taxes by rolling the proceeds of your sale into a similar type of investment within 180 days. This like-kind exchange is called a 1031 exchange after the relevant section of the tax code. Although the rules are so complex that people have jobs that consist of nothing but 1013 exchanges, no one trying to avoid paying this capital gains tax fails. This piece of valueless paperwork does the trick.
5. Stock exchange. Stock investors with highly appreciated securities can also do a like-kind exchange. Certain services offer investors with one highly appreciated security a way to trade it for an equivalently valued but more diversified portfolio. This expensive service can help investors avoid paying even larger capital gains taxes.
6. Exchange-traded funds. ETFs use stock exchanges to avoid triggering capital gains taxes when stocks move in or out of the index on which the ETF is based. Stocks moving out of the index are exchanged for stocks moving into the index. Investor cost basis transfers to the new securities.
7. Traditional IRA and 401k. If you are in the higher tax brackets during your working career, you can benefit from contributing to a traditional IRA or 401k. This both reduces your income while you are in the higher brackets and eliminates any capital gains as a result of trading in the account. Rebalancing by selling appreciated asset classes in a tax-deferred account avoids the capital gains tax normally associated with such trading. During the gap years, between retirement and age 70, withdrawals from these accounts could be made in the lower tax brackets.
8. Roth IRA and 401k. Traditional accounts can postpone taxes to a more favorable year, but Roth accounts can avoid them altogether. Having paid tax on deposits, a Roth account allows tax-free growth for the remainder of not only your life but also the lifetime of your heirs. Unless you are in the higher tax brackets and approaching the gap years, Roth accounts are usually an excellent tax strategy.
9. Health Savings Accounts. HSAs are one of the few accounts where you can receive a tax deduction for contributing to them, invest them and receive tax free growth and then not pay any taxes as long as you use withdrawals for qualified health expenses. Investing your HSA account to receive tax free growth is another way to avoid paying the capital gains tax.
10. Give stocks to family members. If you are facing a high capital gains rate, you can give your highly appreciated securities to family members who are in lower brackets. Those receiving the gift assume your cost basis for computing the gain but use their own tax rate.
11. Move to a lower tax bracket state. State taxes are added on to federal capital gains tax rates and vary depending on your location. California has the highest U.S. capital gains rate and the second highest internationally, with a top rate of 37.1%.
In the United States, seven states add nothing to the federal top rate of 23.8%: Alaska, Florida, South Dakota, Tennessee, Texas, Washington and Wyoming.
12. Gift to charity. Instead of giving cash to the charities you support, you can give appreciated stock. You receive the same tax deduction. When the charity sells the stock, it is not subject to any capital gains tax. The cash you would have given is the same amount you would have had for selling the stock and paying no capital gains yourself.
13. Buy and hold. Many investors buy good index funds that never need to be sold. Even if you rebalance regularly, rebalancing can often be accomplished by using the interest and dividends paid to purchase whichever investments need to be bolstered. The downside is that your capital is locked inside the investment vehicles and not free to be used for greater economic gain.
14. Wait until you die. Most people die holding highly appreciated investments. When you die, your heirs get a step up in cost basis and therefore pay no capital gains tax on a lifetime of growth.
Because most savvy individuals can decide the timing and amount of capital gains they choose to realize each year, the capital gains tax is considered very elastic. The amount of capital gains realized depends heavily on the favorability of the capital gains tax rate. As a result, over half of capital gains are never taxed.
I've written a couple times about buying term life insurance and investing the difference. For those of you unfamiliar with the phrase "buy term and invest the difference," it simply suggests that you do not buy permanent life insurance and instead by the cheaper term life insurance and invest the money you saved doing so. If you do this, you'll end up having more money in the long run as well as life insurance during the time you need it.
Turns out that Money magazine's "Mole" agrees that buying term and investing the difference is the best option for most people:
If you are a disciplined saver, I strongly recommend buying term and investing the rest. If you need a forced savings vehicle and you can't find that vehicle elsewhere, then you may want to consider a permanent policy. But either way, make sure you understand what it is you're buying and how much it's costing you.
He hit this one exactly on the head in my opinion. If you are disciplined enough to actually invest the difference (and not spend it), then buying term and investing the difference is probably for you. But if you're not able to save on your own, permanent insurance, though much more expensive, is likely a better option for you.
I'm interested, how many of you buy term and invest the difference and how many own permanent insurance? Why do you do what you do?
I was browsing through my Amazon affiliate sales the other day and noticed that I had sold copies of two great books: The Millionaire Next Door and The Richest Man in Babylon. I got to thinking about these books, what they contain, and the people who bought them. I also started to think about my own life and how it's been impacted by a few good books. This is when I became VERY happy.
I became very happy for the people who bought the books. I know that if they read and apply the ideas found in these books (see Two Books that Will Change Your Financial Life for details), they will be much, much, much better off financially. In fact, if they apply the ideas over several years, they will become quite wealthy. So for a few dollars, these people now have the ideas that could help their net worth increase by tens of thousands, hundreds of thousands, or even millions of dollars.
So what's the return rate on those investments? If you bought something for $10 and 30 years later it had helped you become worth $1 million, that's a pretty amazing rate of return. In fact, it's close to an infinite rate of return. Now you could get these books from the library and make the return rate infinite (since there's no cost to you), but based on my experience, you need to have your own copies of these so you can read and re-read them often, underline, mark, and write in them, and refer to them at various times in the future. (Now if you get one as a gift, the return could be infinite too.) ;-)
That's why I recommend the books that I do. It's because I've read them over and over, have applied the principles they discuss to my life, and have seen my net worth grow substantially as a result. That's also why my recommended book list isn't 100 books long -- there just aren't that many books (at least that I've found) that meet my criteria. For now, the only books I can give this recommendation to are:
If you don't have any of these books, I encourage you to get, read, and apply them. Doing so will give you a return close to infinite.
BTW, I like/listen to podcasts for the same reason!
Money magazine asked its readers over 50 what is the most effective way to build wealth. The results:
Anyone surprised? Not me.
In fact, it's not only the opinion of these readers that saving more is the best way to maximize your wealth, but the numbers prove it out as well. As I noted in The Best Way to Maximize Your Investment Return the key to growing your wealth is saving as much as you can for as long as you can.
And yet personal finance publications, radio shows, TV shows and the like spend the vast majority of their time and effort on investment return. I guess it's because it's more glamorous, but it's not the most effective way to grow your net worth.
Thank goodness that's the case. Because it's a lot easier to save over time than it is to improve investment return. That and the fact that most people aren't able to increase their investment return -- but everyone can work to save more.
Fortune recently ran some investing advice from Warren Buffett. The whole article was quite interesting, but I want to highlight and comment on a couple points he made. Here's the first:
You don't need to be an expert in order to achieve satisfactory investment returns. But if you aren't, you must recognize your limitations and follow a course certain to work reasonably well. Keep things simple and don't swing for the fences. When promised quick profits, respond with a quick "no."
A few thoughts here:
Quote #2:
My money, I should add, is where my mouth is: What I advise here is essentially identical to certain instructions I've laid out in my will. One bequest provides that cash will be delivered to a trustee for my wife's benefit. My advice to the trustee could not be more simple: Put 10% of the cash in short-term government bonds and 90% in a very low-cost S&P 500 index fund. (I suggest Vanguard's. (VFINX)) I believe the trust's long-term results from this policy will be superior to those attained by most investors -- whether pension funds, institutions, or individuals -- who employ high-fee managers.
Ha! Love, love, love this advice and sentiment.
Couldn't agree with him more! I've detailed my thoughts on this issue previously in Why I Invest with Index Funds.
It says something when the best (or at least one of the best) investor in the world recommends index funds for most people, doesn't it?
I recently stumbled onto the BiggerPockets Ultimate Beginner's Guide to Real Estate Investing, a free PDF on how to get started investing in real estate. It was a decent read, even for someone like me who's been in real estate a bit, but it mostly reinforced what I already knew -- I didn't learn a bunch. It also spent a lot of time on areas of real estate investing I'm not interested in, so I skipped those sections. That said, I thought I'd share it with you because the price was certainly right. It was FREE! :)
The book listed three "rules" of investing in real estate that I thought I'd share with you. Then in a later post, I'll share my "rules" (or at least how I evaluate a property). BTW, I don't use any of their rules. Not to say theirs are wrong and mine are right, just letting you know this upfront. I'll let you decide what you like and don't.
