Category: Education

Mutual Funds Guide: What Are They?

A mutual fund is an investment vehicle that is made up of money contributed by many people for the purpose of investing in stocks, bonds, real estate or other kinds of investment vehicles including money market instruments.

Mutual funds are operated by money managers who make the actual investment decisions and who attempt to provide capital gains and income to the investors.

One of the main advantages of mutual funds is that they give small investors access to professionally managed, diversified portfolios of equities, bonds and other securities, which would be quite difficult (if not impossible) to create with a small amount of capital.

When a mutual fund sells a security like a stock or bond or collects income such as a dividend or interest payment these are passed along to the shareholders of the fund.

Passive vs. Active Mutual Funds

A passive mutual fund invests in a portfolio that mirrors the component of a market index. For example, an S&P 500 index fund is invested in the 500 stocks of Standard & Poor’s 500 Index. There is no attempt made to try to determine which stocks are expected to do well and which are not.

Actively managed funds are managed by an individual manager, co-managers, or a team of managers. The mangers try to buy stocks that they think will outperform the market.

The costs associated with passive investing are lower than the costs of active management. Active managers attempt to justify their higher costs by doing better in either up or down markets.

Cost Structure

Sales Charges

Some funds (load funds) sold by brokers, insurance agents or investment advisors have a front-end sales charge which is paid by the investor and passed along to the seller for his services. The charge is deducted from the amount being invested.

Other mutual funds (no load funds) are offered directly to the investing public by fund companies, or they are offered to investors by financial intermediaries who have a compensation arrangement (hourly, flat fee or a percentage of assets) with the purchaser. In this case, a sales charge is not involved, and the investor fully invests his or her available money into funds sponsored by a no-load fund company.

There are several other arrangement by which load mutual fund companies compensate sales people that are less obvious than front end sales charges in a variety of fund share classes – A, B and C. Many fund families offer special no-load share classes (F-1, F-2) for fee-based advisors who want to use their funds but do not want their clients to pay a sales charge. Before anyone invests in a mutual fund it is important that the investor understands how the broker, salesperson or investment advisor is compensated.

Expense Ratio

A mutual fund’s expense ratio is the amount of money that the fund charges for running the fund. It is usually shown as a percentage of the fund assets. All mutual funds charge investors a fee for their services. In general, passively managed index funds have a lower expense ratio than actively managed funds and bond funds have a lower expense ratio than stock funds.

Redemption Fee

Many mutual funds are charging a fee if the investor withdraws his money from a fund within a certain specified time of making an investment. This is designed to discourage market timing which can complicate the process of managing a fund.

Popular Mutual Funds

There are more mutual funds that there are stocks on the NY stock exchange. To make sense of the variety here are some of the most common fund types.

• Money market funds. These are funds that invest in very short term, liquid securities that offer a safe place to put cash. They offer a very low rate of return but try to maintain a net asset value of $1 per share.

• Bond funds invest primarily in fixed income securities. These could be government bonds, corporate bonds, municipal bonds, convertible bonds or mortgage backed securities.

• Stock funds (equity funds) invest primarily in stocks. They are subdivided into many categories according the size of the companies they invest in (large cap, small cap), the investment style (growth, value) and geography (US, Foreign).

• Balanced funds combine the features of stock and bond funds.

• Specialty funds may invest in certain industries (technology, drugs), countries (Britain, Korea) or real estate (REITs).

Well balanced portfolios frequently include funds from many of these categories in proportions appropriate to the risk tolerance of the investor.

Traditional Funds vs. ETFs

When people think about traditional mutual funds they typically think about funds known as “open ended funds.” They are the most commons funds. Shares of the fund are bought or sold though the fund company. There are no limits to the number of shares that can be issued and shares prices are determined once a day, after the market closes. At that point the total value of the assets in the mutual fund are determined and divided by the number of shares. This is the “net asset value” (NAV) and everyone who buys a share on that day pays the same price and everyone who sells also gets the same price, not matter what time of the day the order to buy or sell has actually been entered.

