Category: Education

Three benefits of a Separately Managed Account

A Separately Managed Account (SMA) is an investment account managed by a professional investment manager that can be used as an alternative to a mutual fund.  They provide diversification and professional management.  But they differ from mutual funds in that an SMA investor owns individual stocks instead shares in a fund.

Here are some of the benefits of SMAs.

  • Customization: Investors in SMAs can usually exclude certain stocks from their portfolio.  They may have an aversion to certain stocks, such as tobacco or alcohol.  Or they may have legal restrictions on owning certain stocks.  SMAs allow some customization that’s not available in mutual funds.
  • Taxes: Investors in SMAs can take advantage of tax loss harvesting at the end of the year by instructing a manager to sell certain stocks to reduce capital gains taxes. In addition, an SMA has another advantage over mutual funds in that each stock in an SMA is purchased separately.  Mutual fund investors are liable for “embedded capital gains” even if the shares were purchased before the investor bought the fund shares.
  • Transparency: You know exactly what you own and can see whenever a change is made in your account.  Mutual fund investors don’t see the individual securities they own or what changes are being made by the portfolio manager.

These are features that are attractive to certain investors.  However, they are not for everyone.  Most SMAs require minimum investments of $100,000.  That means that they are only appropriate for high net worth investors who will typically use several SMA managers for purposes of diversification.  In addition, the fees associated with SMAs are often higher than fees for mutual funds.

For more information, please contact us.

Types of mutual funds: 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.

As always, consult your investment advisor.

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Types of mutual funds: popular types

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.

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Types of mutual funds: 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.

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Types of mutual funds: passive vs. active

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.

What are mutual funds?

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.

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How does your financial advisor get paid?

No one expects their professional service provider to give their services away for free. Doctors don’t, lawyers don’t, CPAs don’t nor do financial advisors. However, in the financial services industry often what you actually pay is not clear.

Cerulli Associates surveyed investors and found that most investors wanted to understand how their advisors were getting paid. They wanted “transparency.”

“Helping investors understand the full extent of an advisor’s potential revenue streams has been a persistent challenge for both advice providers and advisors, and has become even more complicated with the ongoing evolution of integrated wealth management conglomerates,” Smith explains.
“The financial industry was built around the premise that investors understand the fees they pay and sign documents affirming their awareness,” Smith continues. “Cerulli’s research indicates that investors who truly comprehend the entirety of their costs are more the exception than the rule. The overall expenses of pooled investment vehicles, including management fees and other embedded fees such as 12b-1s, are essentially nonexistent to many investors-if they do not see a line item deduction from their accounts, they do not recognize a transfer of wealth from themselves to their advisor or provider.”

Even that last sentence can add to the confusion if you aren’t very familiar with the terminology of the investment industry, with terms like “pooled investment vehicles,” “embedded fees,” and “12b-1s.” To better understand how (and from where) financial advisors are paid, here’s a brief list:

“Commissions:” when you buy of sell a stock, bond, or fund, you pay the broker a commission. This also applies to insurance products such as life insurance and annuities. Broker commission formulas for stocks are often based upon the stock’s price and trading volume. Commissions for insurance products and annuities are generally a fixed percentage of the size of the policy being sold, but they can be as high as 10{030251e622a83165372097b752b1e1477acc3e16319689a4bdeb1497eb0fac93}-15{030251e622a83165372097b752b1e1477acc3e16319689a4bdeb1497eb0fac93} for some products. Commissions for bonds are discussed below.

“Mark-up” or “mark-down:” this typically applies to the purchase or sale of bonds, and is the difference between the market price of a bond and what an investment firm offers an investor. In other words, it is the difference between what the bond is actually worth and what you can buy or sell it for. The mark-up or mark-down formula is based upon the number of bonds being bought or sold, their price and their bond rating.

“Load:” a sales charge that is assessed when purchasing a mutual fund. Some load fees are charged up front (referred to as a “front end load,” often seen with A share class mutual funds bought or sold via a broker), when sold (referred to as a “back-end load,” often seen with B share class mutual funds bought or sold via a broker), or as long as the fund is held (referred to as a “level load,” often seen with C share class mutual funds bought or sold via a broker). The load you pay is passed along to the broker. Front end loads are usually between 3{030251e622a83165372097b752b1e1477acc3e16319689a4bdeb1497eb0fac93} – 8{030251e622a83165372097b752b1e1477acc3e16319689a4bdeb1497eb0fac93}, with 5{030251e622a83165372097b752b1e1477acc3e16319689a4bdeb1497eb0fac93} being fairly typical. Back end loads are the most confusing, and (thankfully) are being eliminated by many fund companies. In very general terms (for the sake of this article), they don’t charge you a front end load, but if you want to sell the fund within 5 or 6 years of purchasing the fund, they will hit you with a fee (called a “deferred sales charge”) of between 1{030251e622a83165372097b752b1e1477acc3e16319689a4bdeb1497eb0fac93} – 5{030251e622a83165372097b752b1e1477acc3e16319689a4bdeb1497eb0fac93}, depending on how soon you sell it (with the higher fee coming the earlier you sell it). Oh, and on top of that, they typically also charge you a 12b-1 fee (discussed next) of 1{030251e622a83165372097b752b1e1477acc3e16319689a4bdeb1497eb0fac93}. Level loads typically don’t charge a front end load or a back end load, but they do maintain a 1{030251e622a83165372097b752b1e1477acc3e16319689a4bdeb1497eb0fac93} 12b-1 fee for as long as you own the fund.