Here's their first rule:
The 2% rule states that your monthly rent should be approximately 2% of the purchase price.
Example, a $100k home should rent for $2,000 a month.
Of course, if monthly rent is more than 2%, I assume that's even better, right? :)
My monthly rents, once I get done remodeling all my units (the last one is almost done!), will be a bit above 1.8% of purchase price plus remodeling costs.
Personally, this rule would eliminate all the properties that I've purchased (which have great returns, by the way). They admit that it's very conservative and it should be used as a guide only. There's also a lot of debate in their forums that it's very unrealistic. I'll let you decide what you think.
Rule #2:
The 50% rule simply states that 50% of your income will be spent on expenses -- not including the mortgage payment.
Personally, I HATE this rule. Why? I don't like to ESTIMATE expenses with a flat percentage. I prefer to do a pro forma for every property before I make an offer on it. Only then can I know if my properties are worth the investment.
That said, once all my properties are completed, it looks like my expenses will be 50% or so (maybe a bit more) of my income. But I don't have mortgages, as most of you know.
Rule #3:
The 70% rule says that you should only pay 70% of what the after repair value is, less the repair costs.
They use this example to explain the rule:
A home which, after being fixed up, should sell for approximately $200,000, needs approximately $35,000 worth of work. Using the 70% rule, a person should multiply $200,000 by 70% to get $140,000 - and then subtract the $35,000 in repairs. The most a person should pay for this property, therefore is $105,000.
Huh?
They note that this rule is used by flippers, so no wonder it seems strange to me. I'm not a flipper. Though who knows, maybe one day I will be. :)
The BiggerPockets people end their rules section by noting that these are just rules of thumb designed to give a potential buyer an idea of whether or not a property is worth looking at a bit deeper. I think that's fair. I have my own rules which I use to give me a sense of whether or not a property is at least in the ballpark of what I'm looking for. Those rules help sort out the vast majority of houses on the market, allowing me to focus on the ones that could be winners.
So, what are your thoughts on the rules above?
Remember the interesting conversation we had about dividend investing?
I discussed my plan to retire without spending any of the capital I've accumulated (I want a retirement where I can simply live off the earnings of my assets without decreasing the principal). I mentioned that dividend investing, along with real estate, could be a possible way to reach my goal.
Shortly after that piece posted, a reader sent me this piece that lists three reasons dividend stocks tend to outperform non-dividend stocks. The reasons:
1. Dividend Stocks Often Have Higher Quality Earnings Because You Can't Fake Cash
2. Dividend Yields Can Support a Stock During a Market Crash
3. Dividend Policies Put Pressure on Management to Be More Selective About Uses of Shareholder Capital
These are good points and worthy of consideration. But then the same reader sent me an even more interesting article on dividend investing, this one from someone who I admire and respect, Jonathan Clements at the Wall Street Journal. Here are some highlights he lists for using dividend investing in retirement. It begins with the same goal I'm looking for in retirement:
It's OK to spend your income, but never, ever dip into capital. Remember that old financial commandment? It was discarded long ago as a fuddy-duddy rule that doesn't work in our low-yield world. But as I ponder retirement, focusing on dividend-paying stocks, so you don't have to dip so often into capital, looks better and better— for seven reasons.
He then lists his seven reasons as follows:
He then ends with the following:
This isn't to say you should bet your retirement solely on high-dividend stocks. The financial world is too uncertain for that. But tilting toward high-dividend stocks deserves a place alongside other retirement-income strategies, including delaying Social Security, annuitizing a portion of your savings and holding a hefty cash reserve.
If you're collecting 3% in dividends and your goal is the often-recommended 4% portfolio withdrawal rate, you will need to augment your retirement income by dipping a little into capital and doing some occasional selling. But thanks to the dividends, you won't have to do much selling—which means you can watch those stock-market swings with far greater equanimity, while you wait for your next dividend check to arrive.
Exactly. This is exactly what I was thinking when I wrote the original post. It was just that Jonathan was much better at explaining it than I was.
This strategy could be added to the others that I detailed in my retirement budget to help me retire and live (rather easily) off the earnings of my assets, not having to spend the assets themselves.
What do you think?
Here's a piece from CNN Money that asks whether you should rebalance your portfolio or not. Their thoughts (FYI, this piece was published at the end of 2013, hence the numbers below are not for 2014):
Rebalancing your portfolio has long been investing orthodoxy, yet it has never been easy.
Shifting money from winning funds into laggards is counterintuitive, even though doing so can help reduce risk. But rebalancing has rarely been more challenging than it is today.
The Standard & Poor's 500-stock index is up 16% this year, and the 10-year Treasury bond has dipped 5.2%, which means you should move money from stocks into bonds.
Uh-oh. This is a dicey time to be plowing cash into fixed income. The Federal Reserve has repeatedly signaled that it will dial back its policy of buying bonds to keep interest rates low -- something that will pummel bond prices.
"I'm usually skeptical when someone says, 'This time it's different,' but once in a great while it is," says investment consultant Charles Ellis, author of Winning the Loser's Game. "You really need to think twice about owning bonds today."
Some thoughts from me:
How about you? Do you rebalance regularly? Do you think you need to or is it not worth the effort?
MSN Money lists a simple portfolio of three funds as follows:
Some experts are pushing a back-to-basics approach to investing. As drastic as it may sound, they say it's possible -- even at times desirable -- to construct a very well-diversified portfolio using just three low-cost mutual funds or ETFs.
Which three funds to use? A classic trio provides exposure to U.S. stocks, foreign stocks and U.S. bonds.
Many "Bogleheads" -- a group of investors who favor index investing as inspired by Vanguard Group founder John Bogle -- suggest a three-fund portfolio consisting of the U.S.-focused Vanguard Total Stock Market Index (VTSMX)fund, Vanguard Total International Stock Index (VGTSX), and Vanguard Total Bond Market Index (VBMFX). Together, the three mutual funds, which also offer ETF shares, track more than 15,000 global securities.
This is a very interesting piece to me for a couple reasons:
If you look at the results over the past several years, you'll see that this plan has worked out quite nicely. :)
I have altered my investments a bit over the time I first wrote on this issue and now. For instance:
Anyway, I prefer simple investing and thus really like the three-fund plan. How about you?
Here are what I consider to be the few, key steps to get the most out of your savings and investments.
While many people seem intimidated by investing and don’t know where to begin or what to do, being a successful investor is not that complicated (just like building wealth isn't that complicated). In the end it comes down to three basic (but important) steps as follows:
1. Save as much as you can. From the time you get your first job, start living on less than you earn. As your income increases, continue to keep your expenses low (I call this process increasing your surplus -- growing the difference between what you make and what you spend.) Obviously, the more you can invest when you are young, the more you will have saved at retirement. And the sooner you save, the better (more on that in a minute.) This sounds basic, but there are many people who graduate from college and immediately start to spend like drunken sailors. Don't do this!
2. Save as long as you can. All three of the main investment variables (1) how much is invested, 2) how long it's invested, and 3) the return rate) are important to investing success. However, the one that has the most impact on your results as an investor is how long you invest. As such, the younger you are when you start saving and investing, the larger your nest egg at retirement. The key factor that makes this so: the power of compound interest -- your savings starts to earn money on itself. And the sooner you get this process started, the better.
If you are only beginning to invest in middle age, how much you invest grows in importance because you will need more money to play catch up. That said, how long you invest is a vital success factor for any investor at any age.
3. Get a good return rate. My favorite way to get a good return rate is to use index funds. They deliver better returns than most actively managed funds after expenses simply because they are less expensive than most other alternatives. Furthermore, they are easy to manage (not much time required) and they allow you to diversify your holdings.
Notice how I didn't say "get a GREAT return rate"? Why not? Wouldn't getting a great rate beat getting a good one? Yes, it would. But the fact is, the vast majority of people (probably 99%+) are unable to invest to consistently beat the returns generated by index funds. In fact, even the most highly educated investing "professionals" with almost endless time and financial resources at their disposal can't regularly beat the performance of index funds. So you think you can? Nope. Neither can I. Thankfully, index funds provide us all with a great alternative.
In the end, successful investing comes down to three simple steps—saving as much as you can to invest, saving as early as you can, and getting a good rate of return. Do these three and you will be well on your way to making the most of the money you invest.