“Exchange Traded Funds” (ETFs) are newer but have become popular because they are bought and sold like a stock and are traded on major exchanges. The price of the shares can fluctuate during the day and the price that an investor pays for the shares can be different from minute to minute, just like the price of a stock will fluctuate during the day. That means that an ETF can be bought in the morning and sold in the afternoon for a profit or a loss depending on the change in value. The market price of an ETF is kept near the NAV by large institutional investors who will detect any difference between the NAV and the actual share price and use “arbitrage” to make that difference go away.

Because ETFs are more flexible in terms of trading strategy, they have become very popular with many active investors and speculators. In addition, because many ETFs are “passive” funds they often have lower expense ratios than many traditional mutual funds.

There are a number of other issues that an investor should be aware of with ETFs such as liquidity, commissions to trade, the bid-asked spread, and the viability of any specific ETF.

Final Thoughts on Mutual Funds

That wraps up our guide on mutual funds, what they mean, the most popular types of mutual funds, and traditional funds vs ETFs.  As always, consult your investment advisor for more information. You can also contact us through our contact page.

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Golden Piggy Bank

6 Charitable Tax Moves to Consider Before Year-End

The recently passed Tax Cuts and Jobs Act is the most extensive and far-reaching change to the tax code in more than thirty years.  In addition to altering the existing tax brackets, the standard deduction has also been nearly doubled, which means that going forward taxpayers will need to provide more itemizable deductions in order to exceed the standard deduction.  If you plan to give to charity before year-end, here are six planning moves to consider.

1. Donate Highly Appreciated Stocks or Mutual Funds.

The stock market has been on a terrific run, and you may have highly appreciated stocks or mutual funds that you are holding on to because you do not want to pay capital gains taxes.  By donating appreciated investments, you avoid paying the capital gains tax and can receive a deduction for the fair market value of the investments.

If you are considering gifting mutual funds, do so before they declare their year-end dividends and capital gains and you will save on taxes by avoiding that income as well.  While a deduction for appreciated securities is now limited to 30% of your Adjusted Gross Income (AGI), you can still carry the unused portion to future tax years.  When making a gift of appreciated securities, you should notify the charity that you are doing so in order for them to know who to send the record of receipt to (so that you can have that on hand when filing your taxes).

2. Combine Giving from Multiple Years Into One Year

Because the standard deduction has now been nearly doubled, consider lumping several years’ worth of contributions into one year to occasionally exceed the standard deduction. The strategy here would be to “lump” our charitable giving in one calendar year so that our itemized deductions exceed the standard deduction, and then simply claim the standard deduction in the following year(s).  The following graphic attempts to illustrate what this might look like for an individual taxpayer:

3. Use a Community Foundation or a Donor Advised Fund

If you want to create a legacy, are unsure of where to contribute right now, or want to consider “lump” giving, use a Community Foundation or Donor Advised Fund (DAF) to max out your contributions. A DAF is a unique type of account that is maintained an operated by a qualifying charitable organization, including most Community Foundations.  Once you create a DAF and contribute to it, your contribution qualifies for a charitable deduction on your tax return.

However, even though you can deduct the entire amount in the year that you make the contribution, you can make distributions from the DAF in future years to the charities of your choice.  In other words, you aren’t required to distribute all the DAF’s funds in the year that you make your contribution to it.  So, you could “lump” several years’ worth of charitable giving into your DAF and then make annual distributions to your favorite charities over the course of the next several years until your next “lump” contribution.

Additionally, the money in your DAF can be invested, creating the potential for even greater giving in the future via the power of compounding interest.

4. Create a Charitable Lead or Remainder Trust

If you are considering an even larger donation, or are interested in asset-protection, you may want to consider creating either a charitable lead or remainder trust. With a charitable remainder trust, you get a deduction for your gift now; generate an income stream for yourself for a determined period of time; and at the expiration of that term, the remainder of the donated assets is distributed to your favorite charity or charities.  A charitable lead trust is essentially the inverse of the remainder trust: you get a deduction for your gift now; generate an income stream for one or more charities of your choice for a determined period of time; and at the expiration of that term, you or your chosen beneficiaries receive the remaining principle.  The deduction you receive is based on an interest rate, and the low current rates makes the contribution value high.

