Some individuals have the ability to contribute after-tax amounts to their employer-sponsored plans such as a tax-deferred 401k or a defined benefit pension. Generally, since these amounts are after-tax, the contributions start adding up to a sizable amount known as basis. Basis is simply the amount of after-tax money put into these accounts that is not taxed when it’s withdrawn. However, any earnings on the basis are taxable. Individuals considering contributing after-tax amounts to the above plans may also consider if it makes sense to contribute to a non-qualified brokerage account. Like the aforementioned employer-sponsored plans, contributions to a non-qualified brokerage account are made with after-tax dollars, thus they can build a sizable basis – which is not taxed when withdrawn. Also, like the above employer-sponsored accounts, any earnings are subject to taxation. The major difference is in the way the earnings from the non-qualified account are taxed. Earnings on […]
Diversification and asset allocation are important components to any investment plan. Additionally, where assets such as stocks and bonds are held, also called asset location, should also be considered. Asset location refers to the type of account that asset classes are held. Such accounts are generally traditional and Roth IRAs, employer-sponsored plans such as 401ks, etc., and after-tax, non-qualified investment accounts. The reason asset location becomes important is to help make use of tax efficiency in an investment portfolio. For example, stocks held in after-tax, non-qualified accounts for longer than one year as well as qualified dividends are taxed at much more favorable rates. These favorable rates can range from as little as zero to 20%. Bond interest, however, is taxed as ordinary income, leaving an investor being taxed at potentially higher amount. As many readers know, amounts contributed to qualified, pre-tax accounts such as deductible IRAs, 401ks, etc., are […]
Previously I wrote about the Most Important Factor and the Second Most Important Factor to Investing Success. Continuing this streak I’ll give you the third most important factor to investing success: Leave it alone. To recap: The most important factor is to continuously save and add to your nest egg over your career; the second factor is allocation – make sure you’re investing in a diversified allocation that will grow over time. The third most important factor to investing success: Once you’ve started investing, leave it alone. Resist the temptation to sell off the component of your allocation plan that’s lagging; the reason you have a diversified allocation is so that some pieces will lag while others flourish, and vice-versa. Reallocate your funds from time to time (once a year at most) to match your allocation plan, but that’s all the fussing you should do with your investments. Leave it […]
If you’re like most folks, when you look at a 401k plan’s options you’re completely overwhelmed. Where to start? Of course, the starting point is to sign up to participate – begin sending a bit of your paycheck over to the 401k plan. A good place to start on that is at least enough to get your employer’s matching funds, however much that might be. In this article though, we’re looking at investing your 401k money. It’s not as tough as you think. In fact, it can be done in just two steps – taking no more than 30-45 minutes of your time. Step 1 – Look at your options When you’ve signed up for the 401k plan, review your options for investing your 401k. Look at the list of investments available – and from here you can take a shortcut if you like. If your plan has a “target […]
Many individuals understand the power of compound interest. They understand that compound interest means money or interest earned on interest received. That is, if I earn 5 percent interest annually on one dollar, in one year I’ll have $1.05, but in two years, I’ll have $1.1025, not $1.10. Granted, this may not seem like a lot; and it isn’t. But on several thousand or hundred thousands of dollars it really starts to add up. This post is mainly for those individuals who haven’t heard of this concept or haven’t started utilizing it to their advantage. Mainly, I’m addressing millennials and college students. Those individuals in the cohort I’m address have one powerful thing on their side: time. We’ve written before on this blog about the power of time and starting to save early. We showed the comparing of someone starting right away either during or right after college and another […]
We’ve all been there. Cooking dinner around the stove and mistakenly touch the burner or element with our finger. Instantaneously and instinctively our hand immediately withdraws from the heat and we quickly look to see if we need to run it under cold water or worse, grab the bandages. Individuals can have a similar instinctive reaction when they are burned by the market. When the market is highly volatile they’re gut reaction may be to pull their hand away quickly and easing the pain by selling and getting out. It would seem almost malapropos to keep a hand on the hot stove knowing that doing so will result in further pain and injury. And it would be unthinkable to place the other hand on the stove so both are feeling the heat. Naturally, no one likes to lose money. When markets go down it is perfectly understandable for individuals to […]