Readers, any other tips you would give new investors to maximize their investments?
The following is a guest post from Marotta Wealth Management.
Many people believe the rich inherit great fortunes and then sit idly by while their stocks make them more money. When you're working long hours, this belief can provoke jealousy and inspire questions like "Do investors even deserve to make money?"
To respond, we must first define ownership, which is best thought of as a set of rights. When I own something, I decide what to do with it. I have dominion and authority.
Your autonomy is only limited by your duty to respect the autonomy of others. Just as you have a right to act however you see fit, so do others. If you infringe on the rights of another without permission, you are acting in the wrong.
In their paper "The Biological Basis of Human Rights," Hugh Gibbons and Nicholas Skinner argue that the biological basis for legal wrong is "actions that, if undertaken, will diminish the will of another human."
This self-ownership is then the basis of all our other rights including property rights. Ownership is "self-propagating," meaning that the rights of ownership transmit from property to its products. Because you own yourself, you also own the fruits of your labor.
For example, when you make a stew, your efforts produced the food and you also own the product. The same goes for my chicken. I own the eggs the chicken produces just like I own the chicken. This is the right to property. With this ownership, I can trade my rights of ownership of goods for the rights to own something else.
Before currency, the product of my labor was the only way I could acquire the product of your labor. In a barter system, I trade my chicken or the promise of my chicken for your stew. If I don't have any goods you want, I can't acquire the rights to your stew.
However, in today's monetary system of trade, instead of getting an inherently valuable good as a reward for my labor, I get money. This money is just a placeholder of my labor not yet rewarded.
When I work my 9 to 5 job and earn a paycheck, I receive a paper certificate I can trade in for the real reward of my labor. Instead of trying to guess what a farmer really wants for his chicken, I can give him a monetary certificate for him to use as he wishes.
So long as his payment remains in the form of currency, his labor in raising the chicken has still gone unrewarded. But when he uses that money to buy chicken feed or dinner for his family, he is finally reaping the reward of his labor.
Workers can delay the reward of their labor in many ways, sometimes indefinitely. One obvious method is loaning money to someone else who needs it because he either has not labored enough or not saved enough. When you loan someone your money, you are essentially loaning your labor.
Hard work was required to earn that money. Because you let this labor go unrewarded, you are now able to let the money, in some sense, work for you. By making the loan, you allow him to reap your labor's reward first. In return for this privilege, he pays you back with interest.
Another way to prolong the reward is buying stores of value like real estate, precious metals, collectibles and stock ownership. Each of these stores the value of your reward. Unlike an ice cream cone where the value is either consumed immediately or lost, stores of value safeguard your ability to be rewarded for your labor at a later time.
If the value does more than remain constant but increases regularly, the store of value is an investment. Rental property and stock ownership as well as owning a private business are all common investments. Each one tends to increase in value over time.
Like loaning money, buying investments defers the reward of your labor while earning you more reward.
If I run my business well, the reward from my business will increase beyond its purchase price. If I run my business poorly, the certificates of labor I spent will forever go unrewarded.
In a business where the only employee is the owner, he obviously deserves all the profits. He is the one who invested money into it and the one laboring for it.
A restaurant is a more interesting example. Often one owner has hired employees to host people, bus tables, and cook and serve the food. The owner may not work in the restaurant herself, but she will still receive all of the profits.
From those profits, the owner pays her employees, mortgage or rent, bills and her own salary. She deserves a portion of the profit because she owns the store. Her unrewarded labor is at the heart of the value of the company. The present reward for the work done in the past is the store. Just as you own yourself, you own the fruits of your labor. So too when you own a store, you own the fruits of your store.
Imagine this restaurant owner decides to sell her business. A man comes along and buys the place outright. A trade occurs when the previous owner's unrewarded labor is freed from the store while the new purchaser's unrewarded labor is sunk into it. The new owner deserves the fruit of his property's labor just as much as the previous owner did. Even though the previous owner was the one whose sweat equity built the company, she sold her right to ownership. With that right, she transferred the right to the fruits of the property.
Stock ownership works just like this example. Only instead of investors buying companies outright, they are buying the tiniest percentage of a publicly traded company. Their share of the ownership means they are due that share of the profits. Their unrewarded labor, their money, has bought them a store of value.
Investors defer consumption of their reward to get bigger and better compensation in the future. This system of property rights is not only responsible for civilization as we know it but also the most mundane aspects of financial planning.
For example, deferred consumption is the basis for all retirement planning. Taking care of our own retirement requires being able to store the value of our labor in property that not only safely stores the present value but can beat inflation by continuing to produce more value. Nothing can replace this. To consume your reward later, a financial vehicle is needed to carry that value into the future.
That being said, sinking all of your retirement aspirations into one business might jeopardize those dreams. Small business owners often make the mistake of pouring all their resources into the business they understand best where they have the most control. But every business is at the mercy of macroeconomic changes, and small business owners benefit from diversification.
Property rights give our society the basis for financial security. Some have even argued that property rights are more critical to civilization than democracy. Everyone can benefit from the ability to buy and sell what they own, even minority business ownership.
I recently received a card in the mail from Vanguard. It read (in part):
Happy anniversary! You've been a client-owner of Vanguard for 20 years.
It went on to thank me for my loyalty, congratulate me on "reaching this milestone," and so forth.
Overall, I think it was a nice touch from them.
I have been with them a long time and IMO they are a great company. I'm hoping for another 20 years (at least!) together.
For those of you interested, here are the three funds I use the most at Vanguard.
I almost went through the exercise of calculating how much I've saved/earned with Vanguard in 20 years simply because my expense ratios have been almost nil compared to an industry average of over 1%. As we all know, 1% compounded over 20 years adds up to some BIG MONEY!
We also computed performance based on rebalancing the diversified portfolio monthly.
Rebalancing normally means selling what has gone up and buying what has gone down. This contrarian strategy challenges our intuition. We are wired to hoard what is up and regret what is down. However, when an asset class drops, the best tactic is to rebalance and buy more. And when an asset class rises and investors wish their entire portfolio was similarly invested, the best move is to rebalance and sell some.
To keep our example simple, we rebalanced monthly. However studies suggest that using a longer interval of time or deviation level from the ideal target is superior to monthly rebalancing.
Then we compared the returns of this portfolio against the returns of the S&P 500 ETF (IVV) by itself.
The diversified portfolio had a better average monthly return of 0.906% versus the S&P 500's 0.685%. This difference of 0.221% compounded monthly equates to the difference between an 11.43% annual return and an 8.53% annual return. The diversified portfolio earned an extra 2.9% annually.
From September 2003 to May 2013 (just short of 10 years; this period is the longest period that all six funds have been available), $10,000 invested in the S&P 500 would have grown to $19,860.
The same amount invested over the same period in the diversified portfolio would have grown to $24,199. Over just short of a decade, the $10,000 investment in the diversified portfolio gained an extra $4,340 over the S&P 500.
Over the same period, $500,000 would have grown to $1,209,939, earning an extra $216,991 over the S&P 500. A $2 million portfolio would have grown to $4,839,756, earning an extra $867,964.
Without rebalancing, the excess return was 9.12% less. A $500,000 investment that is not rebalanced would have only grown to $1,190,160. This is $19,779 less than rebalancing but still $197,162 more than the S&P 500. The rebalancing bonus is significant even using monthly rebalancing.
In any given month, the diversified portfolio never performed better than all of the five indexes. Asset allocation means always having something to complain about. It will never "win." Not even one month. This is an obvious result of diversification. The diversified portfolio is a weighted average of all five underlying indexes. It can't possibly be better than all of its components. It will always lose to something. On average it comes in third or fourth (of the six) each month.
The S&P 500 isn't alone in losing to the diversified portfolio over the long run. The same initial investment of $10,000 over the same period invested in EFA would have only grown to $19,681 and IWN to $22,435.
IGE and EEM, in contrast, would have grown to $29,764 and $31,634, respectively, beating the diversified portfolio.
Natural resource stocks (e.g., IGE) are a smart way to hedge against inflation for a portion of your portfolio. They help balance any bond components. But they do poorly when the dollar strengthens. Even though over this time period the class performed well, it is not suitable for 100% of your asset allocation.
Emerging market stocks (e.g., EEM) performed the best on average over this time period. However, their volatility makes a 100% EEM portfolio too risky to safely achieve your financial goals.