5. Donate Unused Belongings

Donate your extra property, clothes, and household items to charity. Make time to clean out your closets, spare bedroom and garage, and donate those items to one of the many charitable organizations in our area.  CHKD, Salvation Army, Purple Heart, ForKids, Hope House are just a few organizations that will take old clothes, appliances, household items and furniture.  Some of them will even come to you to pick up items.  Make sure to ask the charity for a receipt and keep a thorough list of what you donated.  You can use garage sale or thrift store prices to assign fair market values to the donated items, or you can use online programs (such as itsdeductible.com) to figure out values.

6. Qualified Charitable Distributions (QCD’s)

If you are over age 70 ½, regardless of whether you itemize or not, make a qualified charitable distribution (QCD). We discussed this charitable donation method in detail in an earlier post, which can be found here.  Essentially a QCD allows you to donate all or a portion of your IRA Required Minimum Distribution to a qualifying charity.  The donated amount is not included in your taxable income and also helps to lower your income for certain “floors” like social security benefit taxation and Medicare Part B and Part D premiums.  QCDs are very tax-efficient ways to make charitable donations.

 

Disclaimer:  This material has been prepared for general information purposes only, and is not intended to provide, and should not be relied on for, personal tax, legal, investment, financial planning or accounting advice.  You should consult your own tax, legal, investment, financial planning and accounting advisors before engaging in any transaction.

Positive Change

2 Great Ways to Save on Taxes By Giving to Charity

With year-end tax planning looming in the next few months, we are bringing you two ideas for donating to charity that could save you additional money at tax time.

Donate Appreciated Stocks or Mutual Funds

The first idea is to donate appreciated stocks or mutual funds from your taxable accounts.  Donations of highly appreciated securities actually receive double tax savings.  First you get to deduct the full market value of the donation, up to 30% of your adjusted gross income, which can help to reduce your taxable income.  Second, the donation of securities also allows you to avoid paying the state and federal capital gains taxes that you would have owed if you had sold the stock.

Qualified Charitable Distribution

The second idea is something called a “Qualified Charitable Distribution.”  A few years ago, Congress passed a law that allows those who are over 70 ½ years old to give up to $100,000 to charity directly from your Individual Retirement Account (IRA).  You may use these qualified charitable distributions (QCDs) to satisfy all or part of your annual required minimum distribution (RMD).  Those who give to charity using this method get special tax treatment of their gift.

Typically, taking money out of your IRA is a taxable event – the withdrawal adds to your taxable income and inflates your adjusted gross income (AGI).  However, QCDs do not count as taxable income and therefore have no effect on your AGI.  This is significant because your AGI determines a number of things, including Medicare premium costs, the net investment income Medicare surtax, the taxability of Social Security income, itemized deduction phase-outs, and exemption phase-outs, to name a few.

So making a qualified charitable distribution allows you to satisfy all or part of your RMD without increasing your taxable income or your adjusted gross income.

What are the rules?

  • You must be over 70 ½ on the date of distribution.
  • QCDs are limited to $100,000 per person per year.
  • Only distributions from a Traditional IRA, Rollover IRA or Inherited IRA (where the beneficiary is over 70 ½) are eligible. You may not make QCDs from SEP or SIMPLE IRAs, nor from any type of employer retirement plan; those types of accounts must be rolled over into a Rollover IRA before they may qualify.
  • Your QCD must go to an organization designated by the IRS as a “qualified charity.” This list includes all 501(c)(3) public charity organizations, but explicitly excludes donor-advised funds, private foundations and other grant-making organizations, as well as “split-interest” charitable trusts (such as charitable lead trusts or charitable remainder trusts).
  • The QCD must be made directly to the charity. This is non-negotiable.  The distribution will not qualify if the check is made out to you, or if the money is first transferred into a non-IRA account of yours before it goes to the qualifying charity.  The IRS does not provide a way to correct mistakes.  Most trustees and custodians already have forms and procedures in place to help you make these transfers; make sure you are specific with them about your intent, and that they know how to handle your request.  (Checks should be made out directly in the charity’s name and mailed to the charity’s address.)
  • Ensure that no tax is withheld from your QCD to the charity (no withholding is necessary since this is a non-taxable distribution).
  • Make sure to alert the charity that you are making a QCD to them, as some custodians may not put any information on the check or wire transfer that would personally identify you.
  • Make sure you get a confirmation letter from the charity acknowledging your gift and stating that you received no goods or services in exchange for it.
  • To report a QCD on your Form 1040 tax return, you generally include the full amount of the charitable distribution on the line for total IRA distributions (15a). On the line for the taxable amount (15b), enter zero if the full amount was a QCD (or calculate the taxable amount if your QCD was less than your total required minimum distribution) and write “QCD” in the blank space next to the line.

