Exchange Traded Funds and Mutual Funds: Two Investment Vehicles – How to decide?

First, let’s start with the basic definition of an Exchange Traded Fund (ETF). “An Exchange Traded Fund is a marketable security that tracks an index, a commodity, bonds, or a basket of assets like an index fund, ” according to Investopedia.com.

Second, let’s look at the basic definition of a mutual fund. “A mutual fund is a company that pools money from many investors and invests the money in securities such as stocks, bonds, and short-term debt,” according to Investor.gov.

A comparison of ETF’s and mutual funds.

ETF’s and mutual funds share more similarities than differences. Both investment vehicles offer diversification. By pooling money together from many investors, ETF’s and mutual funds have greater buying power, enabling them to buy many different securities in large quantities. They gather money from many investors and use it to acquire stocks, bonds, and other assets. Another similarity is transparency. Compared with actively managed funds, most index ETF’s and index mutual funds are extremely transparent. Also, in the United States, all mutual funds, as well as the vast majority of ETF’s, are subject to strict regulation under the Investment Company Act of 1940 and associated Securities and Exchange Commission rules and regulations.

“The tax efficiency of an investment product generally has more to do with how it is managed—index versus active—than whether the product is structured as an ETF or mutual fund,” according to Vanguard.com.

This brings our discussion to that of the differences between ETF’s and mutual funds. The first major difference between ETF’s and mutual funds is trading flexibility. Unlike mutual funds, an ETF trades like common stocks on a stock exchange. This means that ETF’s experience price changes throughout the day as they are bought and sold. On the other hand, an order to buy or sell a mutual fund is executed at the end-of-day price, known as the net asset value. This means that mutual funds experience price changes only at the end of the trading day.

Next, the most prevalent difference between ETF’s and mutual funds is the way costs are charged to the investor. While ETF’s and mutual funds share some common costs, ETF’s have unique costs not associated with mutual funds. The main difference is the Bid and Ask spread. “While trading ETF’s on the secondary market, there is a difference between the price a dealer is willing to pay for the ETF (the “bid”) and the somewhat higher price the dealer will accept to sell the ETF (the “ask”), ” according to advisors.vanguard.com.

“The amount by which the ask price exceeds the bid price is called the “bid-ask spread.” An ETF usually trades as closely to its net asset values, or NAV, as possible. The market provides a lot of liquidity to the system in order to ensure this. However, for some low-volume ETFs, bid-ask spreads may exist and widen. Trading ETFs with large spreads may decrease potential returns since they affect the ETF purchase and sales prices. Investors may also purchase an ETF above its NAV, which essentially means paying a premium for the basket of securities,” according to a recent article on finance.yahoo.com.

In the end, ETF’s and mutual funds may be suitable alternatives to stocks and bonds. Investors need to consider all of the similarities and differences between the two in order to make an informed decision.

 

 

Making Sense of Mutual Fund Lingo

 

                      Making Sense of Mutual Fund Lingo

The jargon of investing may seem designed to confuse, but understanding a few of the terms can help you navigate your way more easily through the maze of financial information.

Measuring Performance              

The NAV -- or net asset value -- of a fund is the price to buy or sell one share of the fund. It is calculated on a regular basis by the fund company using the closing price of each security held in the fund. In some retirement plans, the actual unit value of shares may differ from the NAV.

Capital appreciation (or depreciation) is the difference between the price (NAV) of your shares when you bought them and the current price. While maximizing capital appreciation is the objective of growth funds, money market mutual funds strive to maintain a constant NAV of $1, so they offer no opportunity for capital appreciation.

Yield is the interest earned or income generated by the fund as a percentage of its NAV. Although some equity funds may pay interest, yield is most relevant as a measurement for bond and money market funds that have income as their primary objective.

Total return is calculated as a percentage change in the fund's NAV, plus any other income. It represents the gain -- or loss -- of any fund over time, assuming that all distributions by the fund have been reinvested. It may be useful to compare your fund's total return to an appropriate benchmark index as well as to other mutual funds with similar investment objectives.

Fund Distributions

When the securities in a fund pay interest or dividends, the fund passes them along to its shareholders. In the same way, any capital gains -- or profit -- realized by the sale of a security in the fund are distributed as well. Through your retirement plan, these dividend and capital gains distributions are automatically reinvested in the fund to foster long-term growth. You receive additional shares (or fraction of a share) rather than cash.