The average monthly standard deviation (SD) for the S&P 500 and the diversified portfolio were 4.25% and 5.27%, respectively. For the S&P 500 that means the average monthly return is between -3.6% and 4.9% for 1 SD. The range is between -7.8% and 9.2% for 2 SDs.
The SD for every other asset class is higher. Emerging markets is the highest at 7.26%. The range of monthly returns for emerging markets within 1 SD is -6.0% to 8.5%. Within 2 SDs, it is -13.3% to 15.8%. That's monthly, not annually.
The diversified portfolio's range of returns for 1 SD is between -4.4% and 6.2% and between -9.6% and 11.5% for 2 SDs. The markets are inherently volatile. Blending the asset classes helps include a portion of the returns of riskier, faster growing asset classes like emerging market stocks without experiencing all the gyrations normally associated with them.
Remember that 98% of the daily movement in the markets is just noise. Most of the movements of the market do not affect the overall return of the investment. Up movements pair with down movements, canceling each other out in the long run.
If you pair the S&P 500's monthly up-and-down movements, 79% are just noise. Only 21% of the monthly movement actually contributes to your ultimate return.
The diversified portfolio does not eliminate this situation. The noise of the markets cannot be changed. But they can be ignored. Noise is only dangerous if you listen to it. The wisest investors ignore daily and monthly market movements. Instead, they periodically rebalance back to their target asset allocation.
Here are five principles to keep in mind:
1. The markets are inherently volatile. If you want decent returns, you have to endure a large monthly SD.
2. Ignore the daily market movements. Also disregard the monthly noise, and don't let a season in the markets ruin a brilliant investment strategy.
3. Diversification works over long periods of time. One asset class can win for months at a time. It's better to rebalance than to chase returns.
4. It is always a good time to have a balanced portfolio. Although you may lose each month, you will win in the long run.
5. Planning works better than intuition. Without an asset allocation, you can't rebalance back to it and received the rebalancing bonus. Without an asset allocation, we are all tempted to sell what has gone down and buy what has gone up. But that is the exact opposite of what we should do.
If you are diversified across all these asset classes, be thankful for your returns. Stay the course, even when you come in third.
I'm approaching 50 years old. I remember when my mom became 50 and I thought "Man, she's old." :)
Anyway, CNN Money ran a series on "Best Moves if You're _____ Years Old." This one is the piece for those 45 to 54 years old and contains a target investment mix at age 50 as follows:
I get the U.S. and foreign stocks, but does anyone else think the bond amount is too high of a percentage? I do, for two reasons:
Sometime in the future I'll be sharing a post on my specific asset allocation (there's a lot of movement now with me selling some funds to buy real estate holdings), but one tidbit I can give you is that I just sold a large portion of my bond holdings because I thought I was over-weighted in them. The reason? Exactly the ones I stated above.
So, what's your take on this issue?
US News has a piece detailing investing lessons from the game Monopoly. They interviewed the author of a new book who has "30 years judging the United States and World Monopoly Championships" (who knew there were such things?) Anyway, he offers some investing advice based on what he's learned from the game. Some highlights:
I think Monopoly is the first and perhaps most significant training ground kids get in learning the importance of the art of negotiation and how to do it. It's the safest way imaginable to learn the impact of financial dealings, because you don't lose real money if you make a mistake. Along the way, you pick up how to be an appealing trading partner—meaning you don't rub people the wrong way when brokering a deal—and at the same time be able to get a little more out of the deal than your opponent does.
Monopoly is reflective of the impact of chance in real life. The game is more significant in teaching life lessons than a game like chess, where there is virtually no luck. No matter how much control we think we have over each day, or each fiscal year, in reality we don't have control over all the unforeseen events that will happen.
Timing is seldom under your control. For example, there may be a time you want to buy a new home in six months, but lo and behold, the home becomes available today and you're not in the right financial position to buy it. You have to know when the window of opportunity is closing. In Monopoly, real estate is the same way: You land at a property you may not want to buy yet, but you realize you have to put it up for auction, which may be a risk you're not willing to take.Monopoly requires you to have diversification. You want to buy a blend of properties; don't put all your eggs in one basket. One lesson is you're going to need one color group you need to develop, but that probably is not enough to win the game. You're in good shape if you have utilities and railroads to earn cash to fund your Monopoly.
It teaches you debt can control your life. If you owe $10,000 in credit card debt, you not only owe the principal but you're paying a stiff fee for interest. Suddenly, you're not working for money—money controls you. Now, in Monopoly, you have a credit reserve in a mortgage value. Let's say you have 10 properties, so you have 10 opportunities to lean on the bank for setbacks or if you want to mortgage properties to bankroll more investments. But when you mortgage a property, you lose its income. So now you owe the bank a lot of money and you have no money coming in. The same can happen in the real world.
It's a fascinating piece and (probably) an interesting book. I have requested a copy from the publisher and perhaps I'll post more on it in months to come.
Some of you "old timers" may recall when I published Money Lessons from Monopoly back in 2009. It has a broader but similar perspective to what's written above.
We play a decent amount of Monopoly. It runs in fits and spurts -- a ton of games over the course of a month and then none for several months. My daughter really likes the game and plays it on her iPad quite often.
I grew up playing the game. My dad and I would start a Monopoly marathon around 9 pm on a Friday or Saturday night and end up playing until 3 am or 4 am in the morning. He won more than I did -- but just because he is the LUCKIEST man alive when it comes to rolling the dice. He'd say, "I need a three" and he'd get it. Then he'd say, "I need a nine" and he'd get it. It was very frustrating for me. It's one reason I took up chess. :)
Do any of you play Monopoly? Do you think it's taught you anything about managing money?
On the way home from our cruise we spent a few hours in the Delta Sky Club (first in New York, then Detroit). They both had Fox News playing in the background. I wasn't really listening to it (I was getting caught up on email after being gone 2 weeks), but I did notice one thing: they have a TON of commercials for gold and silver investing.
After a while I started keeping track of the advertisements, wondering what the difference would be from one company to the next. Service? Shipping? Something else? I thought that pricing would be the same (after all, isn't the price of gold/silver a well-known commodity price?) Boy, was I mistaken.
When I got home and settled I decided to do an experiment. I went to each site advertised and compared the price of one basic, generic, and well-known item just to see the difference between the companies. On February 12 at 4 pm I visited each of the sites below. The 1 ounce silver price at that point was $31.12. Here's what each company had listed as the cost of a 1 ounce Silver American Eagle coin:
So is anyone else confused/surprised or is it just me? I'm surprised that there isn't one standard price. I guess these coins are just like mutual funds -- you can get some with higher expenses and some with lower expenses -- even though you're getting basically the same thing.
I was also surprised at the spread. If I was buying one coin, then I can live with paying almost $4 over spot price. But if I was investing $100k that would add up to a large amount of money (I know, still the same percentage). Perhaps they would give a better price for a larger purchase.
I didn't check the cost comparisons of shipping, storage, and the like, since those would likely only muddy the picture further.
It's a wonder that anyone buys physical gold and silver considering the strange (or at least strange to me) process. I know that you're buying (supposedly) for capital protection and a hedge against inflation, but it still seems to be a murky world compared to other forms of investing.
Perhaps those of you out there who are more educated in this area can enlighten me. Anyone invested in physical gold or silver? If so, can you tell us about your experience?
This is a guest post from Mike, MBA and author of The Dividend Guy Blog where he writes about dividend investing. He is also the author of the book Dividend Growth: Freedom Through Passive Income US Edition.
In my previous guest post, I wrote about the reasons why successful investors choose dividend investing as their core strategy. Unfortunately, picking just any dividend stocks is not enough to guarantee that you will make money on the stock market. In order to avoid the dividend traps, it’s important to have a sound investing strategy. Here’s how you can do it in 4 easy steps.
Step #1: Screen The Right Stocks With The Right Metrics
A good dividend stock in your portfolio is one that you will keep for several years. You must be careful to not to fall for a high dividend yield stock or buy a company with inconsistent sales.
The power of dividend growth investing resides in companies that double their dividend at least every 10 years. This is how you can retire with a dividend portfolio yielding over 10%. In order to find this lucky lady, you can start your research by filtering the stock market with the following ratios:
There is a great free stock screener called FIN VIZ Stock Screener. I use it personally for 3 reasons:
#1 You have the ability to add several filters;
#2 You can go back to your original search and modify 1 or more filters and see the new results;
#3 You can export your search into Excel and play with them as you want.