With either of these charitable donation and tax-saving strategies, it’s always a best practice to let the organization that you’re making the gift.  This way they will know who to send the record of receipt to, so that you will have documentation to hold on to for your tax returns.

As we’ve mentioned before, we are not accountants and therefore suggest that you consult with your accountant to see if either of these ideas would make sense for your particular situation.

DIY Banner

The Risks of Do-It-Yourself Retirement Plans

A report recently published by the Federal Reserve Bank on the economic well-being of U.S. households discusses what people have saved for retirement versus what they will actually need, commonly known as the “retirement gap.”  The survey found that only 47 percent of DIY investors were comfortable with handling their own 401(k)s, IRAs or other outside retirement accounts.

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Financial Planning is the New Employee Benefit

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Some of the most progressive companies are introducing a new employee benefit: company-paid financial guidance.

Concerned about their employees’ retirement funds, and acknowledging the increasing scarcity of skilled employees, companies are looking for a benefit that is relatively inexpensive while making a big difference in employee satisfaction.

Financial Stress Is A Distraction

Financial insecurity troubles most people, from the entry-level employee to the highly compensated professional. Half of U.S. households are at risk of being unable to maintain their standard of living in retirement, according to one study. For most people, financial stress is a distraction from work and leads to lower productivity.

Money is the single largest source of stress for employees, ahead of work, relationships or health.
Employers are concerned about the impact employees’ financial problems are creating problems at work. Here’s what employers say they are most concerned about:
• Lack of retirement readiness 16%
• Paying down debt 15%
• Lack of emergency savings 13%
• Other 3%

Without professional guidance, most people take a seat-of-the pants approach. But that leaves them and their families wondering how they will survive the decades that they will spend after leaving the work force.

Many companies offer a retirement program, like a 401k, but are ill-equipped to do more than provide a menu of investment choices. To fill the information gap, more companies are offering financial-wellness programs. Others are considering such a move.

A program offered by Korving & Co. is a series of programs, provided by a CFP® (Certified Financial Planner™) professional. These are designed to educate participants about debt, investing, and retirement income planning.

Providing employees with professional education about these issues, on company time, in a relaxed setting is an economical way for companies to help their employees reduce stress. It also creates a great deal of good will and loyalty on the part of employees.

Call 757-638-5490 or use our contact page for additional questions or to get started today!

Can You Answer These Basic Money Questions?

The NY Post published an article Most Americans can’t answer these 4 basic money questions.   They questioned “Millennials” and “Boomers” to see who were most knowledgeable about investing.
Here are the questions – see how well you do.

  1. Which of the following statements describes the main function of the stock market?
    A) The stock market brings people who want to buy stocks together with people who want to sell stocks.
    B) The stock market helps predict stock earnings
    C) The stock market results in an increase in the price of stocks
    D) None of the above
    E) Not sure
  2. If you had $100 in a savings account and the interest rate was 2 percent per year, after 5 years, how much do you think you would have in the account if you left the money to grow?
    A) Exactly $102
    B) Less than $102
    C) More than $102
    D) Not sure
  3. If the interest rate on your savings account was 1 percent per year and inflation was 2 percent per year, after 1 year, how much would you be able to buy with the money in this account?
    A) More than today
    B) Exactly the same as today
    C) Less than today
    D) Not sure
  4. Which provides a safer return, buying a single company’s stock or a mutual fund?
    A) Single company’s stock
    B) Mutual fund
    C) Not sure
    D) Not sure

The correct answers are

  1. A
  2. C
  3. C
  4. B

If you had trouble getting the right answers you could benefit from the guidance of a good RIA (Registered Investment Advisor).