Taking the time to decipher the language of investing can be an important step toward taking control of your financial future.

Because of the possibility of human or mechanical error by Watters Financial Services (WFS) or its sources, guarantees the accuracy, adequacy, completeness or availability of any information and is not responsible for any errors or omissions or for the results obtained from the use of such information. In no event shall WFS be liable for any indirect, special or consequential damages in connection with the use of the content.

Interest Rates: What's the Connection to Your Portfolio?

              Interest Rates: What's the Connection to Your Portfolio?

 

When it comes to interest rates, one thing's for certain: What goes down will eventually come up.

The federal funds rate -- the rate on which short-term interest rates are based -- has varied significantly over time. It's a cycle of ups and downs that can affect your personal finances -- your credit card rates, for example. But what about less familiar effects, like those that interest rate changes can have on your investments? Understanding the relationship between bonds, stocks, and interest rates could help you better cope with inevitable changes in our economy and your portfolio.

Bond Market Mechanics

Interest rates often fall in a weak economy and rise as it strengthens. As the economy gathers steam, companies experience higher costs (wages and materials) and they usually borrow money to grow. That's where bond yields and prices enter the equation.

What is yield? It's a measure of a bond's return based on the price the investor paid for it and the interest the bond will pay. Falling interest rates usually result in declining yields. As rates spiral downward, businesses and governments "call" or redeem the existing bonds they've issued that carry higher interest rates, replacing them with new, lower-yielding bonds. Why? To save money. (A homeowner refinances his or her home at a lower mortgage rate for the same reason.)

Interest rate changes affect bond prices in the opposite way. Declining interest rates usually result in rising bond prices and vice versa -- think of it as a seesaw relationship. What causes this change? When interest rates rise, investors flock to new bonds because of their higher yields. Therefore, owners of existing bonds reduce prices in an attempt to attract buyers.

Investors who hold on to bonds until maturity aren't concerned with this seesaw relationship. But bond fund investors may see its effects over time.

Evaluating Equities

Interest rate changes can also affect stocks. For instance, in the short term, the stock market often declines in the midst of rising interest rates because companies must pay more to borrow money for expansion and capital improvements. Increasing rates often impact small companies more than large, well-established firms. That's because they usually have less cash, shorter track records, and other limited resources that put them at higher risk. On the other hand, a drop in interest rates may result in higher stock prices if corporate profits increase.

So why do some stocks increase in value even as interest rates rise, or vice versa? Because industry or company-specific factors -- such as the development of a new product -- can impact stock prices more than rate changes.

Taking Action

Is there anything an investor can do when faced with interest rate uncertainty? You bet. Although you can't change interest rates, you can assemble a portfolio that can potentially ride out the inevitable ups and downs. Risk reduction begins with diversifying your investments in as many ways as possible.

Let's start with equities. Consider investing across different sectors, because no one knows which of today's industries will fuel the next expansion. Also be aware that some sectors -- such as energy -- are more economically sensitive than others, which can lead to increased volatility. Additionally, consider stocks or stock mutual funds that invest in different market caps and have different investing styles, such as both value and growth investing.

On to fixed-income investments. Do your bond funds hold bonds of different maturities -- short- and long-term -- and types, such as government and corporate? Different types of bonds react in their own way to interest rate changes. Long-term bonds, for instance, are more sensitive to rate changes than short-term bonds.

Interest rates will always fluctuate in response to economic conditions. Rather than trying to guess the Federal Reserve's next move, why not concentrate on creating a portfolio that will serve your needs well -- no matter which way rates go?

Because of the possibility of human or mechanical error by Watters Financial Services (WFS) or its sources, guarantees the accuracy, adequacy, completeness or availability of any information and is not responsible for any errors or omissions or for the results obtained from the use of such information. In no event shall WFS be liable for any indirect, special or consequential damages in connection with the use of the content.

 

Ways to Protect Yourself from Identity Theft

Ways to Protect Yourself from Identity Theft

 

Over the past year, I have had a number of clients have Identity theft incidents. Clients have had collection agencies contact them about  outstanding  balances on cards they never took out or cash withdrawn from their bank accounts. A few even had their tax files and  refunds taken from them.

 This is a time for all of us to be more proactive in protecting ourselves. Here are a few important safeguards I recommend.

1. Get your free credit report every year from the 3 major ratings agencies (Equifax, TransUnion, and Experian).  We can request this for you. Contact my office if you would like us to do so.