This is how you find stocks paying healthy and sustainable dividends. This won’t lead you to the flavor of the month but sound investments.
Step #2: Don’t Buy The Same Stocks Twice
After pulling out your search results, you will be tempted to pick from this list since they are all supposed to be solid dividend growth stocks. Think again, your research process has just begun! You can continue your investment journey by making a list of 20 potential stocks. Then, a good reading of financial statements is required. You must make sure that the metrics you are looking at in your screener are not showing due to exceptional events and the business is sustainable.
You can also accelerate your process by considering a good diversification among your stock selections. If you have selected 4 stocks operating in the same sector, you might not want to pick all of them. They might be great stocks individually but if their sector is affected by economic events, you will have 4 stocks dropping at the same time. This is why it’s important not to buy the same stock twice.
For example, if you are looking at consumer staple stocks, you will probably find stocks like Clorox (CLX), Colgate-Palmolive (CL), Kimberly-Clark (KMB), Procter & Gamble (PG) and Johnson & Johnson (JNJ). Each company is not exactly the same but they share several points in their business models and operations. If you look at the graph for the past five years, you will notice that they follow a similar pattern but some have performed a lot better than others (click image to enlarge):
This is why it is important to select the “best” stocks for each sector instead of buying the whole industry. Someone who had many banks and financial services stocks in 2008 probably cried a lot!
The US stock market has many great dividend stocks in several different sectors. For example, you won’t have a hard time finding what you are looking for within financials, techno, or consumers. While I just showed you how your portfolio could fluctuate in a short period of time if you have invested in the financial, the energy sector is no different. In fact, the reason why you don’t want to concentrate too much in a specific sector is that you can’t know for sure if it’s a good move or not. You think you are smarter than the average bear and that you can’t go wrong? Well that’s only true if you are already a multimillionaire trader and have made your money through stock trading. You’re not? Then you are not likely smarter than me or the average investor. Just stick with good sector diversification instead of gambling ;-).
Step #3: DRIP IT!
It’s not always easy to build a diversified stock portfolio when you start investing. Chances are that you don’t have a lot of money to invest and this will limit the number of stocks you can hold in your account. By diversifying your holdings, you will have small positions in several stocks. A great way to increase each holding is by using the stock Dividend Reinvestment Plan also called DRIP.
Each time that a dividend payout is made by a company, the investor has two options:
1) Receive the dividend payout in cash in his brokerage account
2) Buy new shares under the DRIP program with no transaction fees
Here’s how a DRIP can be setup:
Assume you own 400 shares of Clorox (CLX). The stock price is trading at $75 and the quarterly dividend paid is $0.64 per share. This means that upon the dividend date, you will receive $256 in dividends (400 * $0.64). The amount can be deposited in your brokerage account and you will have to wait until you have more money to buy another stock. Or, you can setup a DRIP. Upon the dividend date, your number of shares will increase by 3 or 3.41 if your DRIP broker allows fractional shares. If you can’t hold fractional shares, you total shares will jump to 403 and you will receive $31 in cash ($256 - $225 of share purchase).
The interesting part is that your dividend payout will increase each quarter since you buy more shares. Following the above mentioned example, you will receive $257.92 in dividend the following quarter instead of $256. This magic results in a dividend payout increase of 0.75%. After a year, now show 412 shares and receive $263.68 per quarter, a dividend payment increase of 3%. Imagine what happen if you DRIP a stock for 10-15 years. You just get a small preview of the power of compounding interest!
Step #4: Don’t Blindly Follow Your Lover
Don’t we say that love is blind? Well I know that it’s true if you fall in love with your stocks! I’m sure you have seen investors keeping a blind faith in companies that have lost money and pushed their stock value down the hill. They keep saying that the company will come back and that they can’t sell right now. Falling in love with your stocks is probably the best way to lose a lot of money.
Instead, I suggest you follow your stocks through their quarterly results. You will be in a better position to see if the company keeps the reasons why you have selected it in the first place. Don’t give your stocks “chances” to be better in the future. If the dividend payout ratio is too high (over 80%) or if the company announces a dividend cut, you should pull the trigger early and sell it.
Here’s a quick tip: You can run your ratio analysis four times a year (about a month after each quarter… so on February 28th, May 30th, August 30th, November 30th). Why wait so long after the financial quarter finishes? Because companies usually don’t disclose their results until 4-5 weeks AFTER the end of the quarter.
Time Will Become Your Best Friend
Dividend investing is for patient investors. It’s only over the long run that you will benefit from the compounding of dividend growth and that you will clearly see the power of dividend investing. It’s important to establish your own set of rules and follow them. Most of the time, a sound investing strategy is boring but it pays in the end!
Disclaimer: I hold shares of JNJ.
The following is a guest post from Mike, MBA and author of The Dividend Guy Blog where he writes about dividend investing. He is also the author of the book Dividend Growth: Freedom Through Passive Income US Edition.
“You can make a lot of money from the stock market.”
I’m sure you’ve heard something similar to this in your lifetime. You probably got all excited, opened a brokerage account and started investing. You were already thinking about the nice house you will build from your investing profits or the vacation to Hawaii that would be paid for by selling a few good stocks. This was until you received your first statement showing that you were losing 10% of your cash. Your dreams faded away and you then realized that making money off the stock market is not that simple. So… can you really make money from the stock market?
I’ve been investing for several years and meet with investors regularly as part of my work. The most successful investors I have met over the past 10 years all have their own investing strategies and their little trading secrets. But they share one thing in common: their love for dividends. After reading another guest post on FMF called “Dividend Investing is Not the Perfect Solution for Yield”, I wanted to share with you the reasons why successful investors choose dividend investing to build their core portfolio.
How About Making Double Digit Returns with Your Investment?
Would you believe me if I told you buying Coca-Cola (KO) will lead to a double digit return year after year? This is the case of several dividend paying stocks as they use the power of dividend growth to reward their investors. Let’s take a look at the KO example and you’ll understand. Let’s start with the KO dividend graph over the past 10 years (dividend payout is adjusted considering 2:1 split in August 2012). (Click image to enlarge.)
Since 1971 Coca-Cola has increased its dividend yield at an annualized rate of almost 10%. This means you double your dividend yield every 7 years or so. Back in 2003, the stock was trading around $22.00 (price value adjusted with the 2:1 split in 2012). The dividend yield back then was about 2%. Today, KO is now paying a quarterly dividend of $0.255 or $1.02 per year compared to a $0.11 per quarter back in 2002. The $1 dividend currently paid on an original investment of $22 per share represents a 4.64% yield.
If you had bought 1000 shares of KO back in 2003, you would have paid $22,000.
The share is now trading around $37.00.
Your investment is now worth $37,000. That’s a 68% investment return.
In the meantime, you have also received a total of $7,220 in dividends (or 32.81% total dividend return).
So in 10 years, you would have made a total profit of $22,220 on an investment of $22,000. That’s a 101% investment return for an average (not annualized) return per year of 10.1%.
The interesting part is that a third of your return is coming from the dividend. On top of that, you are now holding an investment paying a 4.64% dividend yield based on your cost of purchase. In another 10 years, chances are that you will be showing a 10% dividend yield if you keep holding this stock.
The Best Sign of a Solid Business Model
Besides the power of dividend growth, the fact of paying a steady dividend is a great sign of a solid business model for investors. When you find a company that has been paying a dividend for the past 10, 20 or even 50 years, you have a great indication (while not being a certitude) that the company business model is sustainable.
Since dividends are paid from after tax revenues, the company must ensure that it constantly generates a higher profit per share (followed with the Earning Per Share ratio) to be able to increase its dividend accordingly. A long dividend increase history shows you a responsible management team and a business model being based on solid assumptions.
As an investor, you can also easily follow what the company is doing with its profits as a part of them are returned back to you. It ensures that they don’t “waste” their money on irrelevant projects. By looking at the Dividend Aristocrats or Dividend Champion lists, you find solid and sustainable businesses that will continue to be in business for several years to come.
The Best Protection against Yourself
Do you remember how you went through 2008? What happened when you saw your stock portfolio drop by 30%? Did you panic? I can tell a big part of you did since everyone was selling on the market to go back into cash and bonds. Then you woke-up in 2013 and found that most of your losses had been recovered… but this is all on paper since you sold your stocks in 2008 and you will never see this money again.