Many investors understand the importance of asset allocation and diversification. They choose among various assets to invest in such as stocks, bonds, real estate and commodities. Without getting too technical, the reason why investors choose different asset allocation is due to their correlation (often signified by the Greek letter rho ρ) to the overall stock market. Assets with a correlation of +1 (perfect positive), move identically to each other. That is, when one asset moves in a particular direction, the other moves in the exact same fashion. Assets with a correlation of -1 (perfect negative), move exactly opposite of each other. That is, when one asset zigs, the other asset zags. Generally, the benefits of diversification begin anytime correlation is less than +1. For example, a portfolio with two securities with a correlation of .89 will move similar to each other, but not exactly the same. Thus there is a […]
Occasionally, someone will ask me a question in the following different ways: “Did you see what the market did today?” or “How did the market do today?” To be honest, I’d love to use the line that Charley Ellis has used from the movie Gone with the Wind; “Frankly my dear, I don’t give a damn.” Professionally, my response is more in line with “I couldn’t tell you.” or “I don’t follow the market really.” The response is not meant to be rude or abrupt, but more to simply say that for most investors (myself included); they shouldn’t be worried about what the market is doing on a day to day basis. This is especially true for the Dow Jones Industrial Average. A price weighted index of 30 stocks is hardly representative of the market, yet it’s what most people think and refer to as “the market” when they ask […]
On these very pages not too long ago, I pointed out the most important factor to achieving investing success, which is consistent accumulation. The second most important factor? Asset allocation. Asset allocation is the process of dividing your investment “pile” into various different types of investments in an effort to maximize your exposure to the unique benefits of each type of asset class – while at the same time utilizing the risk as efficiently as possible. When it comes to asset allocation, there are two primary factors which help to determine how you might allocate your investment assets: risk tolerance and time horizon. Risk tolerance deals with whether or not you can sleep at night knowing that your investment could fall (or rise!) by 15%, for example. If you’re a person who feels compelled to monitor your investments every day and can’t stand it when you see a loss, you […]
Recently I had a chance to have some fun with some of my undergraduate students. Polling my entire class I asked them to make a list of wants (not needs) that they frequently spent money on. Answers varied from smartphones (and the respective bill), cable and satellite TV, dining out, coffee shops, beverages (you know which ones), and appearance (spending extra to dye hair, pedicures, etc.). Here’s a list of how each expense was broken down as told by the students. In other words, it was their numbers not mine.
Traditionally when we think of investing our minds turn to stocks, bonds, mutual funds or real estate. While these may or may not be the best investments for an individual’s portfolio there is one investment that is almost always the right choice for any individual – human capital. Human capital is an individual’s worth of their own potential. Coined by economist Theodore Schultz, human capital can be invested in like any other asset in order to add value to an individual’s life through earnings, health, and quality of life.
Admittedly, this is a pretty deceiving headline. We see headlines like these every day in the newspapers, TV and from colleagues at work. The truth of the matter is that there are certainly going to be assets classes that will behave horribly while other asset classes do extremely well. The point is, neither you nor I (or anyone else) will accurately be able to predict which ones will do better than others. For every person that says stocks will have a meteoric rise in 2015 there will be just as many that will say to avoid them. You’ll have others saying that bonds are doomed while others will sing their praises. Buy gold, sell gold; buy real estate, sell real estate. The point is no one knows which asset classes will do well and which ones will fall.
When considering investing with a particular financial planning firm or mutual fund consider looking at what benchmark they’re comparing their returns (disclosure: the funds we use are the benchmarks). It’s pretty easy for a mutual fund company or adviser to tout their funds when they have beaten the benchmark over a certain period of time. For example, I had the opportunity to look at a client’s investment performance report that they had with another company. Written across the top in the adviser’s handwriting was the phrase, “Looks like we beat the benchmark.”