“12b-1 fee:” an annual fee, usually 0.25{030251e622a83165372097b752b1e1477acc3e16319689a4bdeb1497eb0fac93}, paid by the mutual fund to the broker to help the fund market its products. It’s often referred to a “trailer.” As mentioned above, for B and C share class mutual funds, this fee is typically a much higher 1{030251e622a83165372097b752b1e1477acc3e16319689a4bdeb1497eb0fac93}.

“Management fee:” this is the fee that an investment manager charges for creating and managing a portfolio of securities.

A “Fee Only” investment advisor’s only compensation is the management fee. This eliminates the conflict of interest inherent in the other types of compensation such as commissions, loads and trailers. It provides an incentive for the Fee Only advisor to shop for the lowest cost investment products for his clients.

This Simple Tip Could Make a Big Difference in Your Retirement Account

You can make a 2016 contribution to your IRA or Roth IRA as early as January 1, 2016 and as late as April 15, 2017.  It would seem obvious that the sooner you contribute to your retirement account and invest the money, the more money you’ll have by the time you retire.
However, according to research from Vanguard, people are more than twice as likely to fund their IRAs at the last minute as opposed to the first opportunity!  When Vanguard looked back at the IRA contributions of its clients from 2007 to 2012, only 10% of the contributions were made at the optimum point in January, and over 20% were made at the very last month possible.
IRA Contribution Month
To demonstrate the type of real, monetary impact this can have on someone’s retirement savings, take the following hypothetical example.  On January 1 each year, “Early Bird” contributes $5,500, while “Last Minute” makes their $5,500 contribution on April 1 of the following year.  Assume that each investor does this for 30 years and earns 4% annually, after inflation.  Early Bird ends up with $15,500 more than Last Minute.  Put another way, Last Minute has incurred a $15,500 “procrastination penalty” by waiting to make his contribution until the last possible month.
Procrastination Penalty
At the beginning of every year, make fully funding your IRA contributions a habit. (And if you’re the type of person who works better when things are automated, look into setting up an automatic savings & investment plan from your paycheck or bank account to your IRA to save on a monthly or per-paycheck basis.)

How Do I Start Saving and Making My Money Grow?

We contribute to several forums that provide advice to novice investors. One of the most popular questions goes like this:

• I’m 28 and will start a new job soon. I have accumulated $10,000 in a savings account and will be able to save an additional $1000/month when I start my new job. I need advice on how to start an investment plan.

It’s a good question. The person asking it usually has some money in the bank and has enough income to add to his or her savings. But because interest rates are so low the savings are not growing. There are three common reasons for not starting an investment program.
Not knowing where to start. The mechanics of opening an investment account can be complicated.
Fear of making a mistake. People work hard for their money and don’t want to lose if because they made some rookie error.
Not knowing who to trust. Who will provide good, honest advice for you?
Here’s how to begin an investment plan that works for people of all ages.

  • Find a Registered Investment Advisor (RIA) who is a fiduciary: who put their clients’ interests ahead of their own and provide unbiased investment guidance. They will help you through the process.
  • Find someone with experience. You don’t want to deal with someone who’s learning with your money.
  • Find someone who is accredited. A CFP™ (Certified Financial Planner) is trained to give advice on all aspects of financial planning.
  • Find someone who does not charge commissions. It eliminates conflicts of interest.
  • Find someone who has a good reputation in the community.

At Korving & Company, we’ve been helping people just like you make better decisions about their money and their lives for thirty years.

8 Things Every Parent Should Know About 529 College Savings Plans

We often are asked by parents (or grandparents) of young children about college savings plans.  529 college savings plans offer tax-advantaged ways to save for the various costs of higher education.  While these plans have a lot of name recognition, many people still have questions about the details.  Since it is the first day of school for most kids here in Virginia, it seemed an appropriate time for us to share these eight things you should know about 529 college savings plans:

  1. Earnings on 529s are tax-free, as are withdrawals, as long as you use the money for qualified educational expenses.  Qualified expenses include tuition and fees, books, room and board, supplies, and even computer-related expenses.
  2. There are no income restrictions to open and contribute to a 529 account.  Even high-income earners can open and fund college savings plans.
  3. The money in a 529 account can be used towards in-state or out-of-state schools, both public and private.
  4. The contribution amounts are very high: you can contribute up to $350,000 per beneficiary into a 529 account.  (Keep in mind that you will need to get a little deeper into gift tax rules if you intend to contribute more than $14,000 to a 529 account in any one calendar year.  You can do it, but you should know the rules first.)
  5. The beneficiary is portable.  If your child decides they want to do something else instead of going to college, you can name someone else the beneficiary (sibling, first cousin, grandparent, aunt, uncle, or yourself).  You do not need to decide on a new beneficiary the moment that your child decides not to go to college.  For instance, you could hold onto it and eventually name your grandchildren the beneficiaries.
  6. Charitable family members can contribute to an existing 529 account that you own or set up their own 529 and name your child as beneficiary.
  7. In Virginia, putting money into a 529 plan has the added bonus of providing a state tax deduction for contributions up to $4,000.  Thirty-three other states also offer state tax deductions for contributing to a 529.
  8. If your child gets a scholarship, you will not lose the money.  You can use the plan to cover expenses that the scholarship does not, such as books, room and board, or other supplies.  You can keep the plan open in case your child goes on to graduate school.  You can change the beneficiary and name another college-bound relative.  A final option would be to simply cash out the plan.  Doing so would subject you to income tax and a 10{030251e622a83165372097b752b1e1477acc3e16319689a4bdeb1497eb0fac93} penalty on the earnings.  If you were feeling generous, you could name your child the owner and let them cash it out at their (presumably) lower tax rate.

If you have questions, or are interested in finding out how to start a 529 plan, please let us know!

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