Dividend stocks are usually less affected by major drops in the stock market. For example, I pulled-out five dividend growth stocks and compared them with the S&P 500 from Jan 1st 2007 to Dec 31st 2009:
This is a great example to show you that if you had held a dividend portfolio in 2008, you would have probably lost money but a lot less than by holding the S&P 500 index for example. During a stock market crisis dividend stocks usually:
#1 Continue to pay their dividend which reduces your loss
#2 Hold more investors on board which avoids massive stock value losses
#3 Prove their business models are among the most solid on the market
Think About Retiring With a Smile
In my opinion, I think the two major challenges we will face regarding retirement planning in the future is inflation combined with an aging population. Back in the 60s, we didn’t expect to live past 70 or so. Today, we retire around 60-65 and expect to live at least to 85. This means that you need a lot more money on the side to keep up with your lifestyle.
The problem is that once we retire, we don’t want to take risks anymore. We usually turn to CDs and bonds. Now that those investments don't even cover inflation, how can you expect to live 15 years longer with a portfolio that loses purchasing power each year?
By choosing stocks growing their dividend payout faster than the rate of inflation year after year, you can build a solid portfolio and live from your dividend payouts almost indefinitely. Your lifestyle won’t be affected by inflation since your dividends will increase every year to cover the rate of inflation.
Dividend Investing is the Way
On top of these 4 reasons why dividend investors are sucessful, I personally favor dividend investing for 3 other reasons:
#1 Dividend Investing is Easy to Understand – A prestigious financial background is not required if you follow simple and time-tested investing principles.
#2 Dividend Investing is Perfect for Lazy People – Not much time is required once you learn the basic principles of how to select your stocks.
#3 Dividend Investing, if done right, equals Receiving Money Monthly! – Dividend payouts are regular.
It’s obvious that simply buying dividend stocks is not enough to guarantee a good investment return from your portfolio, but I truly believe that this is the right place to start if you want to make money from the stock market.
Disclaimer: I own shares of KO, JNJ & CVX
Many regular FMF readers are familiar with Old Limey, a regular, popular commenter here. Through his comments we know that he is a retired engineer who took his relatively modest retirement savings, invested it during the dot com boom, and turned it into a multi-million dollar portfolio.
I recently emailed Old Limey to ask if he'd write a series for FMF on "how to be successful as an active investor." Since he has regularly made comments about how others can/should be successful at active investing (versus passive/buy and hold investing), I thought he surely had suggestions for how the rest of us could succeed as well. I even thought I might give the effort a try with part of my portfolio. And, of course, I knew the readers would LOVE hearing from him.
He responded quickly with the following thoughts (edited for length):
For the following reasons I am not willing to write a series on active investing.
1) I am no longer an active investor. These days I primarily only own municipal and corporate bonds, and CDs, that will be held until they mature between now and 2040.
2) Being an active investor requires a lot of knowledge that requires much reading to acquire. You also need to subscribe to a large database of funds, ETFs, and indexes, the cost of which is about $900/year. The database also needs to come with a very comprehensive charting, ranking, and analysis program. Learning how to use this software is beyond the capability of the average person and requires a great investment of time, first to get up to speed, and then on a daily basis whenever you feel that it's necessary to move money from one investment into another. It's really out of the question for a person that has a very busy and time consuming day job. You need to have a passion for making money as well as an education that is very solid in mathematics and analytical techniques.
3) Once you start you need to do a post mortem on every trade that you make and learn from both your successes and failures.
4) Active investing is an ongoing learning experience and it takes a very disciplined individual to become successful. You have to be the exact opposite of a Buy and Hold investor. You have to abhor losing any of your precious money, especially since the more money you have, even small percentage losses can result in losing a large amount of money.
5) You need to attend lectures and seminars, read some books on investing, and learn from some of the most experienced active investors around.
6) In order to become a successful active investor you have to be very disciplined and not allow your emotions to get in the way of your decisions.
7) The more experienced you become, the more successful you will be, but you have to have a sense of when to be a participant and when to stay out.
8) I went through some stressful periods as well as some very exhilarating periods. Some people just aren't cut out to be active investors, especially if they are also experiencing stress from other sources such as work related and family related situations.
9) I was very active from 1993 through 2007 and it was a great relief to reach a point where I had enough money to quit the rat race, move to the slow lane, and settle for income rather than capital gains.
10) Lastly, I feel that the current state of the US economy, debt, and employment situation is far too dangerous to take the kind of risks that are needed. Don't underestimate the unique and incredible impact that the Internet and the Computer revolution made. This revolution fortuitously started just as I was retiring and was starting down the path of becoming an active investor.
When I was writing the software that I was able to market very successfully, I was working at home, for 2 years, 7 days/week, from 8am to midnight with small breaks for food.
That mammoth task ended one day when my wife came into my office with a hammer in hand, vowing to smash my computer if I didn't find a way to wrap it up soon and market it.
She was a great help when an ultimate 1602 orders started to roll in and we were kept very busy making CDs, having manuals printed, and hauling packages to the Post Office. That MS-DOS software is now obsolete.
A fellow program developer of mine told me that he used to stay in his office and his wife would put a tray of food outside his door, He came to the same resolution that I did in order to save his marriage.
These days, I don't see anything comparable for an extended Bull market on the horizon, all I see is a lot of strife, tension and unrest all over the world.
This is a totally different and far more dangerous world than existed from 1993 through 2007.
Here's my summary of Old Limey's thoughts above on why it's very difficult to be a successful active investor:
1. It requires a VERY unique individual -- one who has just the right temperament, abilities, and amount of time to make such an effort successful. This criteria alone eliminates all but a handful of potential candidates.
2. The market conditions need to be correct even for those with the talents in #1. It was just right when Old Limey invested, but today's market is not a fertile field for investment gain.
This basically says that virtually no one can be successful with active investing today.
I was a bit surprised at this response since Old Limey seems to be such an advocate of active investing. I noted this in my response and he replied:
Active investing is of course still alive and well today, particularly with many investors that trade stocks.
Even an index fund investor could become an active trader if he followed a simple trading strategy. For example, a very simple approach would be to follow four indexes and maybe put 60% in the strongest one and 40% in the second strongest. You would then need to use an analytical method that calculated the relative strength of the four indices. Then, every day you would check the relative strength values to ensure that you were still invested in the strongest two out of the four.
To refine it even more you could layer on market timing by saying that if the S&P 500 falls below its 200 day moving average you would sell your two positions and move into some kind of income investment. Then when it moves back above its 200 day moving average you sell the income investment and move back into the two strongest indexes out of the four you have chosen. A simple system of this type would have saved a Buy and Hold investor from taking such a beating in the huge drop and then got him back in soon after the recovery started.
One module in the software that I wrote would have enabled a person to test out this strategy from 9/1/1988 (or a later date of your choice) to the present day and then play around with all of the variables until you found the combination that had the greatest success as measured by making the largest overall gain along with experiencing the smallest max. drawdown. It's the drawdowns that are so hard to live with. On the day that the max drawdown occurs you are sitting there having experienced a huge drop in the value of your portfolio but you have no idea whether you have hit bottom. That's the whole purpose behind active investing. It's attempting to extract the greatest gains while suffering through much smaller drawdowns.
The obvious criticism of approaches like this is that history usually doesn't repeat itself, but it would almost always be better than Buy and Hold. What I have described is just one simple strategy. There are of course scores of different strategies that have been developed. The software I developed had over 80 modules, each one using a different strategy. When I wrote my software I was in contact with over 250 users of the database and received lots of good ideas from the best of these experienced investors. I also gained a lot of information and ideas from attending the annual conference that was held at a different city each year.
Another thing is that 20 years ago there were only a fraction of the investors that exist today and news travelled a lot slower. This helped the active investor to outshine the investors that were not using any kind of backtested fund selection and market timing techniques. Today we have a very different environment with the Fed supplying stimulus money to the large investment banks that use it, largely for their own benefit to drive the market the way they decide. They also use supercomputers that run preprogrammed methods to make thousands of stock trades per day, some trades the buy and sell orders are less than a minute apart in order to reap thousands of small gains with negligible losses. I read an article that mentioned that the very best graduates of MIT in Computer Science end up working at the huge investment banks and not in technology companies here in Silicon Valley.