The last few weeks have shown that the market is certainly volatile. Once at a peak of over 17,000 the market has pulled back to just over 16,000. While this certainly makes for news (notice how I didn’t say interesting news) I wanted to give our readers a little perspective on why I (nor they) shouldn’t care.
Recently a colleague told me that he’d “give that a try”. I responded (tongue in cheek of course) “Try not. Do or do not. There is no try.” In case you don’t recognize it, that’s a line that Yoda gives to Luke Skywalker in the Star Wars “Empire Strikes Back” movie. Yoda was pointing out to Luke that if he simply “tries” to undertake the action, he will not succeed. I think it shows that Yoda would also suggest a low-cost index mutual fund for investing. If you think back to the excellent article that Sterling wrote a few weeks ago, “Not All Index Funds are Created Equal”, Sterling used a particular load mutual fund as an example. The objective of the fund (paraphrasing here): Seeks to match the performance of the benchmark… Let’s analyze that objective. The “benchmark” in question is an index, in particular the S&P 500 index. […]
When saving and investing for retirement many folks as well as advisors helping those folks plan save and invest for retirement generally will have the conversation that includes how much they can save per month or year, how much they need at retirement and how long they have to save until retirement. Essentially, all of the ingredients in the previous paragraph boil down to a phrase mentioned many times in financial planning classes as well as courses in finance, investing and business: the time value of money. The time value of money helps individuals and businesses figure out how much they need to save, earn, and spend in order to achieve certain financial goals. What it boils down to is what is a dollar worth, if not spent today, and instead invested and allowed to grow for tomorrow (the future).
Since there’s been an appreciable run-up in stocks over the recent past, now may be a good time to reallocate your investment allocations in your retirement plans and other accounts. You’ve probably heard of reallocation before – but what does it really mean? Reallocating is the process of changing your current mix of investments to a different mix. It could be that you’ve changed your risk assessment and wish to have more stock and fewer bonds, vice versa, or your investments have grown in some categories from your original allocation and you need to get the mix back to where you started. At any rate, reallocation is a relatively simple operation, and research tells us that it is important to reallocate regularly, such as on an annual basis. Below are five steps that you can use for a simple reallocation in your accounts.
If you’ve ever planned for a day out, picnic, family day or relaxing day outside chances are you turned on your TV, radio or grabbed your smartphone app and got an idea of what the weather was going to be for the day of your trip. When you looked you got a prediction, based on the probability of what the weather patterns have shown in the past and you got an idea of what your day would look like. And sometime in your life, what was predicted to be a bright sunny day was laden with storm clouds, rain and gloom. Trying to predict the market is like predicting the weather, only more confusing, more expensive, and less likely to get your desired outcome.
We had a great question come in by request this week that we address the question of whether folks should have gold in their portfolios. Gold can be included under the umbrella of a larger asset class known as commodities. Think of commodities as items used to make or produce other items – such as gold is used to produce jewelry, circuitry and coinage, while timber is used to make lumber and paper, while coal is used to make electricity and disappoint not-so-good kids on Christmas morning (sorry, couldn’t resist). Getting back to gold, the reason an investor may want to consider it as part of their portfolio is because gold is correlated differently from the stock market. Simply put; its pricing moves differently relative to the stock market. This does not mean I’m recommending investors buy gold. Here’s why. Imagine a lump of gold sitting on your kitchen table. […]
When you own certain kinds of assets and you sell them, you may incur a capital gain or loss that is applicable to your income tax preparation. If the original purchase price plus applicable expenses associated with the asset (known as the basis) is less than the proceeds that you receive from the sale of the asset, you have incurred a capital gain. On the other hand, if the basis of your asset is greater than the proceeds from the sale, you have incurred a capital loss. Capital gains are taxable to you, using a separate tax rate – and capital losses can be deducted from your capital gains for the year. Excess capital losses (above your capital gains for the year) can be used to reduce your income by up to $3,000 per year, carried forward until used up (or for your lifetime). The IRS recently produced their Tax […]