Mutual Fund Shares and Why They’re Important

Mutual fund share classes are little understood by the investing public, but they are important because they determine how much the investor pays in fees.

Fund classes are identified by an alphabetical letter that follows a mutual fund’s name in most newspapers.

Mutual fund “A” share classes typically have a “front-end load,” a sales charge payable when you buy the fund. This fee is used to pay the brokerage firm and part of it goes to the broker who sells the fund.

The amount of the load depends on the kind of fund – bond funds generally have lower loads than stock funds – and the amount of money invested. The more money that’s invested, the lower the fee. Known as “break points,” they refer to points at which front-end charges go down. For example, the front-end load for the Growth Fund of America class A shares is 5.75% on investments up to $25,000. But if you invest $1 million dollars or more the front-end load is 0%.

Mutual fund “B” shares typically have a “back end load” payable when you redeem the shares. These decline over a period of years (usually 6 to 8 years) until they finally disappear.

Both “A” and “B” shares usually have an “12b-1” marketing fee, generally 0.25%, charged annually.

Class “C” shares have no front-end load, a small back end load, usually 1%, that goes away after 1 year. However, they have higher 12b-1 fees, typically 1%.

There are other share classes such as I, Y, F-1, F-1, F-2. In fact, some funds have as many as 18 share classes. They are all the same fund; the only difference is the fee charged to the investor.

Many fund families offer “institutional” share classes that are only available to certain investors. Institutional shares are purchased by businesses who are in the investing business such as banks, pension funds, insurance companies and registered investment advisors (RIAs) who buy them as agents for their clients. This is one of the benefits of working with an independent RIA who has access to lower cost funds, load waived funds and no-load funds that are often not offered by the major Wall Street firms.

Contact us for more information.

Should I roll over my 401(k) from my previous employer?

Question from young investor to Investopedia:

I am currently 21 years old and a senior in college. I started working at a job back in December of 2016 and opened up a 401(k) with the company. I did this so I could begin saving for future expenses. This job was only meant to be temporary. Within the next month, I will be starting my new career at a different company. Should I roll over my 401(k)? Are there any other options other than this?

My answer:

There are three things you can do with an orphan 401(k).

  1. Leave it where it is.
  2. Transfer it to you new employer’s 401(k)
  3. Roll it into a Rollover IRA.

I prefer option #3 because it gives you several orders of magnitude more investment options.

The problem with #1 is that you may simply forget about it.  In addition, you may find that the account is small enough that your old employer may terminate your account and send you a check, triggering several kinds of taxes and penalties.

Option #2 is better than #1 but it still locks you into the investment options offered by your employer, many of which are poor.

You mentioned that you started your 401(k) to “save for future expenses.”  That’s not the purpose of a 401(k).  Its role, like an IRA, is to save for retirement.  I realize that a 21-year-old starting his first real job is not focused on retirement, but that’s a mistake.  The biggest advantage that you have is time.  If you give time the ability to work for you, you can overcome lots of investment mistakes and end up much richer than someone who starts later in life, even if they save more money.

What Makes Women’s Planning Needs Different?

While both men and women face challenges when it comes to planning for retirement, women often face greater obstacles.

Women, on average, live longer than men.  However, women’s average earnings are lower than men, according to a recent article in “Investment News,”  in part because of time taken off to raise children.  What this means is that on average, women tend to receive 42% less retirement income from Social Security and savings than men.

The combination of longer lives and lower expected retirement income means that women have a greater need for creative financial advice and planning.  The problem is finding the right advisor, one who understands the special needs and challenges women face.

A majority of women who participated in a recent study said they prefer a financial advisor who coordinates services with their other service professionals, such as accountants and attorneys.  They want explanations and guidance on employee benefits and social security claiming strategies.  They want advisors who take time to educate them on their options and why certain ones make more sense.  Yet many advisors do not offer these services.