The other thing I should mention is that if your active trading is taking place in a market and during a time period in which the general trend is strongly upward everything gets a lot easier. My huge gains between 1993 and March 2000 were the result of trading in funds that concentrated in the Nasdaq companies that were in steep uptrends. When the top arrived and it then started steeply down there was a huge rush for the exits and I got totally out over 3 trading days, and stayed out for quite a while until things settled down. A very good sector that follows the rise and the fall of the stock market is the Junk Bond sector. Its huge advantage over stocks is that it has far, far less volatility. This very low volatility gives you a lot more time to make your trading decisions. A friend of mine runs a small Hedge fund and sends me a copy of his monthly market letter, all he ever owns are junk bond and various income funds and yet he far exceeds the performance of stock indices and maintains very low drawdowns. This market letter would help most Buy and Hold investors but for people that aren't invested in his fund the price is $1,400/year. I get a free copy because he used to use my software, as did quite a few people that published market letters. If you look at a longtime chart of the Nasdaq 100 index you will see the huge peak that topped in March 2000, this peak outshines every other stock market index and looks like a profile of Mt. Everest (a peak I was very close to in 1983 when I climbed a nearby trekker's peak that was close to 20,000ft.).
Ok, so you can be successful with active investing today (or at least better than the results you get with passive investing), but it requires:
1. A VERY unique individual -- one who has just the right temperament, abilities, and amount of time to make such an effort successful. This criteria alone eliminates all but a handful of potential candidates.
2. The market conditions need to be correct even for those with the talents in #1. Today's market is not conducive for active investing success.
Personally, this is disappointing to me, but not surprising. I had hoped that active investing was available for the masses (or at least a good sub-section of the population) since I wanted to give it a try (and share my results with you.) But having this conversation with Old Limey reinforced my thinking that it's very difficult (if not impossible) to be a successful active investor. So I'll stick with my simple index fund investing on one hand and concentrate on real estate investing on the other. This seems to be a good balance between growth (stocks and appreciation of real estate) and income (generated by the real estate).
And in case you're interested, here are a few other pieces I've written through the years that suggest it's rare to be a successful active investor:
The following is an excerpt from Dividend Growth: Freedom Through Passive Income.
Dividend investing can be appealing as it doesn’t require you to check your portfolio every week. However, the trick is that you still need to manage your portfolio once it is built and make sure that you are not over- exposing your investments to specific risks.
In order to do so, I would suggest you use a sector distribution list to ensure that you don’t spend too much time on diversification so you don’t put yourself at risk.
One of the most important reasons why you should have bought this book is because you don’t have enough time to properly manage an active portfolio. Dividend investing can be appealing as it doesn’t require you to check your portfolio every week; however, the trick is that you still need to manage your portfolio once it is built and make sure that you are not over- exposing your investments to specific risks.
In order to do so, I would suggest you use two methods to ensure that you don’t spend too much time on diversification and don’t put yourself at risk.
Make a Sector Distribution List
The first thing to do before building your portfolio is to identify the sector that you want to invest in. I’ve showed you how to determine great stocks regardless of their industry, now you will do the opposite: you will look at all of the sectors and then select the one you want in your portfolio. Then, you will be able to go back to your stocks on the radar list and pick the one that fit your sector needs.
Think of selecting sectors that should do well in the future and pick strong dividend payers in each of them. This way, although you might be wrong on the sector, you will own the “best” stocks in each industry. Concentrating on one sector (such as energy, financials or telecoms) will create greater fluctuations in your portfolio. Depending on what you are looking for (growth, steady income, etc.), you may classify your sector like this. Growth sectors will offer greater capital gains potential, but you will have to be ready to ride higher fluctuations as well. Steady income sectors will provide a nice steady dividend, but might not be the sexiest investment options. Here’s a quick review of each US sector (I used sector description from Bloomberg).
How Can You Manage Portfolio Diversification Efficiently
There are several tools to help you manage your portfolio efficiently without losing too much time on diversification. For example, you can calculate and manage the beta of your portfolio. To learn more, check out Dividend Growth: Freedom Through Passive Income.
Recently I received the following email from a reader:
In large part to your valued advice, my wife and I are approaching the SEC definition of an accredited investor. We expect to surpass the $1MM threshold within the next 6 months and I’ve started to research the possible opportunities resulting from this achievement. Of course, the first place I started was on your site but I wasn’t able to find anything. There is a good chance that I may have missed it.
I was hoping that you had some insight since, based on many of your posts, it seems that you are an accredited investor. Any thoughts or guidance would be greatly appreciated and highly valued.
To be honest, I had no idea what an accredited investor was. So off to Google I went...
I ran into the same info at the SEC's website as I found at Wikipedia. Here's the overview from Wikipedia:
Accredited investor is a term defined by various countries' securities laws that delineates investors permitted to invest in certain types of higher risk investments including seed money, limited partnerships, hedge funds, private placements, and angel investor networks. The term generally includes wealthy individuals and organizations such as banks, insurance companies, significant charities, some corporations, endowments, and retirement plans.
The piece then details the requirements to be an accredited investor in the U.S., Canada, and the European Union.
The SEC's commentary is a bit more formal (as you might imagine). Their thoughts:
Under the Securities Act of 1933, a company that offers or sells its securities must register the securities with the SEC or find an exemption from the registration requirements. The Act provides companies with a number of exemptions. For some of the exemptions, such as rules 505 and 506 of Regulation D, a company may sell its securities to what are known as "accredited investors."
The federal securities laws define the term accredited investor in Rule 501 of Regulation D as:
1. a bank, insurance company, registered investment company, business development company, or small business investment company;
2. an employee benefit plan, within the meaning of the Employee Retirement Income Security Act, if a bank, insurance company, or registered investment adviser makes the investment decisions, or if the plan has total assets in excess of $5 million;
3. a charitable organization, corporation, or partnership with assets exceeding $5 million;
4. a director, executive officer, or general partner of the company selling the securities;
5. a business in which all the equity owners are accredited investors;
6. a natural person who has individual net worth, or joint net worth with the person’s spouse, that exceeds $1 million at the time of the purchase, excluding the value of the primary residence of such person;
7. a natural person with income exceeding $200,000 in each of the two most recent years or joint income with a spouse exceeding $300,000 for those years and a reasonable expectation of the same income level in the current year; or
8. a trust with assets in excess of $5 million, not formed to acquire the securities offered, whose purchases a sophisticated person makes.
Given the above, the requirements in #6 or #7 would be the most likely way FMF readers could qualify as accredited investors. Old Limey would for sure, but I'm guessing there are many more that would as well.
So after this investigation, I now know what an accredited investor is. But a bigger question now emerges: "So what's the benefit?"
I'm guessing is that the advantage of being an accredited investor is that you get the chance to put money into some higher return investments. Of course these come with higher risks as well, so depending on your investment style and philosophy you may or may not want to invest in these opportunities.
But how do you even get the chance to discover these options? Do you contact a money manager of some sort, say you now meet the criteria, and ask what he offers? That seems like an awkward and likely unproductive way of finding a good investment.
So I Googled "benefits of being an accredited investor" and found some reasons it may be worthwhile. Here's a summary from Financial Web:
As an accredited investor, you gain the right to participate in certain investments that would not be open to you otherwise. The hedge fund is the most common example of this. A hedge fund, is an investment vehicle that is not bound by the restrictions of the SEC and utilizes a number of different investment strategies to achieve large returns for its investors. Most hedge funds require that you are an accredited investor in order to be involved because they are complicated and risky.
A couple other pieces talked about the opportunity to invest in small companies that need capital to grow their operations. You can read Investing in Private Offerings and One Reason the Rich Get Richer: Accredited Investors if you want more information.
Still, I'm not sure how you take advantage of being an accredited investor. Is it networking? It is cold calling hedge funds? (Surely not). I'm really in the dark on this one.
So I thought I'd open up the topic to FMF readers. I'm betting there are some of you out there who either know how to take advantage of this status or have actually done so yourself. Either way, please share with us what you know about being an accredited investor.
I am no economist -- by a long ways. I am bored by economics, have limited knowledge of the subject, and have no desire to change my relationship to the topic. Even though personal finances are impacted by the economy, I'm more likely to be interested in writing about pink unicorns than I am in writing about economics.