 2. Update your email password and avoid AOL, Yahoo and Hotmail. According to the FBI, 70% of the e-mail hacking incidents have happened to people who had AOL e-mail accounts.

 3. On a Quarterly basis, change your passwords for all sensitive financial sites. It is far less work to change passwords every three months than to go through an identity theft incident.

 4. Do not use the same password for all websites. Use a firewall and have up to date virus software on your computers.

 5. Do not give out your credit card to anyone to use. Write "see ID" on back of your credit cards. This way they have to verify your identity in order to use the card.

6. Make sure your home wifi network uses a password. Update it periodically.

7. Backup your data daily. Consider using an external hard drive and/or offsite data storage.

Identity Theft is becoming a big issue and it requires all of us to be more careful and proactive. Hopefully, the recommendations I have suggested will help you avoid being a victim of Identity Theft.

Are your beneficiary assignments undermining your Will?

Are your beneficiary assignments undermining your Will?

 I find that clients neglect to review their beneficiary assignments and often a deceased parent (or a former wife) is named. While this may be your intent, poorly thought out beneficiary assignments can screw up allot of good planning.

Many people create a well-thought-out estate plan which includes the BIG 4 estate planning documents (Last Will and Testament, Durable Power of Attorney, Health Care Proxy and Living Will) and then they ignore their beneficiary assignments. Why is this a problem? Because the beneficiary assignment may for example:

·       Give money to a minor directly when the Will paid intended to pay the money out to a trust

·       Give the money to a disabled family member when the Will would have paid it out to a Special Needs Trust

·       Give the money to someone who is not the intended beneficiary

Increasingly, investors have the opportunity to name beneficiaries directly on a wide range of financial accounts, including employer-sponsored retirement savings plans, IRAs, brokerage and bank accounts, insurance policies, U.S. savings bonds, mutual funds, and individual stocks and bonds.

The best feature of beneficiary assignments is that they can quickly send out the money to the right party. Also, a spousal beneficiary of an IRA account may continue to enjoy tax deferral for years to come.  A non spousal beneficiary may continue to enjoy tax deferral for years to come but is required to take out a modest amount each year as a Required Minimum Distribution.

The "fatal flaw" of beneficiary-designated assets is that because they are not considered probate assets, they pass "under the radar screen" and trump the directions spelled out in a will. This all too often leads to unintended consequences -- individuals who you no longer wish to inherit property do, some individuals receive more than you intended, some receive less, and ultimately, there may not be enough money available to fund the bequests you laid out in your will.

Not naming a Beneficiary is a NO NO!

Not naming beneficiaries or failing to update forms if a beneficiary dies can create a mess. For example, if the beneficiary of an IRA is a spouse and he or she predeceases the account holder and no contingent (second in line) beneficiary(ies) are named, when the account holder dies, the IRA typically would pass to the estate instead of the children directly as the account holder likely would have preferred. This not only would generate a tax bill for the children, it would also prevent them from stretching IRA distributions out over their lifetime.

Planning Priorities

Given these very real consequences, it is important to work with an attorney to ensure coordination between your beneficiary-designated assets and the disposition of property as it is spelled out in your will.

Also, I recommend reviewing my client’s beneficiary designations on a regular basis -- at least two years -- and/or when certain life events occur, such as the birth of a child, the death of a loved one, a divorce or a marriage, and update them, as necessary, in accordance with your wishes.

Investing Mistakes to Avoid

Investing Mistakes to Avoid

·        Sell when the market is down

There is an old saying about investing, "If you look at the floor and it is red from rose peddles, it is time to sell. If you look at the floor and it is red from blood- it is time to buy". Many inexperienced investors tend to sell when the market drops, locking in losses. However, someone is always willing to buy those shares at a discount.

·        Buy high, sell low

According to JP Morgan Asset Management,  in the 20 year period ending in 2013, the average investor made a return of 2.5%. Yet, in the same time period, the S&P 500 Index earned  9.2 and the Aggregate Bond Index earned 5.7%. Humans are social creatures and tend to follow the herd. Thus, people who have not been investing in stocks before tend to go in at the top of the market only to see their investments go down in value.  Then they sell at the bottom only to repeat this cycle over and over again.

·        Stay on the sidelines until the market calms down

Often, people wait until it feels "safe" to go back in. It will only feel "safe" to go back in after the market has appreciated again and the biggest gains have already happened. It is not easy to time the markets and few do it well consistently.