Men tend to focus on investment returns and talk about beating an index.  Women tend to focus more on quality of life issues and experiences, on children and grandchildren, on meeting their goals without taking undue risk.

If your financial advisor doesn’t understand you and what’s important to you, it’s time you look for someone who does.

Old Woman Exercising With Dumbbells

Three Ways to Stay Financially Healthy Well into Your 90s

According to government statistics, the average 65-year-old American is reasonably expected to live another 19 years.  However, that’s just an average.  The Social Security administration estimates that about 25% of those 65-year-olds will live past their 90th birthday.  We were reminded of these statistics when we recently received the unfortunate notice that a long-time client had passed away.  He and his wife were both in their 90s and living independently.

People often guesstimate their own life expectancy based on the age that their parents passed.  Genetics obviously has a bearing on longevity.  Modern medicine has also become a big factor in how long we can expect to live.  Diseases that were considered fatal 50 years ago are treatable or curable today.  For many people facing retirement and the end of a paycheck, the thought of someday running out of money is their biggest fear.  And there is no question that living longer increases the risk to your financial well-being.

The elderly typically incur costs that the young do not.  As we get older, visits to the doctor and the hospital become more frequent.  There’s also the onset of dementia or Alzheimer’s that so many suffer from.  As our bodies and minds age, we may not be able to continue living independently and may have to move to a long-term care facility.

We should face these issues squarely, especially as we approach retirement.  Too many people refuse to face these possibilities and instead hope that things will work out.  As the saying goes, “hope is not a plan.”

Here is a three step plan to help you remain financially healthy even if you live to be 100:

  1. Create a formal retirement plan. Most Financial Planners will prepare a comprehensive retirement plan for you for a modest fee.  We recommend that you choose to work with an independent Registered Investment Advisor who is also a Certified Financial Planner™ (CFP®).  Registered Investment Advisors are fiduciaries who are legally bound to put your interests ahead of their own and work solely for their clients, not a large Wall Street firm. CFP® practitioners have had to pass a strenuous series of examinations to obtain their credentials and must complete continuing education courses in order to maintain them.
  2. Save. Save as much of your income as possible, creating a retirement nest egg.  Some accounts may be tax-exempt (Roth IRA) or tax-deferred (regular IRA, 401k, etc.), but you should also try to save and invest in taxable accounts once you have reached the annual savings limit in your tax-advantaged accounts.
  3. Invest wisely. This means diversifying your investments to take advantage of the superior long term returns of stocks as well as the lower risk provided by bonds.  While it’s possible to do this on your own, most people don’t have the education, training or discipline to create, monitor and periodically adjust an investment strategy that has the appropriate risk profile to last a lifetime.  We suggest finding a fee-only independent Registered Investment Advisor to manage your investments.  They will, for a modest fee, create and manage a diversified portfolio of stocks, bonds, mutual funds and/or exchange traded funds designed to meet your objectives.

The idea of saving for a long retirement should not be avoided or feared.  With the proper planning and preparation, retirement gives us the opportunity to enjoy the things that we never had time for while we were working, and can indeed be your Golden Years.

What Is The Difference Between A Pension Plan And A 401(k)?

Both plans are designed to provide income for retirement.  There are some very important differences.

A 401(k) is a type of retirement plan known as a “defined contribution plans.”  That means that you know how much you are saving but not how much it is worth when you are ready to retire.  That depends on your ability to invest your savings wisely.  The benefit is that your savings grow tax deferred.  Many employers match your contribution with a contribution of their own, encouraging you to participate.

A pension plan is known as a “defined benefit plan.”  That means that you are guaranteed a certain amount of income by the plan when you retire.  The responsibility of funding the plan and investing the plan assets are your employer’s.

Because your employer is liable for anything that goes wrong with the pension they have promised their employees, many employers have discontinued pension plans and replace them with 401(k) type plans.  This shift the responsibility for your retirement income from the company to you.

If you have a 401(k) for your retirement and are unsure about the best investment options available to you, get the advice of a financial planner who is experienced in this field.

For more information, contact us.

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