Ok, so it's not that bad, but you get the point. Economics is not my strong suit or interest.
And yet I find myself thinking a lot recently about the economy, especially where it's headed and how to prepare for it.
Smart Money stoked this fire when they recently predicted that the wealthy will lose half their wealth over the next few years. The details:
Faber warned in a recent interview on CNBC: The Super-Rich "may lose up to 50 percent of their total wealth."
How? "Somewhere down the line we will have a massive wealth destruction. That usually happens either through very high inflation or through social unrest or through war or credit-market collapse." And as if to punctuate his message, in Barron's recent "Midyear Roundup," Faber was asked, "Will things get worse before they get better?"
Answer: "Yes, possibly much worse," adding "most markets peaked in May 2011." He expects "further weakness in the second half of the year. Corporate profits will disappoint ... stock markets are oversold. The U.S. government-bond market is overbought. The U.S. dollar is overbought, and gold is oversold near term." Worse, he's "very negative about the outlook longer term."
If this was the only source of this sort of thinking, I'd brush it off as some blowhard who knows as much about the future as I do. But this opinion seems to be on the hearts and minds of many people I come in contact with -- especially those who are quite wealthy. Their main concern: the Fed is printing money like crazy. Eventually there will be runaway inflation and that $3 million the "wealthy" have saved for retirement will now be worth $1 million. Poof! 30 years of saving will be lost in a short period of time.
I'm not buying into the hysteria, but I am considering it (in fact, there's an argument that says when "everyone" is saying one thing it's the time to go in the opposite direction). My main concern is inflation. It's not completely outrageous to think that we could have very high inflation and savings would take a big hit. What the chances are of this happening are difficult to estimate, but what seems to be even harder to determine is what to do about it.
Let's say you want to "never lose money" as Smart Money says should be the mantra for investors these days. What do you do with your money to never lose it (either to a market crash or inflation)? Do you invest in gold, commodities, real estate, or something else?
No one seems to have a solid opinion one way or the other, so I thought I would spew a bit on the subject and then let FMF readers (most of whom are more versed on this topic than I am) weigh in with their opinions.
So there you have it. Any thoughts on what I've shared above?
The following is a guest post from Marotta Wealth Management.
I often get asked, "Are investment management fees tax deductible?" The answer is not a simple "yes" or "no." Like many tax questions, the answer is "It depends."
Investment management fees are a tax-deductible expense. They can be listed on Schedule A under the section "Job Expenses and Certain Miscellaneous Deductions." Line 23 includes investment expenses. These expenses get added into unreimbursed employee expenses, tax preparation fees, safe deposit boxes and other qualifying expenses.
Unreimbursed employee expenses can include professional dues, required uniforms, subscriptions to professional journals, safety equipment, tools and supplies. They may also include the business use of part of your home and certain educational expenses.
All of these miscellaneous deductions are totaled. You only receive a tax deduction for the amount that exceeds 2% of your adjusted gross income (AGI) from line 38 of your Form 1040. If your cumulative expenses are under 2% of AGI, you will not get a deduction.
For most of our working clients, their miscellaneous deductions fall far short of the 2% AGI threshold. But when clients retire, they are much more likely to qualify.
If your expenses are close, you gain from lumping most of your expenses every other year. For example, if your AGI is $100,000 and your miscellaneous expenses average $2,500 a year, in most years you will only get a $500 deduction. But if you can pay the same bills in January and December of one year, you might be able to have $5,000 in deductions one year and zero the next. That means you could have a $3,000 deduction every other year. In next year's 28% tax bracket, this would save you $560 more in taxes.
Even if you can't deduct investment management fees directly, you can still pay a portion of the fee with pretax dollars. Investment management fees can be deducted directly from the accounts for which they were charged.
Many fee-only advisors charge a percentage of assets under management. But they can also prorate those fees back to the accounts they are managing. For traditional IRA accounts, the fee is not considered a withdrawal and therefore is not a taxable account. The fee is considered an investment expense. Thus this fee is being paid with pretax dollars. And the cost is discounted to clients by their marginal tax rate.
I've seen advisors take their entire management fee from IRA accounts. I don't think that is warranted by the letter or the spirit of the tax code. Any fee taken from an IRA account should be justified as a fee for the management of a pretax account. You can't simply start paying your bills from an IRA as a nontaxable withdrawal.
Similarly, any management fees paid directly from an IRA account should not be listed as a miscellaneous expense on Schedule A trying to qualify for an additional tax deduction. Only expenses paid from a taxable account should be listed as a miscellaneous expense.
There is no advantage in trying to pay the entire fee from a taxable account in an attempt to boost your deductions. If you pay $2,500 in management fees, it is better to pay $1,000 from an IRA with pretax dollars than to pay for it separately to get a $500 tax deduction. Any amount paid from an IRA is equivalent to getting that same amount as a tax deduction.
Although getting money out of a traditional IRA tax fee is an advantage, taking management fees out of a Roth IRA is not. There are limits on getting money into a Roth account where it will never be taxed again. We recommend paying the portion of management fees prorated to a Roth account out of your taxable account. This allows as much money as possible to stay in your Roth.
One of the advantages of working with a fee-only financial planner is that fees can be taken from the accounts under management or paid separately, depending on which is more advantageous. If fees are stuck on commission-based products, you can't choose to pay the fees for a Roth account separately from a taxable account in order to allow the Roth to grow unimpeded.
This is another advantage to having fees based on assets under management rather than a separate fee or an hourly charge. Management fees are easily justified taken directly from accounts including IRA accounts where you can pay with pretax dollars.
Many advisors charge a percentage of assets under management and then offer comprehensive wealth management advice without an hourly charge. This is ideal. If these charges were separated, less of the fee could be paid with pretax dollars.
No one likes to pay fees. Hidden fees in many ways are easier psychologically. We recommend that when you need unbiased financial advice, seeking a fee-only financial planner makes sense. And it helps knowing there are tax-efficient ways to pay management fees.
The following is a guest post from Mark Biller, the Executive Editor at Sound Mind Investing. I'm a big fan of SMI and have written about the company several times (see Review: Sound Mind Investing and Review: Sound Mind Investing Website). I asked them to cover this topic because I think it's especially appropriate for what many investors are dealing with in today's rollercoaster stock market.
SMI added to this post by creating an offer for those of you who may want to check out their service (for free). Be sure to read all the way to the bottom for details.
When it comes to investing, there’s a lot that you can’t control – the economy, the price of oil, your cousin Bobby’s constant flow of “can’t-miss” investment advice.
However, there’s also a lot that you can control, and that’s where to focus when navigating the often-wild world of investing.
Before you start investing, you should be using a budget (which helps you find the money to invest), be completely out of debt except a reasonable mortgage, and have an adequate emergency fund (typically six months’ worth of essential living expenses). Assuming those steps have been taken, here are three core controllable factors for successful investing.
1. Develop a Written Long-Term Plan
Many people think they have an investing plan. And they do. Sort of. At least until the market drops 10% in two weeks. Then they realize what they really have is a collection of investing tips and vague ideas, all of which tend to ebb and flow based on what’s happening in the stock market.
In contrast, we encourage you to create a personalized, long-term investing plan and put it in writing.
A good place to start is with some of your most important financial goals. When do you want to retire and how much income are you likely to need? Would you like to help your kids pay for college? How much would you like to be able to provide and when?
2. Make Your Most Important Investing Decision
Of all the factors that impact the performance of your investment portfolio, there is one that is far more important than all the rest: how much of your portfolio is allocated to stock-type investments and how much to fixed-income securities such as bonds. This is known as asset allocation.
The allocation of a portfolio is the primary driver of its expected returns and volatility. Knowing that you have the right allocation should give you confidence that you can keep growing your money at a reasonable rate and with a reasonable amount of risk given your age and investing time frame.
3. Choose the Right Investment Strategy
It’s important that you believe in whatever strategy you choose enough to stick with it during the inevitable downturns. Every strategy will falter occasionally. Bailing out at those times in search of a better-performing approach is the equivalent of buying high and selling low — not a good formula for building long-term wealth.
Whether your strategy involves choosing your own investments or relying on professional advice, here are some important points to keep in mind:
The primary obstacle for most people as they pursue financial freedom is not the lack of a "perfect" plan; it’s inertia. By moving forward with these principles in practice, you'll be headed in the right direction.
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