·        Watching for stock market tips on cable TV and radio shows

Few tips on stocks have any lasting value because the stock market immediately updates any news that impacts a company's stock price the moment it is reported. Lessons learned from the field of Behavioral Finance point to the importance of acknowledging all of our investing biases and avoiding the pitfalls caused by them.  Cable TV and radio shows make you more susceptible to panic selling and investor remorse. Every pundit considers himself or herself  an expert. Their advice is typically conflicting. Remember that no one can predict the future and you should only be in the market if you are a long term investor.

·        My best friend says ____ is a sure thing

Here again.... No one can predict the future. Avoid investing tips. They usually lead to investment losses.

    ·        Ignore fees

You should always know the cost associated with an investment. Is there an upfront sales charge, surrender charge or 12b1 charge? What are the management fees or advisory fees?

·        Use an investment model

If you plan to invest in a model that has 60% invested in stocks, you need to periodically rebalance the portfolio back to this model or you could wind up with a much more aggressive portfolio as your stock funds appreciate in a rising market. Periodically rebalancing also allows you to take profits and to buy assets when they are cheaper.

·        People are often swayed by the latest and the greatest

There are always going to be "darlings" in the stock market. Over the years I have seen many favored stocks fall out of favor and lose value. You often make more money investing in a company when it has stumbled and is beginning to recover. Investors are often overly optimistic  in rising markets and overly pessimistic when the market goes down.

·        Doing a " Hail Mary Pass" to an overvalued stock

If only you had invested all your money in __________10 years ago, you'd be a millionaire today. You can fill in the blanks (Apple, Google, Amazon.com etc.). Betting a large portion of your assets one investment in a hope and a prayer is a dangerous gamble and it is not investing, it is gambling.

Having been at this a long time, I remember all of the companies that have fallen on hard times. In fact, in 2011 alone, there were 86 companies that filed for bankruptcy according to BankruptsyData.Com. Some of the largest bankruptcies of all time include General Motors, Chrysler, Enron, CIT, WorldCom, Washington Mutual, and Lehman Brothers. All were "Darlings" at one time.

There is no silver bullet when it comes to investing. Everyone’s goals, time horizon and financial circumstances are different. If you would like to discuss this further just give me a call at 201-843-0044.

How can I Provide for Cash Flow in Retirement?

                          How can I Provide for Cash Flow in Retirement?

 

Clients often ask me this question. Less and less Americans still have a pension check coming in. Thus, they need to focus on Social Security benefits and finding prudent ways to tap their assets in retirement. I have detailed below some of the different ways that people handle their day to day cash flow in retirement:

 

Bucket Approach- Many people choose to set aside a “bucket” of money in a savings account that has enough money in it to cover one to two years worth of expenses.  Then, you withdraw from that fund a monthly stipend in order to cover your cash flow expenses.  Under this approach, people have traditionally taken out a withdrawal equal to 4% of their portfolio value. The assumption is that the portfolio over time would return them that much or more.  Given that we are in a fragile economic time, it would be more prudent to take a lower distribution. Perhaps a 3% distribution might be more appropriate (at least until the economy gets better).

 

Payout the Interest and Dividends- You can have all of your funds payout the dividends and/or interest that they earn. The advantage of this is that you do not need to dip into the principal. However, it does not allow you to diversify your portfolio because all of your money needs to be invested in income producing investments.

 

Immediate Annuity- Immediate Annuities offer a way to create a private pension plan similar to what you would receive if you had a pension from an employer. The advantage this offers is that it gives you a stable monthly check for a certain time period or for lifetime. The disadvantages are that it is an irrevocable decision and does not help you plan for inflation.

 

Variable Annuity with Guaranteed Payout- I mentioned that many people have chosen to use variable annuities with a guaranteed principal rider. I am not a big fan of this option because of the high overall fees you would pay each year.

 

Combination Plan- A third approach would be a combination of the first two approaches. Annuities or CDs would be used for the beginning part of your retirement, followed by dipping into the principal of your bond allocation and eventually dipping into your stock allocation later in retirement. Many people have chosen to not go for the annuity approach because it's an irrevocable decision.  However, it does help with the volatility.

 

There is no perfect answer. Everyone’s goals, time horizon and financial circumstances are different. If you would like to discuss this further just give me a call at 201-843-0044.